Will I run out of money? How does cash flow modelling work?
When clients come to us for wealth planning advice, they almost always ask ‘Will I run out of money?’ It’s an understandable concern and, though we may wish it otherwise, no-one knows exactly how long they’re going to live for or what financial challenges they may face.
Cash flow modelling can help to alleviate concerns. It’s the process of assessing your current and forecasted wealth, along with your income and expenditure, using assumed rates of growth, inflation and interest rates, to build a picture of your finances now and in the future.
If you have accumulated wealth, cash flow modelling can help you manage your position and make sensible decisions over the years. However, it’s arguably even more beneficial if you have longer-term personal or business objectives, as you can see how much you need to save and the returns you need to meet those defined objectives. You can also use it for care fees planning.
How does cash flow modelling work, in practice?
We start by asking you about your current financial situation, including outgoings and income, and establish an overview of your assets, including your property. Once we have a clear picture of your existing and future financial commitments and your goals, we can create your lifetime cash flow modelling plan to help you achieve them. That process will:
- produce a clear and detailed summary of your financial arrangements
- work towards achieving and maintaining financial independence
- ensure you’ve made adequate provision for the financial consequences of death or disablement
- plan to minimise your tax liabilities
- deliver an analysis of your personal income and expenditure
- estimate your future cash flow
- develop an investment strategy for your capital and surplus income
- become aware of inheritance tax issues that could affect your beneficiaries.
How does cash flow modelling work? We demonstrate this with a typical retirement case study
Cathy and Chris are both in their 50s, with reasonable savings and two children who remain financially dependent. They’ve reached a point where they wish to take stock of their finances and think about the future. Their goal is to retire in their early sixties and sail around the world.
To help them achieve this, we created a financial plan to assess whether their current savings would be enough to provide the £3,000 per month they want to live on in retirement. At the same time they also need to repay their mortgage, cover their children’s university fees and help them onto the property ladder. Cathy and Chris are also, naturally, worried about care costs in old age.
The cash flow plan breaks down Chris and Cathy’s finances year by year over their projected lifetimes. It includes all their savings and investments, pensions, spending in retirement and the financial support they’d like to offer their children.
This snapshot illustrates the value of their savings when Chris reaches his target retirement age of 60. They will have accumulated nearly £1.2m in savings to help them realise their dream of sailing around the world. However, they also need to repay the mortgage and start drawing their target income. Luckily, an old endowment policy will mature at this time.
At the end of their first year in retirement (2023), allowing for 3% growth, they will have around £905,000 available to meet their ongoing commitments.
The cash flow plan continues to detail each year’s projected financial situation, including when Chris is aged 65 and they withdraw funds from his pension to help their children buy their first home. At 85, they downsize to a bungalow, releasing £750,000 to help rebuild their asset base for later life needs.
You can see below that if Chris and Cathy live to 95 and 93 respectively and need care in later years, their children still inherit around £1m, which should be free from inheritance tax.
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IMPORTANT: Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.