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Some people are enamored with the word tariffs. My new favorite word is assumptions.
I was listening to a podcast today and they told a story of a person who went to two financial planners seeking to determine if his retirement plan was sufficient. The first planner told him he had a 95% chance of success. The second said 75%. Naturally, he went with the first planner, but failed to ask the key question. What assumptions were used in the calculation?
There are so many assumptions to consider – spending levels and patterns, life expectancy, inflation over 30 years or so, risk tolerance, a legacy goal and then there is the biggy, investment returns and the variables within that investment mix and more.
I never had to deal with this, but it sounds scary while extremely important. As the podcast noted, even a 1% difference in investment return assumptions can make a significant difference in the projection – and the income reality in the future.
Turns out in the example which enticed the individual, the 95% success, used aggressive investment return percentages with little deviation. Nevertheless, the – likely unrealistic 95% – was too enticing.
I was surprised to learn from the planners on the podcast that hardly anyone asked about the assumptions used when they presented a client with a plan.
I doubt I would know all the questions to ask, but I know using conservative assumptions would lower my stress even if it meant working a little longer.
How about you? Do you know the assumptions your future is based upon?
As a financial planner that has prepared hundreds of retirement projections for clients, this article is spot on. However, Dick fails to mention one important source of assumptions, the clients’ assumptions. One of the planners responsibilities is to bring up the assumptions the clients forget, such as home maintenance, auto replacement costs, medical costs, etc. Yes, the investment return and volatility assumptions are hugely important, and we always erred on the conservative side on both. It’s also important to point out to the client that assuming relatively minor reductions in future expenses can result in significant increases in the success of their strategy. The planner should tell the client there are no guarantees in their future,and this is simply a reasonable roadmap and invariably will require some adjustments (both positive and negative) as events develop.
The main objective of a properly done retirement plan is to either put the client’s mind at ease that they are well prepared for retirement or convince a totally unrealistic client that they are headed for disaster, as their assets cannot possibly accomplish their goals.
Although not the focus of Dick’s article, a properly done Social Security analysis, especially for a couple, is a huge part of a retirement plan.
Retirement helped me see this more clearly: “…relatively minor reductions in future expenses can result in significant increases in the success of their strategy.” Yet another form of compounding which puts time to work for you.
I understand your point. A few years ago I was doing estate planning and wanted to set aside funds so our children could keep our vacation home. The lawyer asked what we spend a year on the house. I threw out a number and she immediately said “I doubt it.” She was right, I was off by a factor of three.
numbers are ‘juked’ to produce an outcome, to provide a desired result…
in the case of the 95% there was emphasis on producing attention, to attract money, and could be rationalized after the fact to excuse variation from obvious reality (ex: it was biden’s economy–i am not culpable)
the 75% was trying to be rational and escape the inevitable disappointment of irrational expectations, assuming there IS disappointment, we seem to have the deep-dive memories of drunken gerbils these days. i’m not convinced it matters, the sources leading to that disappointment can be confused, obfuscated… (who could have predicted X??)
both camps are using the same data coming to different conclusions…
worrying about materials and methods to come to financial conclusions is to me less convincing then what they are trying to do!! quo bono, que bene? what are they trying to do?
then realize the locked door room puzzle with a can of beans for the hungry economist says ‘assume a can opener..’
Some of these planning models do not disclose all of the assumptions they use, which makes them untrustworthy IMO. These planning models are like black boxes.
I have used spreadsheets with variables like inflation, rate of return, etc; and rows for each year I am planning. The variables can be easily adjusted to see how that matters. I did this when planning my retirement, and they were very helpful. It worked better for me because I knew what my assumptions were and the calculations that were being made. I do not like black boxes.
My future is based on assumptions that change depending on the tariffs that will be imposed and of course their effect on the stock market. 25% on aluminum, 200% on European wine, 100% on Canadian lumber, 150% on SHEIN imports. Thank god for Microsoft Excel.
just kidding of course but without getting political what possible benefit can come from from all this?
I can’t imagine planning without making or knowing assumptions. You have led me to recall my first attempt at financial assumptions, made decades ago on a spreadsheet without benefit of the internet, retirement calculators, or advisors. Though overly simplistic, they guided how I saved and enabled me to estimate a future retirement date.
What were those early assumptions? First, I assumed that my then wage, adjusted by an annual inflation rate of 5% and projected forward, would still be livable at retirement age. Also being ultra cautious, I assumed no future Social Security or pension income. Other assumptions were a 2.5% draw in retirement and a 2% return on investments over inflation. Just five columns then: age, projected wages, annual savings, accumulated savings, and the accumulations-based draw. The row in which the projected draw exceeded projected wages predicted when I could retire. It also provided an estimate of how big my nest egg would need to be. I revised the spreadsheet periodically with actual savings and invested amounts, though doing so became less important once I could see I was meeting my goals. Looking back, I had a good road map.
YES
But with regard to projections I’m more interested in the range of results driven by standard deviation than the average result driven by an assumption.
The way I understand it, the deviation is built into software so I think it is an assumption.
Yes, I just meant that the averages smooth things too much and that the volatility matters too.
Personally I project as matter of interest but my real planning is in rolling 2-3 year periods. Right now I also plan as if SS will get cut 23% in 2034.
Assumptions are important in virtually every aspect of our lives. Important decisions require we make choices, and that entail making assumptions. They may be explicit or implicit. We have no choice but to make assumptions, so we should try to make the best ones we can. Think about the assumptions implicit in the decision to marry – will you be happy for multiple decades, do you both want children, whose parents get most of the time, etc. The same could be said for choices like whether to go to college, what to major in, what job to accept, and where to live. All involve assumptions that help us make choices, and all of these choices could be great successes or failures.
A financial plan is no different. I agree with Jeff’s comment that it’s important to make sure that everyone involved understands what assumptions are being made, and how they impact the plan. My training taught me to provide a margin of safety to protect against things going sideways. I previously wrote about how we apply a margin of safety in our retirement plan.
When I start a project, repair job, gardening, or even going to the store for something, I make a huge assumption. I assume it will take me twice as long as I originally thought. I’m usually wrong, because it takes longer than that. The reasons are variable, but mostly it’s because I’m retired and the pressure to finish is not there. I rarely quit or give up on a project, but sometimes I declare it complete because it’s good enough.
After 43-year career as an engineer, I learned that the key to assumptions is that all participants should be parties to the assumptions made, and have the potential impacts of them explained if they aren’t well understood. Unfortunately, that doesn’t happen very often.
Sort of a different topic on assumptions. When I have my taxes prepared by an expert who worked for the IRS, I now assume that person is going to make mistakes. Out of the last five years, there have been three times my taxes have had to be redone because of transposed numbers or something was left out. Still waiting on a refund, because of an error, from Uncle Sam for 2023 taxes.
Olin, I was a mere preparer of personal tax returns, I’m not a CPA or an EA, but I did participate in the IRS annual tax preparer program, which required continuing education. I was very careful and made very few errors. I sold my practice to an CPA/Tax Attorney whose carelessness caused about 2/3 of my old clients to leave him. It could be that your former guy is careless, or it could be he is having an under qualified employee doing your return.
Either way, I have never been impressed with anyone who has claimed to be a former employee of the IRS.
Good news is that the IRS will eventually pay you interest on the delayed refund.
Olin. I’m sure I sound like a broken record, but one of the best parts of the VITA and AARP TaxAide programs is that every return gets a complete and thorough quality review. We do find errors of th type you describe. Knowing your work is being checked makes one be more thorough. If I had a professional prepare my taxes, I would thoroughly review his work.
I’m in my first year as a TaxAide volunteer. I’m very impressed with their process. It’s almost a failsafe system.
I know from experience that the tax returns done by seasonal prepares at typical accounting firms are rarely double checked by the CPAs.
Further, I worked at a national tax prep company for one season; no returns were quality checked for accuracy.
Rick, and others who prepare taxes, are a great wealth of sharing knowledge on HD. I stopped by a library yesterday that had people waiting for the AARP tax prep assistance. Mainly, I wanted to ask a few questions of what to do if my tax person won’t fix the error before April 15. I found it to be a good source. I like the fact that someone else checks your work.
I had used the AARP tax calculator before going to have my taxes done. But the tax preparer said the amount owed was much higher only because of the errors she did. I thought there was an error on my part with the AARP tool, but there wasn’t. Fortunately, the my tax person is going to get the error fixed this week.
Rick, you raise an interesting point. I have used TurboTax for several years. I think the organization and the questions they make you answer are very thorough. If there is an error it seems it would be on me from entering the data.
Of course there could be a calculation error in the software, but would that be made public pretty soon i suspect.
Are most of the errors you see entry types or in interpretation of what to enter and where?
How would you gage the tax knowledge level of your AARP clients?
The vast majority are typos or omissions. We get clients who forget to bring a form, like a 1099R. One that always prevents the IRS from accepting is the client forgot they had received or asked for a pin. Yesterday I added an extra “a” to a very long last name. I caught it before I handed it over to a colleague.
The clients are all over the place. Some are quite knowledgable, but many have very little knowledge. You need to assess that quickly in the intake interview. The woman with the extra a did not receive a W-2 for 2024. The company collapsed in mid-year, and despite her trying multiple times, no-one associated with the company was answering the phone. ADP said it was up to the company. We developed a substitute W-2 using her 2023 W-2, her 27 direct deposits, and a spreadsheet to extrapolate 2024 form the data. I got within a few $100 and had to tweak the withholding. Luckily the IRS has a form for a missing W-2 where you can put in best estimates and an explanation. None of the 6 preparers had ever done one, so we broke new ground. The taxpayer was very grateful. I doubt she would have been able to do that herself, and I have no idea what a paid preparer would charge.
I reviewed the tax return my accountant prepared and caught an error. Unfortunately, I now owe an extra thousand-odd. If I hadn’t reviewed the return I very much doubt anyone at the IRS would have noticed the error…..
Generally, what type of error, data entry or interpretation?
The questionnaire I filled in asked for my medical insurance premiums, and then what part of that number was for Medicare. When she calculated my deductions she added the Medicare number to the total.
I am thinking of finding a new accountant. I suspect mine is reaching retirement and I would like someone who is more willing to offer advice. Of course, I could do them myself, they’re not that complicated.
Rick…regarding thorough checking, I don’t think I could pay someone to do all the checking I do and you are right, about the professionals.
sometimes they don’t get it right.
Rick, wondering if you’ve had experience as yet with the new property tax relief form, PAS-1. For state of NJ. I know forms are in process of being sent to homeowners, but I believe online filing is availabile now.
It is available. I tried using it but got hung up because it asks about previous years and wasn’t clear what to do if you don’t have any.
Marjorie, we get questions on that every day. I have not filled it out yet, but a number of folks I work with have. The biggest complaint I have heard is about setting up the ID.me account. Here are 2 emails that experienced NJ Tax Preparers have sent to help answer questions.
Sorry to the non-NJ residents for the long comment.
First
NEW online PAS-1 application
I completed the online application this weekend, and it is a PAIN IN THE NECK. This biggest problem is that you must have what is called “ID.Me” account. Setting up one of these is not easy, as the instructions are little fuzzy. It anticipates you will be using a smart phone, so if you don’t use one, I’m not sure you can complete it online. It is still an option to download the form, print, sign and mail
ID.ME settup – some tips. Have your drivers license or passport ready. You will be asked to take a picture of that with your smart phone. After that is accepted, you will be sent a link and asked to take a video of yourself, which will be compared and hopefully accepted. Then you will be given instructions to return to your PAS-1 application, as if you began preparing it on your phone. If you were using a computer (as I was), this is a little confusing. I was finally able to get into my computer application, and allowed to proceed based on my ID.me login. It is also weird trying to print your completed application for your records. The application itself is similar to prior years. There are some nice automated worksheets to come up with your adjusted income (i.e, add back any social security, etc). The form mislabels the base year property tax as “2023 property tax”. A review of the instructions indicates they are really wanting to have the ‘base year” taxes in that box.
I consider myself to be fairly good at using technology, so it was frustrating to try to follow this process. Hopefully I did actually submit the application properly, I received an email acknowleding receipt, so we shall see.
You can still download a fillable pdf file of the application, complete, print, sign and mail.
In hindsight, I wish I had just waited for the new forms to arrive.
Second
NJ PROPERTY TAX RELIEF:
I attended a webinar on the new NJ Property Tax Relief Program. Their explanation was:
1) ANCHOR – if you qualify you first get your Anchor relief
2) SENIOR FREEZE – if you qualify you next get your Senior Freeze relief
3) STAYNJ – if you qualify you finally get your STAYNJ relief but only if your Anchor and Senior Freeze do not add up to the lesser of $6,500 or 1/2 of your real estate tax and then you only get the balance between your maximum STAYNJ amount and the sum of your Anchor and Senior Freeze amounts.
Rick, I apologize as well, to all who don’t reside in NJ. I won’t take up any more time on this but I can see that it will confuse a lot of seniors. Wish you, me, and Dan could get together for a confab one day. Bill Perry might find it interesting too. Thank you for your reply.
I’m in.
Marjorie. That sounds like a lot of fun
Incorrect impressions can lead to wrong assumptions and can get us into trouble.
In all aspects of life, we can try never to assume anything.
All we have to do is look at any social media and see how true that is.
Oh boy!
I’m way back on my High School Debate tea.
”Don’t assume. It makes an ass out of u, and an ass out of me!”
That, of course, was “speech”.
Mathematics class was full of ‘assumptions’, or a ‘supposition or something that is taken for granted without questioning or proof. What we believe is true without proof’.
But I assume you want as much accuracy as possible when planning your financial future.
Great point about the importance of assumptions. We haven’t done this in a few years, but when we did, yes.
One tool required assumptions for life expectancy, social security benefits, any other future income/earnings, growth rate of the portfolio, and inflation rate. We used conservative numbers for everything.
A second tool required similar assumptions, maybe not as detailed.
Fidelity’s tool doesn’t require hard assumptions about returns, but has a choice between historic market conditions, better than these, and worse than these (or something like that, I’m sure my terms are off). We modeled using worse than historic market conditions. Exactly what those numbers mean is proprietary as I recall.
Richard I’m past the time when I concerned myself with assumptions, but from the brief time I spent in that business, I know that the planner can plug in any assumption they like. The would be client didn’t usually have the depth of knowledge to question.
I have also seen individuals using online DIY tools use unrealistic assumptions. Perhaps something in our psyche causes us to be over optimistic about our future wealth.
That’s what the folks on the podcast seemed to say. Clients tend to leave it all up to the planner. I guess most people, including me, would not know what to put in the investment growth assumption. You would think a client would say some about being conservative or otherwise.