Consider what living a life aligned with your goals and values might look like. Maybe it’s taking that dream trip to Italy, helping your kids or grandkids with education, or buying a second home for family gatherings. These aspirations highlight the importance of cash flow planning to ensure that your financial resources support your personal and family goals.
If you neglect to manage your cash flow, you might find yourself unprepared for unexpected expenses or unable to take advantage of sudden investment opportunities. Without proper planning, closely aligned income and spending can become unsustainable, particularly when income levels decrease in retirement. Proactively managing your cash flow allows your wealth to support your long-term goals and prevents financial strain.
Your wealth advisor plays a key role in this process. At our firm, we offer expert guidance on how to think about cash flow in the short term, medium term and long term. And we take all the other components of your financial plan into account as well. Below, we’ll take a closer look at cash flow planning strategies, focusing on accumulation versus withdrawal phases and proven strategies for maximizing your wealth.
Conducting a cash flow analysis
As a starting point, your advisor will help assess your projected cash flow, ideally over the next one to three (or one to five) years, and they’ll develop a savings or withdrawal strategy that reflects your personal goals.
Here’s how you can approach different financial goals within short-, medium- and long-term horizons:
- Short term (1 to 3 years): Goals such as purchasing a car or making a home down payment are typically funded through taxable accounts. The recommended investment strategy focuses on liquidity and stability, using cash, money market funds and short-term bonds.
- Medium term (3 to 10 years): For goals like building a travel fund, you should keep funds in taxable accounts but invest in a hybrid strategy that focuses on stability and growth, including money market funds, short-term bonds and equities.
- Long term (10 years to retirement): Goals like purchasing a second home should use taxable accounts and emphasize growth-focused investments, such as equities and long-term bonds, to maximize returns over a longer period.
Accumulation vs. withdrawal cash flow planning
Your cash flow planning will look different depending on whether you are younger and in accumulation mode or nearing retirement and in the distribution/withdrawal phase.
Accumulation phase
During the accumulation phase, effective cash flow planning involves creating a structured savings hierarchy. This phase is characterized by actively saving and growing your wealth. For working individuals, a fundamental equation to follow is:
Income − Savings = Expenses
This approach prioritizes saving a portion of your income before accounting for expenses, ensuring that saving becomes a deliberate and consistent part of your financial strategy.
A good savings rate, typically between 10% to 20% of your gross income, can help you set aside enough for future needs without compromising your current lifestyle. This rate is calculated by dividing your annual savings by your gross income, providing a clear picture of how much you are saving relative to what you earn.
Withdrawal phase
In the withdrawal phase, the focus shifts from accumulating wealth to distributing your accumulated assets in a sustainable manner. Your advisor can assist in developing a withdrawal strategy that aligns with your retirement goals and provides a steady income stream.
For retired individuals, the equation to follow is:
Income + Sustainable Withdrawals = Expenses
This equation means that your total available funds (income plus sustainable withdrawals from your investments) should be sufficient to cover your living expenses.
A general rule is to aim for a withdrawal rate of about 4% of your total portfolio value, with some flexibility depending on your individual circumstances. This means if you have a portfolio worth $1 million, you would plan to withdraw around $40,000 annually. This approach helps balance your income needs with the longevity of your portfolio, supporting a stable financial situation throughout retirement. It also helps you optimize use of your withdrawals and income sources (such as pensions or Social Security) to cover your expenses.
| Key Focus | Strategy | Financial Ratios | |
|---|---|---|---|
| Accumulation Phase | Saving and growing wealth | Income − savings = expenses | Savings rate: 10% to 20% of gross income |
| Discuss goals, set priorities, and address short-, medium- and long-term funding needs | |||
| Withdrawal Phase | Distributing accumulated wealth sustainably | Income + sustainable withdrawals = expenses | Withdrawal rate: ~4% +/− 1% of total portfolio value |
| Develop a withdrawal strategy that aligns with retirement goals | |||
| Financial Health Metrics | Gauging cash flow health | Assess projected cash flow (1 to 5 years) | Savings rate: Annual savings ÷ gross income |
| Identify and reduce expenses not aligned with goals | Withdrawal rate: Planned distributions ÷ total portfolio value | ||
| Automate savings through direct deposit |
Personal tax rates are probably going in one direction: Up.
If your advisor identifies significantly negative net cash flow or expenses that do not align with your goals and values, they may suggest reducing unnecessary expenses to increase net cash flow. Automating savings through direct deposit can help you stay on track with your financial goals and minimize decision fatigue.
By working with an advisor, you can navigate both the accumulation and withdrawal phases effectively, aligning your cash flow with your long-term financial goals and values.
The value of cash flow planning
Here’s how cash flow planning serves several critical purposes in managing your wealth effectively.
Sustainability of your wealth
Over time, cash flow management may provide the opportunity to comfortably cover daily expenses, luxury purchases and unforeseen expenditures without depleting your wealth. This often involves evaluating spending levels and withdrawal rates to determine whether your financial plan will remain viable over the long term. You might not have to scrutinize every small expense—no need to fret over your latte habit or monthly trips to the salon. But if you have a tendency to increase spending in line with income, it’s important to address that, particularly as you approach retirement, when income may significantly decline.
Investment opportunities
Effective cash flow planning enables you to seize investment opportunities. You’ll know how much cash you have available and be better equipped to make informed decisions that grow your wealth. For instance, having adequate cash flow can allow you to take part in a real estate deal or invest in a promising startup.
Tax efficiency
Understanding your cash flow can help you manage tax liabilities more effectively, timing income and expenses strategically to save on taxes and retain more wealth. For example, by monitoring your cash flow, you might decide to defer a bonus to the next tax year, reducing your current year’s taxable income and taking advantage of a lower tax bracket.
Another way to optimize your tax efficiency through cash flow planning is by carefully timing your charitable contributions. If you itemize deductions on your tax return, you can claim a deduction for charitable gifts made during the year, generally up to 60% of your AGI.1 However, the timing of those contributions can have a significant impact on your tax liability. For instance, if you’re considering making a substantial charitable gift, you might choose to make the donation in a year when you have particularly high earnings, allowing you to offset a larger portion of your taxable income.
Wealth preservation and estate planning
Cash flow planning helps to manage your spending and investments so you can preserve your wealth over the long term, avoid overspending and ensure a lasting legacy. For example, you may opt to fund a trust with a portion of your wealth so you can provide for your heirs and minimize the tax impact on your estate. At the same time, you’ll want to maintain enough liquidity outside of the trust to cover your ongoing expenses and any unexpected costs that may arise.Philanthropy
Cash flow planning helps you meet your philanthropic goals without compromising your ability to cover your own expenses, save for retirement or maintain an emergency fund. By creating a plan, you can determine how much to contribute to your charitable causes each year without jeopardizing your wealth.
Unexpected events
You want to have a substantial cash buffer to handle financial surprises without significant stress. For instance, consider a medical emergency that requires immediate and potentially expensive treatment, or imagine an unexpected major repair for your primary residence or vacation home. Having a well-planned cash reserve allows you to address these urgent needs promptly without liquidating investments at an inopportune time or disrupting your financial strategy.
Strategies for efficient cash flow management
Effectively managing your cash flow involves a range of strategies tailored to optimize your financial resources and support your long-term goals. Below, we explore key approaches to incorporate into your planning for maximum efficiency and benefit.
Equity compensation management
Your compensation may include equity awards, such as restricted stock units (RSUs) or employee stock options (ESOs). If you receive RSUs from your employer, you should consider their vesting schedule and potential market value.2 This can help you decide the best times to sell shares to cover major expenses or reinvest proceeds. Properly managing these equity awards allows you to leverage them as a significant component of your financial strategy, providing liquidity for large purchases or further investment opportunities without disrupting your overall plan.
Deferred compensation plans
Deferred compensation plans offer the benefit of reducing current taxable income and gaining future tax advantages.3 By deferring a portion of your income until a time when you expect to be in a lower tax bracket (such as during retirement), you can minimize your overall tax burden and increase your net cash flow. For instance, if you are currently in a high-income bracket, deferring part of your salary or bonus can lower your taxable income today while providing funds for future use when your tax rate might be lower.
Cash balance plans
Employer-sponsored retirement plans, such as cash balance plans, allow substantial pretax contributions with long-term benefits.4 If you’re a business owner, contributing significantly to a cash balance plan can reduce your current taxable income, potentially moving you to a lower tax bracket and increasing your net cash flow. By maximizing contributions to this plan, you not only save for retirement aggressively but also benefit from immediate tax deductions.
Charitable giving strategies
Incorporating charitable giving into your cash flow management plan can reduce your tax liability while supporting causes you care about. For example, donating appreciated securities may allow you to avoid or reduce capital gains taxes while receiving a tax deduction for the full market value of the donation. Additionally, establishing a donor-advised fund (DAF) or making qualified charitable distributions (QCDs) from your IRA5 can provide immediate tax benefits and help manage your cash flow effectively while maximizing your philanthropic impact.
Roth conversions
Executing Roth conversions during low-income years or before required minimum distributions (RMDs) kick in can offer significant advantages. By converting a portion of your tax-deferred assets to a Roth IRA, you pay taxes on the converted amount now and enjoy tax-free growth and withdrawals in the future.6 This strategy can help manage your cash flow by reducing the impact of RMDs and minimizing your overall tax burden in retirement.
Social Security claims optimization
Developing a comprehensive Social Security claiming strategy can maximize your lifetime benefits and support your overall cash flow plan. By carefully timing your Social Security claims, coordinating with your spouse, and considering the impact on your other income sources, you can optimize your cash flow. For instance, if you delay your Social Security benefits until age 70, you can significantly increase your monthly payments, providing a more substantial income stream during retirement and helping you avoid excessive account withdrawals.7
Cash balance plans
Employer-sponsored retirement plans, such as cash balance plans, allow substantial pretax contributions with long-term benefits.4 If you’re a business owner, contributing significantly to a cash balance plan can reduce your current taxable income, potentially moving you to a lower tax bracket and increasing your net cash flow. By maximizing contributions to this plan, you not only save for retirement aggressively but also benefit from immediate tax deductions.Think of the current estate tax breaks as a limited-time offer.
Take control of your cash flow management today
Effective cash flow planning is an ongoing process that requires regular attention and review. To get started, work with your advisor to conduct an initial analysis of your cash inflows and outflows. This involves creating a comprehensive personal balance sheet that includes all sources of income, such as salary, bonuses and investment returns, as well as a detailed breakdown of your expenses.
Once you have a clear picture of your current cash flow situation, your advisor can help you identify areas for optimization and develop a plan that aligns with your short- and long-term financial goals. This may include strategies for reducing tax liabilities, maximizing investment opportunities, and ensuring that your spending and saving habits are sustainable.
It’s important to remember that your cash flow plan is not a one-time exercise. As your life
circumstances change, whether due to a career transition, a significant purchase or a shift in family responsibilities, your cash flow plan will need to adapt accordingly. Make it a habit to review and adjust your plan with your advisor at least annually, and be sure to revisit it whenever a major financial event occurs.
Sources:
- Internal Revenue Service. (2023). Publication 526 charitable contributions.
- Internal Revenue Service. (2024, June 25). Equity (stock)-based compensation audit technique guide.
- Internal Revenue Service. (n.d.). IRC 457(b) deferred compensation plans.
- Employee Benefits Security Administration. (2011, November). Fact sheet: Cash balance pension plans. U.S. Department of Labor.
- Internal Revenue Service. (2023, November 16). Qualified charitable distributions allow eligible IRA owners up to $100,000 in tax-free gifts to charity.
- Internal Revenue Service. (n.d.). Roth IRAs.
- Social Security Administration. (n.d.). Delayed retirement credits.
This material is for informational purposes only. All investments carry risk of loss. Our statements and opinions are subject to change without notice. Tax, legal and insurance information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice, or as advice on whether to buy or surrender any insurance products. Always consult with a qualified professional regarding your specific situation.
Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.
