Last update on November 6, 2013
The Income Parameters panel is used to configure the basic structure of the income plan, such as assets, income, and length of income generation.
The Income Discovery tool applies to those who are planning their immediate retirement, are currently retired, or will be retiring within a few years. It is not designed to analyze the situation of an investor who is a decade or more away from retirement and in what is referred to as the accumulation and growth phase. Conventional financial planning tools serve the latter case quite well. Most of the articles in the Income Discovery Knowledge Base explain the application usage from the perspective of a person who is retiring or is already retired. The unique aspects of a pre-retiree case, somebody who is few years away from retirement, are described in another article, Pre-Retiree – Defining Income and Wages.
The Income Discovery tool supports analysis in two modes: non-tax mode, which analyzes pre-tax retirement income and ignores tax related details, and tax mode, which gets into the details of taxes, including the taxable portion of all cash flows, separate tracking of capital gains that is taxed at a different rate and other taxable income. The use of this panel in both modes is described below, starting with the non-tax mode first.
The Total Assets field represents the total investable assets of the retiree that will be used to generate their retirement income. In the non-tax mode of the application, configuration of the total assets, rather than a breakdown of the assets by account, is sufficient for the analysis and reduces the amount of data that the user is required to enter.
Part of the total assets is used to purchase annuities and the individual bonds that make up the ladder. The remaining amount is invested in a systematic withdrawal portfolio (SWP), which represents the portion of your client's money in conventional asset classes, such as equities, fixed income, and alternative investments. The allocation model of the SWP can be configured to best suit the retiree's risk preference or under a range of scenarios. The annual return of the SWP can be modeled using Ibbotson historical data or random walk assumption based forward looking expectations. For more information regarding the Capital Market Assumptions underlying the SWP, please see the bottom section of this article and the Creating Custom Capital Market Assumptions article.
Desired Annual Pre-Tax Income
Here, you can configure the Desired Pre-Tax Income, which is the total annual pre-tax retirement income from all sources of cash flow. The cumulative retirement income is generated from Social Security, Annuity payments, bond ladder cash flows, other incoming cash flows, such as a pension or part-time work, and the systematic withdrawal portfolio. You should configure the total cumulative real income in this field, as opposed to the nominal value. The term "real" signifies that the nominal retirement income is adjusted to inflation in future years. Variation of the real income during retirement, based on changing circumstances and unique situations, is configured in the Income Phases tab. For more details, see the Phases – Inflation Adjusting and Varying Income article.
The Planning Horizon for your client can be configured one of two ways. The first, and simpler option, is to establish a fixed number of years as the planning horizon. By using this option, you assume that both members of the household will live for the configured number of years.
The second, and also the recommended method, is to use your clients' individual lifespans as a basis for determining the planning horizon. This option sets the planning horizon as the retiree's percentile lifespan that represents the percentage of same age and gender peers that the retiree is forecasted to outlive. Using the Social Security Period Life Table, the percentiles are converted into lifespan age in years, which can also be seen in the user interface. Income Discovery recommends this method, because it allows for more detailed and accurate planning, as phases of income, Social Security benefits, and other cash flows can be linked to the event of the death of a spouse.
When using a lifespan based planning horizon, other data inputs must be changed in different sections of the tool. A detailed overview of this can be found in the Lifespan Based Planning article.
Plan Start Year
A primary assumption underlying the tool is that the annual income withdrawal occurs at the end of January, which begins with the first January of the plan start year and each January thereafter. The Plan Start Year is auto-generated by the application to the year of the upcoming January and can't be changed by the user.
If the investor is retiring in the middle of the year, the advisor can remove funds from the total assets to set aside specifically for meeting the expenses until the Plan Start Year.
Capital Market Assumptions
Future inflation and investment returns sequences for analyzing the plan can be built either from historical sequences or by using forward looking capital market expectations. The Income Discovery tool creates historical sequences based on data available in the Ibbotson Classic Yearbook. It also offers three additional default forward looking capital market assumptions. You can choose to analyze plans using any of these assumptions. You can even compare the same retirement income strategy side-by-side, under different capital market assumptions, by changing the assumptions before running the plan.
In order to create a new capital market assumptions set, you must have a premium subscription to the software. The Creating Capital Market Assumptions article provides a detailed discussion of this aspect of the tool.
In switching between the non-tax and tax modes, you will notice that the main difference within the Income Parameters tab relates to the Total Assets and Desired Annual Income columns. The Planning Horizon, Plan Start Year, and Capital Market Assumptions columns remain unchanged when switching between the two modes.
Desired Annual Post-Tax Income
In the tax mode of the application, the desired post-tax income is configured in the Income Parameters tab. The tool calculates the taxes and adds them, in order to determine the total withdrawals.
Investment assets are not configured in the Income Parameters tab, rather in a separate tab, called Accounts. Each tax-type account, its basis and model allocation are specified in that tab. These details are described in a separate article titled Tax Mode of Income Discovery.