Author: Jason Branning
Jason K. Branning, CFP®, RICP® is co-founder of Modern Retirement Theory.
Forbes: 8 Essential Principles Of Planning For Retirement (Part 3)
A retirement plan involves more than just finances. Rather than beginning at your savings, the starting point for building a retirement income strategy should be the household balance sheet. This fundamental lesson has been proven several in various retirement frameworks, including Modern Retirement Theory, the Funded Ratio approach, and the Household Balance Sheet view.
At the core of these different methodologies is a desire to treat the household retirement problem the same way pension funds treat their obligations.
Assets should be matched to liabilities with comparable levels of risk. This matching can either be done on a balance sheet level, using the present values of asset and liability streams, or it can be accomplished on a period-by-period basis to match assets to ongoing spending needs.
Structuring the retirement income problem this way makes it easier to keep track of and to make sure each liability has a funding source. This also allows you to more easily determine whether you have sufficient assets to meet your retirement needs, or if you may be underfunded.
This organizational framework also serves as a foundation for choosing an appropriate asset allocation and seeing clearly how different retirement income tools fit into an overall plan.
The following table provides a basic overview of potential assets and liabilities a household balance sheet should consider.
In Dr. Wade Pfau’s February 2017 article in the Journal of Financial Planning titled “Retirement Income Showdown: Risk Pooling vs. Risk Premium,” he references Modern Retirement Theory as the example of the safety-first philosophy of retirement income planning. This research concluded that the safety-first approach to retirement income planning supports spending goals and preserves assets for contingencies and legacy.
Modern Retirement Theory is the most comprehensive and useful safety-first retirement planning framework placing the client’s unique Retirement Sheet at the center of planning rather than products.