5 min read 22 May 20
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Cashflow modelling is a common part of many advisers’ process these days. While this has inevitably led to some clear similarities in how cashflow planning is used with clients, there are also interesting differences in approach, as we recently found out in our series of adviser case studies, completed for us by lang cat on retirement planning. What’s really notable too is that cashflow modelling acts as a jumping off point for addressing some other big questions and challenges around retirement planning, which we’ll also explore.
The first thing that some of our adviser case studies told us is that cashflow modelling is one of the key differences between how they work with retirement clients compared to those who are in accumulation.
“In accumulation we wouldn’t really do much cashflow modelling, but as people start to approach retirement they almost fall into the Centralised Retirement Proposition (CRP), so we start doing cashflow then, as well as stochastic modelling for income withdrawals.”
“I would say that cashflow planning is the main difference – it’s an essential part of our CRP and not so with our CIP.”
However, another adviser said they used cashflow planning with every client, regardless of whether they were in accumulation or decumulation. This same adviser also raised an interesting point about why cashflow modelling – and financial advice in general - could become increasingly important for people earlier in life.
“More and more people are coming to retirement with a pot of money rather than with DB (defined benefit) pensions. Hopefully those clients will engage with advice earlier. We’re seeing advisers being more professional in working with this. The younger generation of advisers accept that cashflow planning is the way it’s done.”
Perhaps unsurprisingly, one of the biggest similarities in how advisers use cashflow modelling is to help determine a client’s capacity for loss using ‘what if’ scenarios or a ‘disaster plan’.
“We do a ‘disaster plan’ on the approach to retirement – two or three years out – and in retirement. If there was a crash in the first year of a big pension pot withdrawal or in the year a client retires, you need to ask what difference it would make to them.”
“For example, someone who is receiving a maintenance from a divorce which may stop if their ex-partner dies. We run these ‘what if’ scenarios through our cashflow modelling.”
The interesting thing here is the many different risks and vulnerabilities that retirement clients can experience, as highlighted by the divorce maintenance example in particular, and the complexity this brings with it.
One of our case studies talked about using cashflow modelling to help establish the sustainability of a client’s desired level of income, particularly during the early years of retirement:
“One of our guidelines is ideally not to withdraw more than 4% from a portfolio because that’s a common criterion. While most of our clients would be taking around or about that level, clients can exceed that in the early years particularly if they can accept an increasing level of risk.
“It’s important for the client and adviser to know if this is pushing them into the red at all – we would use cashflow modelling for this.”
When it comes to managing client expectations, some other advisers also pointed to potential issues around expected returns in the not too distant future
“Clients now have to expect lower annual returns in the next 10 years versus the previous 20 years. We need to manage people’s expectations around this – cashflow planning can in some ways help with things like a sustainable withdrawal rate, but the problem with this is that it principally works with long-term expected average returns, so it might not be quite as good at accounting for problems like sequencing.”
“One of the challenges which we definitely see is that clients’ lifestyle expenditure ends up being greater than they anticipated, and this becomes even more of a challenge when combined with the fact that expectations of future returns from investments are now more conservative.”
Yet another factor which can make it challenging to map out a retirement client’s financial needs over the longer-term is assessing whether to factor in any potential long-term care costs. This is an increasing consideration for many advisers and their clients, which turns the typical assumption that someone’s expenditure will decrease as they get older, almost completely on its head.
This question about long-term care is just one example of how cashflow modelling opens up some of the other big issues surrounding retirement planning. We’ll look at what our adviser case studies had to say around long-term care in more detail in another of our upcoming articles in this series, as well as some of the issues around client vulnerability that have been raised here too.
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As the retirement income market grows, it’s becoming an increasing focus for many advisers. We wanted to get a deeper understanding of the different ‘philosophies’ advisers have for retirement planning. In other words, the broad spectrum of needs, priorities, risks and options for clients and how you deal with all that. So, with a little help from our friends at the lang cat, we talked directly to a number of advisers about what they feel are the most important aspects of retirement planning.
It was fascinating to hear about the various approaches – the similarities and differences – and we thank all our advisers for sharing their time and insight.
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The information contained in this page is for professional Financial Adviser use only. If you are a private investor, please visit the Private Investor section or contact your Financial Adviser for more information.