Financial Planning and Market Update

Dear Clients and Friends,

The news about UMass I woke up to last week was deeply troubling. I am a fifty-three-year resident of Amherst, a UMass/Amherst Graduate School Alum and former Professional Staff member whose wife retired from UMass after 35 years — by no means a casual bystander! With so much uncertainty surrounding the Covid-19 and its future course, UMass and other colleges and universities have been forced to shrink to an updated version of “Correspondence Courses”. Schools and other institutions and businesses now must consider many bad and worst-case scenarios, while remaining hopeful that there will someday be a return to a new version of normal. So we hear of plans to re-open later in the fall, for example, and compress the school year in ways that allow for two full semesters. Or plans for an entirely freshmen-free online first semester while planning to open for the second. Or remaining online for the full year. There are many variations of this, and each institution will find its way to what is appropriate to their students’ needs and its own culture and institutional realities.

I guess it’s inevitable that after the emergency measures taken to allow students to complete this spring semester, school administrations would then need to face the economic fallout from attrition and the loss of tuition and fees, not to mention goodwill. UMass certainly is no exception, with State aid accounting for less than half its total operating revenue. The local economies of towns like Amherst, Northampton, and South Hadley that are so dependent on students and their teachers for their lifeblood are already absorbing the shock of comatose downtowns. But what if these institutions were forced to begin the next steps in their process of adaptation – cost reductions that included layoffs, furloughs, early retirements, and program discontinuation with termination of personnel and shuttering of facilities? And what if these measures affected tenured faculty as well as others? I don’t see how such contingency planning could not be a necessity given the terrible clouds of uncertainty surrounding almost everything.

UMass has now entered that next phase. Layoffs (for staff, not faculty, yet) have already been announced, along with guidelines for future reductions of the workforce. For faculty members whose whole professional life has been built around earning and maintaining the security of higher education’s traditionally distinguishing scholarly protection, TENURE, largely unchallengeable lifetime employment and support, their whole world could leave its axis — the word “layoffs”, even “furloughs” for faculty tolls the distinct ring of doom.

Here’s a story: With only scraps of information (and no shortage of rumors) available to her, one of my clients, a senior, tenured faculty member in the humanities began to panic. She is planning to retire in six years, a number chosen according to a plan that began with her moving from the State traditional pension plan (known as a “Defined Benefit” plan) to a “Defined Contribution” plan featuring TIAA Cref. She worked with me on making that move, and, employing our detailed, highly granular financial planning process, we were able to measure the security of the State pension system (which depends on the full faith and credit of the Commonwealth of Massachusetts for its risk management system) against the fungibility of a plan that kept assets and income flows under her control, and potentially could transfer at death to her son. There were many considerations in making this decision, but in the end, as we illustrated the comparison between the two retirement plans using our powerful financial planning software, in her case, given that she is a disciplined saver and spender, and the moderate allocation of her funds in her 403(b) — which has stood her in good stead even in these volatile times — the choice was an easy one to make. But there was one essential feature that she was banking on, literally – she would need to work for at least ten more years (from then) for her savings (and the matching funds from the State) to surpass the benefits of remaining in the State pension system. Life insurance would cover the deficit for her son were she to die early. She had covered all the bases and we factored them all in. Except one: the potential need to be forced to retire early, or be furloughed for an extended period time, or, worst of all, be laid off with almost no prospects for other teaching positions.

Of course, as soon as the news and rumor began filtering in about the choices now being mulled by the University leadership, my client got in touch with me. Distress and fear were palpable in her voice as she reported what she had heard. With so many possibilities, how could she continue on the path of careful planning and discipline that had placed her in such a good position up to now? She and thousands of others here (and all over the world!) are now faced with unprecedented levels of uncertainty. What could she do? What contingencies should she be planning for? And how? How could she regain that sense of control and envision a future grounded in the facts our financial planning had given her?

Because there were so many real and rumored possibilities, such as furloughs of anywhere from five days to possibly much more, early retirement with an (extremely) modest “severance” bonus, and of course the possibility of loss of employment through firing or layoff, I suggested that we choose to look at a severe but not the worst possibility, and then test that to see its potential impact on the long term plan we have been cultivating. I suggested we illustrate a one-year furlough, beginning in January 2021 (we can do other scenarios as the situation develops, of course). I could feel a sense of relief already, in that we were actually “naming” something, taking fear and uncertainty and replacing it, albeit temporarily and for illustrative purposes, with something concrete, which in its knowability was immediately less threatening than a generalized sense of menace, which cannot be “planned “ for and is thus the most terrifying of all.

It was then that we saw in a new light the true payoff of those years of having done the work of financial planning together. We already had done the hard work of building a model of her financial life, complete with all anticipated sources of income over the years; all expenses, including living expenses, gifts to children and charity, taxes, insurance premiums, and liabilities (such as her mortgage); details regarding health insurance and plans for long term care; estate plans; and of course, all investments (no matter where they were held) linked so that their daily value was reflected in the plan. All we had to do now was to create an alternative plan, changing only those things that would change — such as living without her income for one year! — to see if it could work, whether it was manageable.

There were some obvious things that would change: she would not be contributing to her UMass Retirement Plans for that year of the furlough, so that would have an affect on her retirement options, but also would decrease her net negative cash flows; there would be tax consequences, though these would be positive in nature for that year in terms of cash flow; once she resumed contributing, after the furlough, she would potentially need to maximize her contribution to catch up. Other things would change also, e.g., potentially less travel during that year. Also, her $10,000 per year life insurance premium would now be a burden. Where would those funds come from? In general, there would likely be less spending (auto fuel savings, parking, other employment related expenses).

With all these factors there would certainly still be negative cash flow – we’re talking here about the loss of a healthy six figure income! We were able to calculate that the net deficit would be about $55,000 per year – much less than the first emotions-driven estimate one might have assumed. But even for this, where would she find the funds to fill the gap? According to the algorithm we had selected establishing liquidation priority to optimize tax efficiency, shortfalls would come from available cash on hand, which she had placed per our recommendation in an “emergency fund” so crucial for the inevitable “rainy days” that come, like these. Next in line would be withdrawals from non-retirement investment assets. We would be able to distribute available cash in these accounts, and then we would raise additional cash if needed by selling assets in tax efficient and market-wise ways. Only then would she need to distribute monies from her retirement funds — she is over 59½, and therefore would have no tax penalty, so there would only be regular income tax on distributions, and without her salary she would be in a lower tax bracket so the bite would not be too bad. She could also pay her life insurance premium using a loan to her from her cash value within the policy, creating a “cash flow” saving of $10,000. Home Equity would be there were cash needs greater than anticipated, but it is unlikely that home equity or other personal loans would be required, and not adding to her debt load would help her rebuild after the furlough.

The conclusion that we reached is that however disturbing something like a possible extended furlough would be, my client would still be able to retire in 6 years, with only a very modest, non-meaningful drop in investment assets at retirement age and a slightly lower potential estate transfer at the end of the line. This would be true even if the markets don’t cooperate and follow the typical bullish pattern in the years following a bear market. If they do, so much the better. And if she could survive this, surviving anything less severe would be a piece of cake!

Most important in this whole exercise was identifying a serious problem, possibly among the harshest that we could be faced with, and then “taming” it by simulating how it would play out in a comprehensive planning context. As we reached our conclusion, my client, breathing a sigh of relief, wondered, “What are people doing who don’t have this kind of format for planning and decision-making in place? How will they be able to sleep at night?” I answered that many wouldn’t, but added that it was not too late – it’s almost never too late to create a planning platform that allows for this kind of rational decision-making and projection of future prospects and difficulties as circumstances change. The process does not eliminate potential disasters, but certainly helps us face the possibility that there will be such events and do the planning we need to do to have confidence that we can survive them.

I expressed some frustration to my client – this had clearly helped her so much, but most people do not have this kind of planning support that has made such a difference to her. How could we let others know about the kind of work we do? My client said that I should feel free to share her story if I thought that would help others, and that’s what I have just done! I hope it has been useful. Further, I encourage anyone reading this to be in touch with us to see if our planning process would be suitable for them. We offer a complimentary full consultation with a member of our team, via Zoom or phone, whichever is more comfortable. We are great believers in our process – we have seen it work in all kinds of circumstances in so many ways – I’m looking forward to helping others too in these unprecedented times. We have enhanced capacity as we have recently added advisory and administrative staff and are fully functional from our home offices.

Thanks for reading this tome! I also hope you enjoy Daken Vanderburg’s attached Market Update. It is in my opinion on the “bullish” side, but his views are always well supported by data, and they are always interesting. Time will tell.

Stay Well, Stay Safe, And be in touch!

Allen Davis for the DFG Team
CRN202205-264675

Allen J. Davis, CFP® ChFC
Financial Planner and Advisor
Davis Financial Group, LLC
10 Bay Road, Hadley, MA 01035
(413) 584-3098 x211 office
(413) 570-8311 direct line
(413) 584-0160 fax
www.davisfinancialgrp.com
ajdavis@davisfinancialgrp.com

Due to the escalating COVID-19 situation, we have suspended in-person meetings and visits to our office to protect our clients, employees and the greater community, and to do all we can to flatten the curve. That said, we remain fully staffed and capable to conduct all business remotely via phone, email, web conferencing and paperless technology and serve existing and prospective clients alike. So please don’t hesitate to call or email us if there’s anything we can do to help you.

We wish you good health and look forward to hearing from you soon.

Our Contact Information:

Allen Davis
Direct Line (413) 570-8311 email ajdavis@davisfinancialgrp.com
Lou Davis
Direct Line (413) 570-8316 email ldavis@davisfinancialgrp.com
Joanna Ballantine
Direct Line (413) 570-8313 email jballantine@davisfinancialgrp.com
Carol Valade
Direct Line (413) 570-8310 email cvalade@davisfinancialgrp.com
Ellen Carey
Direct Line (413) 570-8315 email ecarey@davisfinancialgrp.com