Knowing your funded ratio can help improve your chances of achieving a secure retirement. By securing your retirement, you put yourself on a path towards financial security now and into the future. Putting yourself into a stable financial position provides you with the ability to help others along the way and leave a legacy to your children or the causes that define you. As an Estate Planning attorney in Austin, TX, I help clients put these pieces together as part of a comprehensive wealth plan.
Knowing your funded ratio now, you have the opportunity to take steps to improve it. You're going to retire whether you know your funded ratio or not. However, by knowing it, you can empower your future self with the steps you take today.
So, what am I even talking about? A funded ratio is simply your assets over your liabilities. If that is one or above, you are fully funded. If it is below one, you should take steps to move it towards one.
Let's start with a look at the balance sheet:
So, your economic net worth is your Financial Assets (M) plus your Gross Human Capital (GH) plus your Social Capital (SC), minus your Explicit Liabilities (eL) and your Implicit Liabilities (iL)
To find your funded ratio, we are looking to find:
The easy part is tracking down your Financial Assets and your Explicit Liabilities. If you use an app or excel spreadsheets, that should be pretty simple.
And, if you are finding it difficult because you have so many accounts at various institutions, by all means, please take the opportunity to consolidate them. If you don't, someone you love will have to do so - or they will pay someone a lot of money to do it for you.
But I digress...
The more difficult part of calculating your funded ratio requires you to estimate your Gross Human Capital. This is the present value of your estimated income from today until you retire or expire. For simplicity, use after-tax income.
Next, you will have to estimate the present value of your Social Security benefits (if you are so eligible). This can be a complicated task. However, if you go to the Social Security Quick Calculator, you can get an estimate of your monthly benefit in today's dollars. So, for example, if the calculator comes back with an estimate of $2,875 per month (let's deduct 15% for the estimated tax to give us a round $2,500) and you estimate that you will live for 20 years after retirement, you would multiply $2,500 x 20 x 12 = $600,000. You could multiply that by the number of months you expect to live after retirement for a lump sum.
You may be thinking, "Yeah, but when Social Security collapses, I'll see none of that!" Well, I've discussed that before. And, whether you agree or disagree, I can adjust that figure in my specific calculations of your funded ratio according to your confidence level if you engage my services.
You will want to add an estimate of any expected inheritance to your Social Capital input. If you expect the inheritance in 10 years, you would estimate the future value of the sum at that time, and discount it back to the present.
Finally, you would need to estimate your Implicit Liabilities. This an estimate of your minimum (lowest tolerable standard/) cost of living. This part of the funded ratio input would include your minimum cost of tolerable housing, food, clothing, and health care.
Start with an estimate of your monthly Implicit Liability and multiply it by the number of months you expect to live, discount it to the present, to come up with a lump sum.
Plug these present value sums into the appropriate inputs of the Funded Ratio equation.
You would be "Fully Funded" if the equation returned a one; "Over Funded" if you have anything over one; and "Under Funded" if you are below one.
If you find yourself below one (and I'm assuming you aren't in a buy, borrow, die situation), then you should take steps to improve your assets and reduce your liabilities.
You can improve your assets by seeking greater returns with your Financial Capital. You may be able to achieve greater returns through improved asset allocation of your portfolio without necessarily taking on greater risk. I can help you optimize your portfolio in this manner.
In addition, you may be able to considerably improve your assets between now and retirement by keeping an eye on the mutual fund expense ratios in your portfolio. I can help you understand these expenses. In a further post, I will show you how much these seemingly small numbers can compound over the years taking significant portions of your nest egg out of your reach.
To reduce your liabilities, you can create a plan to pay down debt. There are two approaches you could consider. First, you could sort your debts by interest rate and pay down the debt with the highest interest rate. You would make extra payments on the highest interest debt whilst making minimum payments such that you don't incur further debt. Then, once you've paid off the highest interest loan, you move down your list to the next highest interest loan and begin paying that down as quickly as possible.
Alternatively, you could sort your debt by the lowest to the highest outstanding balance. You would then make extra payments on the lowest balance loan first. When you have paid that debt off, you move on to the next lowest loan. This is called the snowball strategy. By chalking up quick and easy wins, you gain momentum and get into the habit of reducing your liabilities.
Understanding your funded ratio is a good first step towards achieving your financial goals.
If you found this post about finding your funded ratio interesting, you should check out the valuable tips I share in the FREE report: The Readiness is All.
As an Estate Attorney in Austin, TX, I love helping clients organize their finances by providing an Estate Plan that includes wealth and retirement planning. With a Funded Ratio analysis, I can help clients improve their financial trajectory towards more security today, and in retirement.
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Austin, TX 78738
