Income Planning: A Cash Needs Approach

By Katy McDonald, CFP® | May 04, 2024 |

Your financial needs vary over a lifetime—from accumulation when building your nest egg to decumulation when drawing down your savings for daily expenses in retirement. Income planning focuses on identifying your cash requirements at different stages of life. This includes short-term and long-term cash needs, such as daily expenses, emergency funds, significant purchases, and retirement income.  

Its key benefit is providing a structured framework for distributing income based on your immediate and future financial requirements.  

By identifying your cash needs, you can ensure that you have sufficient funds available when necessary, thereby reducing financial stress and providing peace of mind. 

Developing a cash flow budget

Establishing a cash flow budget is a crucial step in effective income planning. By understanding your income sources and expenses, you can gain control over your finances and make informed decisions about managing your cash flow. 

Here are three steps to develop a cash flow budget: 

  1. Identify your income sources: Begin by enumerating all your income sources, such as salaries, bonuses, rental income, dividends, and any other regular income streams. It’s crucial to clearly understand the total amount of money coming in each month. 
  2. Ascertain your expenses: Then, categorize and list all your expenses. This includes fixed expenses like rent or mortgage payments, utilities, insurance and variable expenses like groceries, entertainment, and travel. Ensure you are thorough and include all expenses, both essential and discretionary. 
  3. Analyze your cash flow: After identifying your income sources and expenses, analyze your cash flow by subtracting your expenses from your income. This will provide you with a clear picture of how much money you have available each month. 

Effectively managing cash flow is vital for achieving financial goals and maintaining financial stability. Here are some strategies to help you manage your cash flow: 

  • Create an emergency fund: Allocate a portion of your monthly income to establish an emergency fund. This will provide a safety net for unexpected expenses and help you avoid relying on credit. 
  • Track your expenses: Keep a record to identify areas where you can cut back or make adjustments. Numerous budgeting apps and tools are available that can assist you in tracking your expenses easily. 
  • Regularly review and adjust your budget: As your financial situation evolves, it’s crucial to review and adjust your budget accordingly. Regularly evaluate your income sources, expenses, and cash flow to ensure you’re on track to meet your financial goals. Oftentimes, we see clients who have one idea of their expenses, but when we look more closely at their spending, they discover they are undershooting this amount. It is beneficial to utilize a budgeting app or to track your monthly Credit Card payments to ensure what you think you spend is what you actually spend. Where we can add value by running an analysis with your desired spending amount and desired retirement age to see if additional savings need to occur during your working years. Together we can then work through how to reduce your current spend to obtain this goal.  

By developing a cash flow budget and implementing effective cash flow management strategies, you can gain greater control over your finances and work towards achieving your long-term financial objectives. 

Strategies for retirement income planning

One thing we often see clients having anxiety around is where the monthly income stream they are accustomed to will come from. What we often do is implement a strategy known as Portfolio Paycheck. This entails a monthly distribution from the client’s portfolio to their bank account to replicate the paycheck they previously received. We work with our clients to determine an amount that is both sustainable for their plan and also feels sustainable to them and their lifestyle goals.  

We often utilize a lens that focuses on balancing cash flow while also prioritizing retirement goals. While covering your day-to-day expenses is crucial, allocating funds towards your long-term goals, such as travel, hobbies, or leaving a legacy, is equally important. We recently had a client who wanted to discuss the maximum spend amount they can do each year while leaving a million to their heirs. We were able to find a number that would allow them to live retirement as desired while also being able to support their goal of leaving assets for their heirs.  

Maximizing cash reserves in retirement

Having a well-planned cash reserve strategy is crucial during retirement. It provides a safety net and ensures you have the necessary funds to cover unexpected expenses or emergencies without relying on investments that may be subject to market fluctuations.  

Determining the ideal cash reserve amount depends on your circumstances and risk tolerance. Factors such as your monthly expenses, income sources, and potential healthcare costs should be considered. To err on the side of caution, we often run our analyses with high-end healthcare costs to ensure plans can sustain increased premiums, etc. We also like to cross-check the portfolio in case of a long-term care need. This allows clients to see how their current spending will withstand expenses most do not plan for.  

When investing your cash reserves, there are various options to consider. These may include high-yield savings accounts, money market funds, or short-term certificates of deposit (CDs). Each option has advantages and considerations, such as liquidity, interest rates, and potential fees. 

Analyzing retirement income needs to ensure your future

When planning for retirement, calculate your retirement income needs, understand the wage replacement ratio, and decide whether to use a top-down or bottom-up approach. 

Calculating retirement income needs is the first step in determining how much money you will require during your retirement years. Consider various factors such as your current lifestyle, anticipated expenses, and desired standard of living. You can develop a comprehensive plan that aligns with your retirement goals by thoroughly evaluating your cash needs. 

When approaching income planning, you can choose between a top-down or bottom-up method. The top-down approach involves starting with your desired retirement lifestyle and working backward to determine the income required to support it. On the other hand, the bottom-up approach involves assessing your current income sources, such as Social Security and pensions, and then identifying any income gaps. 

Collaborating with a financial advisor is essential for effective income planning. At Brighton Jones, our experienced advisors work closely with you to develop a personalized income plan that aligns with your goals and values. We take the time to understand your unique circumstances, risk tolerance, and desired lifestyle to create a comprehensive income plan that supports your long-term financial objectives. 

Let’s talk

Reach out to learn more about how our comprehensive approach to wealth management can help you achieve your goals.