Documenting Assumptions in a Financial Plan
Every financial plan rests on assumptions about the future. Investment returns, inflation rates, life expectancy, and tax rates all involve uncertainty. Documenting these assumptions explicitly serves two purposes: it makes the plan's foundation transparent, and it creates a framework for testing how sensitive your outcomes are to changes in those assumptions.
Core Assumption Categories
Inflation Assumptions
Inflation erodes purchasing power over time. A dollar today buys less in the future.
Historical context:
- U.S. average inflation 1926-2023: 2.9% annually
- U.S. average inflation 2000-2023: 2.5% annually
- Federal Reserve target: 2.0% annually
Reasonable assumption ranges:
- Conservative (higher costs): 3.0-3.5%
- Moderate (historical average): 2.5-3.0%
- Optimistic (lower costs): 2.0-2.5%
Category-specific inflation: Healthcare costs have historically risen faster than general inflation (5-7% annually). Education costs have risen 4-6% annually. Housing costs vary significantly by location.
Documentation example: "This plan assumes 2.5% general inflation, 5.5% healthcare cost inflation, and 4.0% education cost inflation."
Investment Return Assumptions
Return assumptions drive projections for wealth accumulation and retirement income sustainability.
Historical nominal returns (1926-2023):
- U.S. large-cap stocks: 10.3% annually
- U.S. small-cap stocks: 11.8% annually
- U.S. long-term government bonds: 5.5% annually
- U.S. Treasury bills: 3.3% annually
Real returns (after inflation):
- U.S. large-cap stocks: 7.2% annually
- U.S. bonds: 2.4% annually
Forward-looking considerations: Current market valuations, interest rate environment, and economic conditions suggest many analysts project lower returns for the next decade than historical averages.
Reasonable assumption ranges for diversified portfolios:
| Portfolio Allocation | Conservative | Moderate | Optimistic |
|---|---|---|---|
| 80% stocks / 20% bonds | 5.5% real | 6.5% real | 7.5% real |
| 60% stocks / 40% bonds | 4.5% real | 5.5% real | 6.5% real |
| 40% stocks / 60% bonds | 3.5% real | 4.5% real | 5.5% real |
Documentation example: "This plan assumes 6.0% real (inflation-adjusted) returns on a 70/30 stock/bond portfolio during the accumulation phase, reducing to 5.0% real returns after age 60 as allocation becomes more conservative."
Life Expectancy Assumptions
Underestimating longevity creates the risk of outliving your money.
Current life expectancy data (U.S.):
- At birth: 76.4 years (2023)
- At age 65: Additional 18.5 years (to age 83.5)
- At age 65 for couples: 50% chance one survives to age 92
Planning recommendations: Individual planning: Age 90-92 Couple planning: Age 95 (for the longer-lived spouse) Conservative planning: Age 95-100
Documentation example: "This plan models income needs through age 95 for the surviving spouse, with healthcare cost estimates extending through that age."
Tax Assumptions
Tax rates affect both accumulation (how much you keep) and withdrawal (how much you net from retirement accounts).
Current federal tax context (2024):
- Top marginal rate: 37%
- Capital gains (long-term): 0%, 15%, or 20% depending on income
- Qualified dividends: Same as long-term capital gains
- Standard deduction: $14,600 (single), $29,200 (married filing jointly)
Reasonable assumption approaches:
- Assume current rates continue (legislative risk)
- Assume rates increase by 2-5 percentage points
- Assume your marginal rate in retirement based on expected income
Documentation example: "This plan assumes federal tax rates remain at current levels through 2030, then increase by 3 percentage points across all brackets. State tax rate assumed at current 5.75% throughout."
Healthcare Cost Assumptions
Healthcare represents a significant and growing expense, particularly in retirement.
Benchmark data:
- Fidelity estimate for couple retiring at 65 (2023): $315,000 lifetime healthcare costs
- Medicare Part B premium (2024): $174.70/month standard
- Medigap policies: $150-$400/month depending on coverage
Documentation example: "Healthcare costs modeled at $8,000/year pre-65, increasing to $15,000/year from ages 65-75, $20,000/year from 75-85, and $30,000/year from 85-95, all amounts in today's dollars inflated at 5.5% annually."
Social Security Assumptions
Social Security provides a foundation of retirement income but faces funding challenges.
Current status:
- Trust fund projected depletion: 2034 (per 2023 Trustees Report)
- Projected benefit if no changes: 77% of scheduled benefits after depletion
Assumption approaches:
- Full scheduled benefits (optimistic)
- 75-80% of scheduled benefits (moderate)
- Delay claiming assumptions to age 67 or 70
- Exclude Social Security entirely (most conservative)
Documentation example: "Social Security benefits modeled at 80% of currently projected amounts, with claiming at age 67 for both spouses."
Worked Example: Sensitivity Analysis
Sensitivity analysis shows how outcomes change when assumptions vary. This reveals which assumptions matter most to your plan's success.
Base Case Scenario:
- Current age: 40
- Retirement age: 65
- Current retirement savings: $400,000
- Annual savings: $30,000
- Investment return: 6.5% real
- Retirement spending: $80,000/year (today's dollars)
- Life expectancy: Age 92
- Social Security: $30,000/year at age 67
Base case projection:
- Portfolio at age 65: $2,180,000
- Sustainable withdrawal: 4% = $87,200/year
- Plus Social Security: $30,000/year
- Total income: $117,200/year
- Result: Exceeds spending need with buffer
Testing Return Assumption Sensitivity
| Return Assumption | Portfolio at 65 | Sustainable Income | Outcome |
|---|---|---|---|
| 7.5% real (optimistic) | $2,580,000 | $103,200 + $30,000 = $133,200 | Significant surplus |
| 6.5% real (base) | $2,180,000 | $87,200 + $30,000 = $117,200 | Meets needs |
| 5.5% real (conservative) | $1,830,000 | $73,200 + $30,000 = $103,200 | Meets needs |
| 4.5% real (pessimistic) | $1,530,000 | $61,200 + $30,000 = $91,200 | Slight surplus |
Analysis: A 1% decrease in returns reduces portfolio by roughly $350,000 and sustainable income by $14,000/year. Plan remains viable across reasonable range.
Testing Inflation Sensitivity
| Inflation Rate | Spending at 65 (nominal) | Required Portfolio |
|---|---|---|
| 2.0% | $132,000 | $3,300,000 |
| 2.5% | $145,000 | $3,625,000 |
| 3.0% | $160,000 | $4,000,000 |
| 3.5% | $176,000 | $4,400,000 |
Analysis: Higher inflation increases the nominal spending requirement substantially. A 1% increase in inflation assumption requires roughly $800,000 more in retirement savings.
Testing Longevity Sensitivity
| Life Expectancy | Years of Withdrawals | Sustainable Rate | Required Portfolio |
|---|---|---|---|
| Age 85 | 20 years | 4.5% | $1,780,000 |
| Age 90 | 25 years | 4.0% | $2,000,000 |
| Age 95 | 30 years | 3.5% | $2,290,000 |
| Age 100 | 35 years | 3.0% | $2,670,000 |
Analysis: Each 5-year increase in longevity assumption requires approximately $300,000-$400,000 more in savings.
Combined Stress Test
Worst reasonable case:
- Returns: 4.5% real
- Inflation: 3.5%
- Life expectancy: 95
- Social Security: 75% of projected
Result:
- Portfolio at 65: $1,530,000
- Required spending (3.5% inflation): $176,000/year
- Sustainable withdrawal at 3.5%: $53,550/year
- Social Security (75%): $22,500/year
- Total income: $76,050/year
- Shortfall: $99,950/year
Response options:
- Increase current savings by $8,000/year
- Delay retirement by 3 years
- Reduce planned spending by 15%
- Plan for part-time work in early retirement
Documenting Assumptions Format
Create a dedicated section in your financial plan with this structure:
Assumption Documentation Template:
| Category | Assumption | Source/Rationale | Last Updated |
|---|---|---|---|
| General inflation | 2.5% annually | 20-year historical average | Jan 2025 |
| Healthcare inflation | 5.5% annually | CMS historical data | Jan 2025 |
| Portfolio return (accumulation) | 6.0% real | Vanguard CME, 70/30 allocation | Jan 2025 |
| Portfolio return (retirement) | 5.0% real | Vanguard CME, 50/50 allocation | Jan 2025 |
| Life expectancy | Age 95 (surviving spouse) | Society of Actuaries tables + buffer | Jan 2025 |
| Social Security benefit | 80% of projected | Trustees Report uncertainty | Jan 2025 |
| Federal tax rates | Current rates + 3% post-2030 | Legislative uncertainty buffer | Jan 2025 |
| State tax rate | 5.75% (current) | Virginia current rate | Jan 2025 |
Review Cadence for Assumptions
Annual Review (During Comprehensive Plan Review)
Check each assumption against:
- New data (actual inflation, market returns)
- Updated projections from credible sources
- Changes in personal circumstances
- Legislative or regulatory changes
Update triggers:
- Actual results differ from assumptions by more than 1% for two consecutive years
- Major policy changes (tax law, Social Security reform)
- Significant life changes (health diagnosis, inheritance, divorce)
Sources for Assumption Updates
Inflation: Bureau of Labor Statistics CPI data, Federal Reserve projections Investment returns: Vanguard Capital Markets Model, Research Affiliates, Morningstar Life expectancy: Social Security Administration tables, Society of Actuaries Tax rates: IRS announcements, Congressional Budget Office projections Healthcare costs: Kaiser Family Foundation, CMS National Health Expenditure data
Assumptions Documentation Checklist
- Documented inflation assumption with source
- Specified separate healthcare inflation rate
- Stated investment return assumption for accumulation phase
- Stated investment return assumption for retirement phase
- Documented whether returns are nominal or real (inflation-adjusted)
- Specified life expectancy assumption for planning
- Documented Social Security benefit assumption and claiming age
- Stated federal tax rate assumptions
- Stated state tax rate assumptions
- Listed any income growth assumptions
- Documented healthcare cost projections
- Created date stamp for when assumptions were set
- Ran sensitivity analysis on return assumptions
- Ran sensitivity analysis on inflation assumptions
- Ran sensitivity analysis on longevity assumptions
- Tested worst reasonable case scenario
- Identified response options if stress test fails
- Scheduled annual assumption review date
- Listed sources for future assumption updates