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How Backwards Budgeting Can Help Your Clients

Backwards budgeting helps clients come up with a sensible monthly spending limit that ensures they won’t outlive their money.

By Bruce M. Fogel, Esq.

Key Takeaways:

  • Even some of your savviest clients may not know how much they typically spend in a month, let alone in a year.
  • The backwards budgeting process helps clients come up with a sensible monthly spending limit that ensures they won’t outlive their money.
  • Backwards budgeting also factors in a cushion to allow for unanticipated bills, inflation or spending that may not have made it into a client’s regular budget.

With summer in the rearview mirror, students, parents, employees and even the elderly are reluctantly returning to their daily lives. And with the return to more conventional clothing and bedtimes comes a return to more sensitive budgets—both short-term and long-term.

Many of you have clients who are retired, or who are hardworking members of the “sandwich generation” trying to make ends meet while paying kids’ college tuition and parents’ assisted living expenses on top of their own mortgages and other debts.

Like you, I’m frequently asked what the single “best” approach to financial planning is. My answer? Any approach at all is not only good but important. It allows clients to prepare for what lies ahead, rather than react to emergencies.

There are as many different approaches to planning as there are people looking to have a plan. For almost anyone, however, I strongly recommend starting by looking back. Creating a “Backwards Budget” is critical to the process. On the surface, this may seem basic, but when looking closer, backward budgeting can help even the most affluent of your HNW clients.

I know some clients fear the word “budget.” While a more traditional budget looks at income vs. expenses, I do not use it as an imposition on their lifestyle. A backwards budget is a calculation to help ensure their financial security and to make sure they don’t outlive their money.

How backwards budgeting works

The Backwards Budget involves looking back at all of your clients’ finances for a period of one year. List all their spending during that period. Be realistic. List ALL payments—those required, such as rent or mortgage, utilities and food, as well as discretionary spending, like entertainment, retirement contributions, vacations, gifts, savings, etc. Make sure they know that no one will be judging them. This exercise is simply a tool to help them learn. Once all payments are listed, calculate how much they spend on a monthly basis. In order to complete this calculation, take annual expenditures and divide them by 12, semiannual bills by 6 and multiply weekly expenses by 4.3, until you arrive at a total spent per month. Then add approximately 3 percent to 5 percent to allow for unanticipated bills, inflation or spending that may not have made it into your budget.

With that final step completed, this may be the first time a client has ever seen a comprehensive snapshot of their spending habits. Now you are able to compare the monthly expenditure number provided by the Backwards Budget against their monthly income. This is your “Goldilocks” opportunity: Help clients understand, “Where am I overspending? Where am I underspending? Where am I just right?”

Now that you’ve created this baseline for clients, you can embark upon planning not only for a client’s current situation, but for what lies ahead. Wherever they are on life’s continuum, armed with your Backwards Budget figures, you will have information to help identify the funds they can or should commit to addressing such matters as saving for college or a home, or purchasing life, disability, or long-term care insurance to deal with the risk and cost of a nursing home.

Another important aspect is planning for retirement relative to strategies for current investments and future income. I often advise clients of their opportunity (or obligation) to maximize deferred income through various retirement plans, and it is important to consider what sort of risk tolerance is warranted for investment of cash savings, retirement funds or securities. At the same time, many individuals and families also want to be able to leave something behind for loved ones.

No matter what your stage of life, I suggest that one truth is applicable to all of us: We do not want to outlive our money. This consideration—this fear—is what puts us in the position of trying to balance our early-life needs and wants against preserving resources for older years. The Backwards Budget is a starting point, a summary. With the information it provides, you should be able to work meaningfully with your clients toward greater understanding and control of their financial lives. I wish you great success and would be happy to answer additional questions.

Portions of this post originally appeared on the Bacon Wilson website January 23, 2015.


About the Author

Bruce M. Fogel, Esq. is a member of Bacon Wilson’s estate planning and elder, real estate and zoning and business and corporate departments. He has extensive experience in matters relating to income, gift and estate taxes, and he focuses on the tax implications of all legal transactions. He can be reached at BFogel@BaconWilson.com 413.584.1287