RETIREMENT PLANNING
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Budgeting: The (Often) Missing Step in Retirement Planning
By Aaron Rubin, JD, CPA, CFP®
We’ve all seen the retirement commercial. The one with the “green line” that is supposed to represent if a person has enough to retire. Those who follow the line will have enough to retire, while their friend (without a line to follow) ponders their own retirement prospects, life choices, and spiritual significance. Unsurprisingly, there is little detail provided.
Nuance doesn’t play well during a 30-second Super Bowl commercial.
While most consumers think of asset growth as being represented by the green line, as advisors we know the truth is that budgeting has more to do with retirement success than anything else. This is especially true as the final day of work draws nearer. A properly constructed budget can inform pre-retirees of their reality, and let them adjust expectations both up and down, if necessary.
Be Nonjudgmental
Everything we do as advisors has a behavioral element to it. When new to the industry, I was pulled aside by a superior who told me we had lost prospects based on the tone of my voice and sentence structure when I had asked this discovery question: Why did you put that in your portfolio? I didn’t have malice or ridicule in my heart but it taught me I needed to tread more lightly when discussing people’s financial decisions.
Advisors must take a sympathetic or at least unbiased approach in helping clients review spending. Even if not intentional, an offhand comment could easily be misinterpreted as disapproval. Shaming is not an effective way to change behavior. Resentful clients aren’t clients for long, and with a bad taste in their mouths are more likely to abandon the planning process entirely, leading to worse outcomes.
When looking at budgeting, the best place to start is with current spending levels. Mostly, people simply don’t budget and have no concept of what their monthly or annual outflows are. Some may feel like they have a sense of their burn rate but oftentimes they underestimate. Asset accumulation can cover up a lot of budgeting blemishes, and while accounts are growing, a budget SWAG seems reasonable to most.
However, the drawdown phase of life calls for careful consideration. Unless a pre-retiree knows their current rate of expenditure, they’ll have no idea what needs to change. With that in mind, a person or couple will have well-established (though undocumented) spending habits just prior to retiring. Likely empty-nesters, they have had five to 15 years of dramatically improved cash flow while working. That said, those who retire substantially early or late may require additional analysis.
Advisors must have budgeting tools in place to help their clients sort through monthly expenses, including those “one-offs” that have a habit of occurring several times per year. Most financial planning tools have built-in semi-customizable budgeting apps to get clients started but there are specialty websites and software that may have more appeal or user-friendly features. The most important thing is that the client is willing to do the work.
For clients who need assistance with organization, or with complex cash flows involving multiple business entities or real estate, bookkeeping can be brought in to do the bulk of the heavy lifting. Though more expensive, getting professional help can give a more accurate, unbiased picture of the current patterns of spending, and may be worth the investment.
Since it is likely the first time many have seen their spending laid out bare, they may not realize the magnitude of their decisions; this is often accompanied by a sense of embarrassment. Any criticism can be perceived as disapproval of lifestyle and personal values. For instance, a large DoorDash outlay could mean they value their time at home and don’t want to spend it cooking.
Run the Numbers
After a review of current spending, the client and advisor should come up with a second version of the budget. This version should decrease the spending that is likely to stop or slow post-retirement (e.g., gas, clothing, business expenses). Conversely, additional recurring expense items need to be increased (e.g., travel, leisure activities, etc.).
With a baseline budget built, using modeling is helpful as a sanity check. Stochastic/Monte Carlo models are helpful in figuring out if as a concept a budget will work given the various assumptions planners make during the process. To make the process more meaningful, stress testing the portfolio can provide the client reassurance or help them realize there is more work to be done. Models can often be pressed by decreasing assumed return, increasing expenses, or changing inflation assumptions.
It’s important to think through scenarios that are likely yet unforeseeable. Included in this would be items such as major medical expenses, house expenses, or long-term care costs, just to name a few. Most apps will let planners run side-by-side comparisons between scenarios, which provides clients with helpful insights into their assumptions and sets the groundwork for dealing with reality.
Plan and Reevaluate Over Time
Retirement cash flow planning is not a one-and-done exercise. As Mike Tyson once said, “Everyone has a plan until they get punched in the face.” Boxing and financial planning are not so different in that respect. Aside from the expected unexpected events, there are going to be the black swans that encroach on even the sturdiest of plans. Sometimes, good things happen too. Unexpected inheritances, stronger than predicted stock markets, or unplanned downsizing can make the picture rosier than predicted. Regular updates are a must.
Each plan and subsequent update is a snapshot in time, and a new picture emerges often enough that plans should be re-evaluated at least once a year to make sure they still make sense for the retiree. Retirement cash flow planning is fundamentally different from pre-retirement planning. With no way to make up for loss of assets, the plan should be reviewed to make sure assumptions are still valid, the client’s goals haven’t shifted, and the client still feels comfortable.
In the end, budgeting for retirement isn’t rocket science—it’s harder. Unlike rocketry, as planners, we have to deal with emotion and behavioral biases along with the numbers. With the right pre-work and post-plan adjustments, clients can have the confidence they need to successfully retire with peace of mind. Just make sure your client’s “green line” is composed of a reasonable budget with elements of conservatism.
Aaron Rubin, JD, CPA, CFP®, is a partner at WRP Wealth Management in San Jose, Calif. His practice focuses on executives at pre-IPO companies with stock option compensation. Aaron published his book Financial Adulting in 2019.
image credit: Adobe Stock Images
