Planning for Cash Flows in Retirement

By Lori Pajunen Luck, CPA/PFS

Editor: Theodore J. Sarenski, CPA/PFS, CFP, AEP

Americans are living longer, and projected life expectancies are increasing. For many, it is scary to think that they may need to prepare themselves for being "unemployed" for at least 20 or 30 years when they retire from their jobs at age 65. Running out of money in retirement is clients' No. 1 financial concern, followed by worries about health care costs and asset withdrawal decisions, according to the AICPA Personal Financial Planning Trend Survey of CPA financial planners who were polled about their clients' concerns during the first quarter of 2015 (the survey is available at

Those approaching retirement and current retirees are looking for someone to turn to who can help them make well-thought-out decisions about cash flow planning. CPA financial planners can help their clients predict how they may fare financially in their retirement years and also help them simulate the financial impact of different decisions, on paper, before committing to a particular course of action, by preparing retirement cash flow projections.

To prepare retirement cash flow projections, the CPA financial planner needs to actively integrate the client into the planning process. It starts with helping the client envision life as a retiree and for the planner to learn about the client's goals. Next, the planner gathers detailed financial information from the client about investment assets, expected retirement income, and current annual spending. Finally, after inputting the data into retirement planning software to calculate and project various scenarios, the planner can use his or her expertise to interpret the results and help clients to align their values and expectations with their available assets. This realistic snapshot of the future can assist clients with important decisions.

Envisioning Retirement

Conversations about retirement plans with the planner may be the first time the client has ever discussed these topics with anyone—or that a couple have ever discussed these topics together—and they can be sensitive topics. Often, couples need to sort out blended-family obligations. The planner must find out who is important to them and whom they need to take care of. Also, what is important to them? How do they currently manage their money and make financial decisions? What do they dream about doing when they retire? What are they afraid of? How is their health, and do they have longevity in their family? When do they want to retire? It is important that the planner encourage both spouses in a couple to speak and express their thoughts. Different personalities require different approaches.

Visualizing retirement is instrumental in helping clients have a purposeful retirement, that is, so they can retire to something, rather than just from something. Asking clients to imagine what a day of retired life might be like may help make it become more real. Sometimes that vision might include starting a second career, pursuing a hobby, or volunteering time and talents to favorite causes. Often one's life work, whether paid or unpaid, helps people thrive.

After the planner has learned about what is important to his or her client, he or she can begin gathering the quantitative information necessary to prepare retirement cash flow projections.

Simulating Retirement

A planner can prepare a cash flow projection to simulate retirement by considering how various assumptions and decisions may affect the client's retirement. It is also a document that the planner and the client can use to compare to actual results to track progress and see if the client is on course as he or she navigates pre-retirement and post-retirement decisions.

Data-Gathering Process

The planner needs to gather the most accurate, detailed information possible from his or her client, input those data into retirement planning software, and, ultimately, calculate relevant retirement cash flow projections. Throughout the process, the planner should educate the client about how the assumptions are used in the projection calculations and consider the client's feedback regarding those assumptions.

Assumptions used in the analysis that the client can directly control include the date of retirement and the amount of spending (and related saving). Spending is one of the largest factors affecting the success of the cash flow projection plan, so it is valuable to devote extra attention to the details now and in retirement. Since the client has control over these items, it can be helpful to show different cash flow scenarios, which vary the amount and timing of expenditures, to see how different decisions affect the plan's success.

Other assumptions that are integral to the projection include the rate of inflation, rate of investment return, income taxes, heath care costs, and life expectancy. At first glance, these assumptions may not seem to be under the client's control, but further discussion with the client is needed to make choices for the plan.

For example, a client's personal inflation rate is influenced by the components of cash outflows. If he or she is paying for a child's college education or has health care issues, a higher inflation rate may be applied to those particular costs than the core inflation rate used for costs such as housing. A client's investment rate of return is influenced by the client's percentage of investment assets allocated among stocks, bonds, and cash. While income tax rates are not under the individual's control, many decisions near or during retirement years have significant income tax consequences that affect the amount of assets available for retirement.

Finally, while the client cannot ultimately control his or her life expectancy, his or her current health, lifestyle, and genetics may influence how much is spent on health care and/or how long he or she may live. If the client does not have a specific illness, some planners assume clients will live to 100, to help them avoid outliving their retirement assets. Thus, it is important to have discussions with clients about every variable before finalizing the assumptions used in the analysis. Further along in the process, it may be valuable to present "what if" scenarios that show how changes in one or more of these assumptions can alter the overall plan.

Cash Inflows

Many important decisions must be made related to expected cash inflows. One important decision most clients face is when to begin receiving Social Security benefits. The planner can use estimated Social Security benefit information to model cash inflows over a client's lifetime demonstrating the impact of starting to receive benefits at a particular age for a single person or for each member of a couple. Clients may consider starting to receive benefits immediately at age 62, at full retirement age, or as late as age 70. A client may be concerned about the viability of the Social Security system itself, which may encourage him or her to consider taking benefits early. This is a good topic for discussion, but it probably should not be a factor in the decision.

If the client expects to live a long life, choosing to delay benefits until age 70 to increase monthly payments may increase the plan's probability of success over a longer retirement period. Income tax implications must be considered if the client takes withdrawals from retirement accounts for living costs during the period between retirement and the date he or she elects to start receiving Social Security benefits.

Some clients may be eligible for federal, state, or private pension plan benefits. Decisions will need to be made as to how those benefits are to be received, whether over single or joint life expectancies, as a sum certain, as a rollover to an IRA, etc. The retirement cash flow projection can help demonstrate how different amounts resulting from different options can affect the plan's success. The related income taxes and a client's longevity assumptions also have a significant effect on these choices.

The client may wish to start a new business or work part time in retirement. The plan can incorporate different target amounts to earn and demonstrate the impact on the plan.

Before retirement, some company executives have complex election decisions to make about the amount of compensation to defer into nonqualified deferred compensation plans and the number of years to receive cash payments from the plan once they retire. Others may have important decisions to make about the timing of retirement, if leaving employment could cause them to lose future benefits of stock options. Illustrating these cash flows, along with the related income tax effect, helps them understand the impact on their retirement nest egg and make informed decisions.

Cash Outflows

A client's current spending is very predictive of how he or she will spend in retirement. It is important to get detailed information about the client's current spending over at least a year. Some clients are very detailed-oriented, keep records in personal finance software, and can provide the planner precise records of their spending. But for some other clients, this may be overwhelming. The planner has to be creative to find ways to help his or her client accomplish this task. Possible solutions include helping the client hire a bookkeeper to track information or having the client start by listing monthly expenses and work with him or her to capture annual expenses. This is an important step, as more accurate data produce more ­reliable projections.

When the list of current annual expenses is complete, further line-by-line analysis is needed to determine which expenses will continue in retirement, which can change, or which should be deleted. Additional expenses may be incurred in retirement such as replacing cars, paying for family weddings, buying vacation homes, or incurring costs of adult children who move back home. A discussion about housing costs is very important. Where people live is part of their identity, and many people have a different vision of where they want to live and how they want to be cared for. Housing costs are usually not treated as an investment but as an ongoing ­living expense.

The planner should ask the client to categorize the costs by priority among core needs, wants, and wishes. Delineating the expenditures into these categories helps the planner understand which expenses could be reduced, if need be, further along in the process if it looks as if spending needs to be modified to achieve a successful plan.

Retirees commonly spend as much as they do in their working years, although the composition of the expenses may change. For example, they may spend less on clothing and commuting but more on health care and travel. Some planners discuss the retirement "smile" graph of expenses over retirement years when expenditures grow ­immediately after retirement when retirees are healthy and vigorous, decline some as they become less active, and then climb again nearer the end of their lives, as their overall health declines.

Health Costs

Health costs are a significant part of future cash outflows and require special attention. Health costs can be viewed in two parts: (1) annual, recurring health costs for a relatively healthy aging person and (2) long-term-care costs for an unknown major health event.

Annual, ongoing health costs should be estimated prospectively and account for the client's unique circumstances. These costs include Medicare premiums, supplemental insurance policy premiums, and out-of-pocket costs.

Planning for long-term-care costs is more difficult. It was estimated in 2014 that at age 65, there is a 70% chance seniors will need some type of long-term care during the remainder of their life. These are high enough odds that the planner should have a conversation about this with every client. Most planners are approaching this contingency by (1) planning for long-term-care insurance to cover all or some part of long-term-care needs and including long-term-care insurance premiums in the annual cash outflows, and/or (2) preparing for a hypothetical health event scenario in the retirement simulation. An example of a hypothetical health event may be to estimate the impact of three to five years of long-term-care costs that occur when the client (or both members of the couple) is in his or her 80s. The costs of care are based on current long-term-care costs in the clients' geographical area inflated for the future. The scenario is designed to stress-test the portfolio to see if it can withstand an expensive health care event.

Many planners inflate medical expenses at least 2% above the annual core rate of inflation. Some planners consider health costs part of annual cash outflows, and others recommend that the client set aside funds in a segregated investment account or target selling a vacation home dedicated to covering medical costs.

Withdrawal Considerations

A client needs to consider several issues before spending money from an investment portfolio, and it can be challenging not only to figure out how much a client may spend but also which account to spend from. Many studies have developed simplified strategies to calculate a safe amount to spend in retirement based on a percentage of the portfolio, subject to different parameters. However, retirement cash flow projections tailored to a particular client's situation and updated over time, provide customized cash flow information to help a client with his or her unique decisions.

Net Cash Reserves

It is helpful to have at least three years or more of net cash outflows (annual cash outflows minus annual cash inflows) in a cash reserve account. This cash provides immediate liquidity for current living expenses and emergency expenses, and gives the client time to weather down markets by providing enough cash to wait for a future market recovery.

Total Return Portfolio

Cash withdrawals may be funded from the total return of the portfolio by generating cash from asset sales and cash produced from interest and dividends. The retiree takes advantage of two components of the return of the portfolio: asset appreciation and yield. This method is efficient from a portfolio allocation standpoint as the client can use appreciation in particular asset classes to rebalance to keep the portfolio diversified and balanced within its target allocations. This method is also efficient from an income tax standpoint since long-term capital gain tax rates are used where possible. It is beneficial to steer clients away from focusing too much on current portfolio yield, where they may be tempted to pursue high-yield investments that are too risky for a typical retiree's asset allocation.

The income tax efficiency of the portfolio may be improved by choosing which investments should be included in taxable accounts versus tax-deferred or Roth accounts. Investments that tend to be more tax-efficient to include in taxable accounts include U.S. and foreign large company investments that produce qualified dividends, municipal bond investments that provide federal tax-free interest income, U.S. government bond investments that offer state tax-free interest income, and foreign investments that provide foreign tax credits. Less tax-efficient investments that should be allocated as much as possible to tax-deferred and Roth IRA accounts include real estate investment trusts (with no qualified dividends), emerging market mutual funds (more volatile so they may need to be rebalanced more frequently), commodities (28% tax rate gain exposure), small company mutual fund stocks (may have high capital gain distributions at year end), and corporate bond funds (interest income taxed at ordinary income tax rates).

Cash Flow Products

Some planners advocate investing a portion of the investment portfolio in an annuity for retirees who do not otherwise have adequate defined benefit pension plan cash inflows. The purpose of this approach is to have a dependable annual cash inflow stream that covers core living expenses and helps to protect the client from spending down the portfolio in early retirement years if there are poor investment returns.

The sequence of returns for a portfolio has a large impact on the success of the portfolio. If one has low returns or losses in the early retirement years, even with the same overall return over the term of the portfolio, the success rate is much lower than if higher returns are achieved early in retirement. One type of annuity product to consider is a single-premium immediate annuity. The internal fees are lower than for other types of annuities, and it has a lifetime guarantee. However, many types of annuity products are available, and the planner should research the pros and cons of each. Special consideration should be given to the viability of the insurance company, current interest rates related to the cost, and fees inherent in the product.

Impact of Income Taxes in Retirement

Many asset withdrawal decisions made by pre-retirees and retirees are affected by income taxes, and their CPA's tax training is critical in providing assistance in this area. Ideally, the planner should help the client target the appropriate income tax bracket. Managing the income tax brackets helps the client choose whether to draw funds from a taxable account, a tax-deferred account, or a Roth IRA account. For example, if the client has low taxable income years early in retirement with the expectation of higher taxable income in later years, he or she may consider a Roth IRA conversion. Pre-retirees and retirees need to make several key tax-related decisions during their 60s and early 70s. The planner should prepare income tax projections over at least 10 years and incorporate the results into the retirement cash flows to evaluate the best decisions for income tax purposes and for predicting cash withdrawals in the plan.


Modeling retirement cash flows is a dynamic tool for flexible retirement planning to help clients achieve their life goals. It is useful for comparing projections to actual results over time and holding clients accountable to commitments. Adjustments should be made to the plan along the way to guide the client to stay on course and promote peace of mind. Resources to help CPAs help their clients prepare for and live out retirement are available at   



Theodore Sarenski is president and CEO of Blue Ocean Strategic Capital LLC in Syracuse, N.Y. Lori Pajunen Luck is the president of CLS Financial Advisors Inc. in Portland, Ore. Mr. Sarenski is chairman of the AICPA PFP Executive Committee’s Elder Planning Task Force and is a member of the AICPA Advanced PFP Conference Committee and PFP Executive Committee Thought Leadership Task Force. For more information about this column, contact Ms. Luck at

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