In our last Financial Empowerment article, we talked about the basics of financial planning. We reviewed the process and the major information needed to start building a plan. Of those pieces of information, we discussed income, expenses, assets, and liabilities.
Today, we are going to focus a little more on one of those topics: income.
There are two overarching types of income: current and anticipated.
- Current income is obvious. If you’re working, that is a form of current income. If you’re collecting social security, that is current income. If you’re collecting alimony, rental income, a pension; that is all current income. Current income is a steady income stream with a defined start date and an estimated end date. Pretty simple, right? You should be able to easily document all your current income streams because they are already a part of your financial life. Create a list of all current income streams, their values, and their estimated end date.
- Anticipated income can be a little opaque. Are you planning on downsizing your home and investing the proceeds? Is there a future financial inheritance upon the passing of a prior generation? These are examples of anticipated income.These are examples of anticipated income, or future positive cashflows with unknown start dates and values. You know monies will be coming but you don’t know exactly when nor how much. How do we deal with such unknowns? Not to worry; we start by making a list. List all your future anticipated income but leave the values, start dates, and end dates blank. We never want our financial plan to be too pessimistic, but we definitely don’t want our plan to be falsely optimistic. Thus, we are going to err on the side of conservatism. The later the start date, the sooner the end date, and the smaller the income value, the more conservative the plan will be. If you think you’re going to sell your home sometime between 2020 and 2025 and invest between $50,000-$75,000 of the proceeds, a conservative approach would be to mark this anticipated income as $50,000.00 in 2025 from “Home Sale Proceeds.” If you anticipate a future inheritance of between $500,000-$750,000, write down $500,000 in a future year well beyond the prior generation’s life expectancy. By using the low end of an anticipated value range and by pushing out the cashflow date, we are making the plan more conservative. Any miscalculations should fall in your financial favor.
In addition to income types, we need to consider cost of living adjustments. They’re not just for pensions! As we’ll discuss in our next article, expenses go up over time. Thankfully, so do many income sources. If you anticipate the value of an income source to grow over time, make note of it. Determine if you think it will increase at a greater or lesser rate than normal inflation. Follow the conservative rule with your cost of living adjustment growth rates, as well. The lower the cost of living adjustment growth rate, the more conservative the plan.
In our next article, we will touch on some of the finer points when calculating and documenting your expenses. Remember, take it all one step at a time. These are the steps to turn financial stress into financial empowerment.