How To Create A Financial Plan: A Definitive Guide to Financial Planning As You Approach Retirement

While you may be five or ten years away from retirement, it’s natural to wonder about how to create a financial plan. How do you plan to “pull the ripcord” on corporate life and ride off into the sunset? Truth is, you can slice a pie many different ways. Creating your very own financial plan is no different.

While this post is by no means the “only” way – it does offer a solid foundation to use if you’re approaching retirement. Use and adapt to your own situation as you see fit. As always, consult with your tax and legal professionals for any specifics you have questions on.

What is a Financial Plan?

A Visual Construct

It can be helpful to think of your financial plan as the old food pyramid we were taught in school. Start with a strong foundation, and the rest can fall into place.

A Visual Construct of a Financial Plan

Keep It Simple

“Simplicity is the ultimate sophistication.” Leonardo da Vinci

Before we get into the weeds on the technical aspects of compiling your financial world, keep in mind brevity is usually best.

All too often our industry prides itself on fancy charts, complex numbers, sophisticated investment strategies, and volumes upon volumes of paperwork. I’m not belittling those things – in all honesty I do think there’s merit in it. Any financial plan takes a good amount of work, analysis, and a number of calculations.

But given the choice, would you rather have an encyclopedia (remember those?) worth of documents put in front of you, or something a bit more concise? How much of that “inside baseball” do you really want to be privy to?

Step 1: Defining Goals – Focusing On What’s Important

Simply put: your goals should be the focal point of your financial plan. It’s the reason you work, the reason you save, and the reason you invest. To be clear, a goal isn’t necessarily tied to a specific number. Invariably I don’t think it should be financial at all. A goal should probably be more qualitative in nature. A few examples:

  • To be able to travel with my family throughout my retirement.
  • Spend more time with the grandkids.
  • Take two month long fishing trips a year.

Why is the rest somewhat unimportant?

For the same reason that you don’t buy a car based on how well calibrated the production line machines are. What you buy the end result in the showroom. You buy the end product that was designed after months of research and due diligence.

The end result in working with an advisor should be the same. Simple, easy to understand and easy to read.

All too often, rather than simplify, we complicate – and that’s the crux. Clients pay their advisors to help make things simple. If you’re that type of client, and you currently don’t understand what your advisor puts in front of you, demand clarity.

Before you get hit in the head with another sharpe ratio or alpha, ask them to boil it down. Rinse and repeat until it’s as clear as day. It’s your financial life in their hands, and it is their responsibility.

With clarity comes comfort, and that leads to peace of mind so you can go about doing the things you really enjoy doing (which should also be clear to both you and your advisor). You owe it to yourself. After all, you were confused before, and that was free.

Step 2A. Cash Flow and Emergency Savings

It’s all about cash flow. We’ve seen firsthand the ravaging effects that loss of employment and other business interruptions can have on families. The COVID crisis magnified this effect tenfold. The strategy here is to build yourself a moat. As a general rule of thumb:

  • Salaried Employees: 6 months of living expenses saved up
  • Business Owners: 12 months of living expenses saved up

Some folks might feel safe with 3 months of savings, others need more than 1 year (especially a good idea if you’re already retired). Adjust to your comfort level.

Creating A Quick Budget

If you’re having trouble compiling the suggested savings amounts, a thorough review of your budget can come in handy. Being that we live in a digital world, here are some quick tips to help you crack down the budget:

  1. Most of us have direct deposit. Log into the account that receives your deposit, and run a filter for all the deposits you’ve received from your employer over the last 12 months. Calculate your monthly average take home pay.
  2. A lot of folks charge everything on their credit cards these days (who doesn’t love reward points). Thankfully, most credit cards have a “Year End Summary.” Pull that summary for each of your cards and calculate that monthly average.
  3. Compare the total of your average credit card expense versus your average direct deposit and you’ll start seeing the big picture. Tack on the items that aren’t charged to your card (mortgage/rent, utilities, etc) and that picture starts to get really clear.

You don’t have to get granular to get an understanding of your finances.Once you understand what you’re actually taking home, you’ll start to see where you can “trim the fat.” Most of the “Year End Summaries” will even break down your spending into categories (free two day shipping can actually be really expensive).

Most important of all, don’t feel guilt or regret. Acknowledge that it’s in the past, identify one or two ways to reduce your expenses, and move forward. Revisit in six months and see if you’ve improved.

There are differing points of view on what else is covered in building your foundation. Some trains of thought insist that insurance is a primary need here, and they aren’t wrong (or right). It’s a matter of preference. My main position on this point is that without cash flow, you can’t fund insurance premiums. That being said, here’s a quick primer on the world of insurance.

A Quick Word on Debt

In my opinion, not all debt is bad. For example, a home mortgage (preferably the fixed rate kind) can be a wonderful thing. Building equity and having a place to call home and raise the family can be priceless.

The bad kind (again, in my humble opinion) is of the high variable sort. Think credit cards. As a hypothetical example, let’s say you have credit card debt that’s costing you 15% APR with Dumbo Financial. My take on the topic is as follows:

If your money isn’t earning you 15%, why are you paying Dumbo that much?

Don’t be a dumbo. The long and short of it is this: get rid of high interest variable debt asap.

Step 2B. Insurance

We could have hours-long debates on the merits of insurance. It’s likely that your employer offers you access to varying group insurance policies for a nominal amount. What’s not likely? Your ability to transfer the insurance coverage to your new employer.

What’s even more unlikely? That your responsibilities will cease to exist if you go on claim. Below are three of the more common types of insurance to consider within the scope of your financial plan:

Life Insurance

No scare tactics here, but knowledge is key. In most cases, having an employer policy for the amount of your outstanding liabilities may suffice. If it falls short? Consider additional coverage with a term policy (even if you leave your employer, you’re likely to find new employment that may also offer term insurance).

Because insurance premiums typically get more expensive as time goes on. It may be worthwhile calculating your outstanding debts, amounts needed to replace your income at home, and any future bequests you’d like to make.

If you think your situation calls for more permanent coverage, you may consider a whole life policy or a variation thereof.

Like term life insurance, whole life pays a benefit when you die. But unlike term life, it can build cash value as you pay your premiums.

These premiums get divided up—some of the money you pay goes to your death benefit, some to insurance company operating costs and profits, and some towards your policy’s cash value.

A key difference is that whole life insurance is relatively more expensive. Premiums are usually several times higher than term life premiums.

Disability Insurance

Your ability to earn income is your primary (financial) asset. It’s how you put food on the table, afford vacations, and fund your future goals. It makes sense to protect it, and it’s exactly why many employers offer this coverage.

You may also find access to extended coverage for pennies on the dollar – oftentimes a wise choice to make. What can be more precarious is the likelihood of disability within your profession. Some professions have a higher incidence of claims which may spur an interest in obtaining your own policy.

Are you a highly specialized professional? Even more reason to explore purchasing your own disability policy.

Long Term Care

Controlling expenses in retirement is paramount to a successful financial plan. Unforeseen expenses can derail that – and quick! In projecting retirement expenses, we typically account for the cost of shelter, food, clothing, entertainment, and regular medical expenses.

However, having to afford in-home care or assisted living facilities will shorten the time you have to draw down your assets considerably. Based on your earnings history, you’re unlikely to qualify for public benefits.

Take a look into your family’s health history and see how feasible it is to have your own Long Term Care policy. New product developments have made this part of insurance for retirement planning a bit more palatable.

Like anything else, when it comes to insurance for retirement planning, it should be tailored to your current (and future) situation – as best as possible. While not an exact science, being proactive pays dividends and can save lots of money down the road.

While you should avoid sacrificing cash flow for the cost of the premium, there is a tradeoff between saving the money on your own (self funding) or leveraging an insurance policy.

Step 3. Developing An Investment Strategy

This is not intended to be investment advice, and should not be construed as such. The reality is that a portfolio should be suited to specific needs, risk tolerances, and goals. That said, there are three rules of thumb you can adhere to that have historically paid off.

  • Stay diversified: Think big. You’ll likely want exposure to different types of markets: stocks and bonds, domestic and international. Have a bit of each. You’ll also want to consider your employer stock as part of your total stock allocation. Like anything else, don’t have too many eggs in one basket.
  • Keep your costs low: There’s no “one size fits all” approach, but there’s an overwhelming amount of evidence that lower cost funds can do the trick over the long term. The more you keep, the more you earn.
  • Make sure you’re saving enough: Behavior tends to be more critical to investment success than what you invest in. If possible, invest early and often. More importantly, resist temptation and turn off the TV. Don’t react to headline news (which is mostly noise). Make changes based on your personal circumstances, not outside interference.

A Quick Word on Patience and The Long Term

If you buy your house at $20,000 and somebody comes along the next day and says, ’I’ll pay you $15,000, you don’t sell it…” – Warren Buffett

Stocks are no different. If you find roller coasters uncomfortable, you’ll know the feeling. As the coaster picks up speed and hurdles toward the ground, your heart rate picks up and your stomach gets tied in knots.

But right before you’re ready to tap out, the coaster picks back up – bringing you temporary relief until the next drop.

To say that the markets can be like a “roller coaster” is a bit of an understatement. While we don’t know what the future has in store, we CAN take a look back and see how certain behaviors may have paid off.

As mentioned in this article during the height of the COVID pandemic, “A typical portfolio of 60% stocks and 40% bonds is down less than 1% for the year to date” (the article refers to year to date as 6/30/20, and other variables should be considered).

The point being that while it’s human nature to want to take action in the face of discomfort, when it comes to a long term investment strategy, it may not always be prudent.

We often feel the need to do “something” because things are changing.

Nobel Laureate Eugene Fama once made a great comparison about money and soap – the more you tinker with it the less you’ll have. The same can be said about your portfolio.

You may feel compelled to sell out of an investment because you see its value deflating. Instinctively you want to stop the bleeding because “now is the time – it’ll only continue to sink.”

But as we can infer from all the other roller coasters we’ve been on, patience will reward you.

Follow your plan. Define your goals clearly, be diversified, and pivot if there is a change in your personal circumstances – not headline news.

Step 4. Crafting an Estate Plan

As you’ve built up your career, amassed some wealth, and obtained some accolades, the list of things you own has likely also increased. While not a subject we like to think of, preparing for the inevitable is a necessity. This isn’t just for the super rich.

Having a valid and up-to-date estate plan will save your heirs lots of headaches,heartaches, and keep you from tipping those you don’t necessarily want to tip (the government). While it’s highly recommended you consult with an estate planning attorney (and the below is not meant to supersede legal advice), here are a few tips to get started:

  • Update your beneficiaries: This may sound simple, but it’s often overlooked. If you’ve been at your employer a few years, it’s easy to lose track of who your original beneficiary designations were. If you’ve changed employers and left behind an old 401k? Even more so. As life progresses, it’s likely your wishes and who you’d like to bequeath those assets to has changed as well. Take the time to look these up and ensure everything is laid out as you see fit. In many cases, you can make those updates online or have the appropriate paperwork filled out with HR.
  • Add beneficiaries: A slight rehash from the above, many of us don’t think to add beneficiaries to our checking/savings accounts. But you can, and probably should. Most banking institutions will allow you to add these at no additional costs. Same goes for any non-retirement investment accounts you own.
  • Review your wills: On a basic level, it’s likely that you and your spouse could benefit from an up-to-date will that spells out your wishes. Ditto for a power of attorney on both health and property. If your situation is a little more nuanced with young children or substantial property, you may benefit from a type of trust.

Estate planning can be simple and it can also be complex. Taking the time to create and update your beneficiaries is a small step in the right direction. The objective, above all, is to avoid having your estate go to probate.

Probate occurs when your assets don’t have a named beneficiary and the court system gets involved in dispersing your assets – a scenario that can be more costly than creating your estate plan to begin with.

Like retirement planning, the sooner you start the better off you’ll be. Certain situations call for more detailed attention, and this snippet is not comprehensive by any means. As families grow, split up, and encounter unique situations, the more intricate your estate plan can be. A little attention now goes a long way.

Step 5. Reducing Taxes in Retirement, Income Planning, and Other Odds and Ends

Reducing taxes in retirement (and pre-retirement) is a big deal, worthy of its own lengthy article. Its position in this specific article is not indicative of its relative importance, however, it’s such a nuanced topic that is hyper specific. As such, we’ll cover it in broad strokes. As always, consult your tax and legal pros.

  • Understand the implications of Required Minimum Distributions (RMD’s): RMD’s are Uncle Sam’s way of saying “time to pay the piper.” You were allowed to defer taxes in pre-tax accounts (401k’s, IRA’s, etc) for a number of years, but not indefinitely. RMD’s are typically counted as ordinary income and taxable at your marginal tax bracket.
  • Use after tax (Roth) accounts if suitable: Not all retirement plans allow them, but if yours does, it could be tremendously useful. While you may not qualify for a Roth IRA, Roth 401k’s do not have an income based limit. It’s a great way to access tax free withdrawals in retirement. The key is to determine how much, if any, you should contribute. While a Traditional 401k has the added benefit of reducing your taxable income, Roth’s don’t. You’ll have to decide whether it makes sense to save some money in taxes now or later.
  • Asset location: Just as important as knowing “which” assets you hold, knowing “where” to hold them is also crucial. Investments that pay interest and can subsequently add to your tax bill might be held in tax deferred accounts. Other investments pass on capital gain distributions. Be cognizant of these implications.
  • IRMAA and the taxation of Social Security: On top of worrying if Social Security will even be there, know that a large part of it may be taxable. Up to 85% of Social Security benefits can be taxable depending on your income level while you’re on benefit.

On Medicare? Know that income may stipulate how much you pay for this health benefit. It adds up.

  • Income Planning: There’s a bit of an art and a science to drawing down your income distributions. Just as important is determining how much you can actually live on, the details of which are outside the immediate scope of this article – simply know it’s one of the more crucial components.

To not completely skip the topic, start with a quick rule of thumb. The 4% distribution rule can be a basis to start with – but it’s not set in stone. Factor in other sources of income as well. I wrote a brief article on the topic here.

It will take some work, but spending the time to create a tax and income strategy within your financial plan can save you a great deal of money along the line. Be mindful.

Conclusion: Tying It All Up

There’s a cheesy infomercial from the 90’s that was popular for the “set it and forget it” slogan. But financial planning isn’t like cooking a rotisserie chicken. It takes time, tending to, and periodic revisiting.

That doesn’t mean it needs constant fidgeting either. There’s a careful balance to be struck between the two. Whether you’re embarking on this journey alone or with the guidance of a professional, just know that success is attainable. Have questions? Click here.