Wealth Forecasting Methodology

Overview

Wealth forecasts in the new planning area in the Morningstar Office 3.4 release are generated using the Ibbotson Wealth Forecast Engine (IWFE). This tool runs Monte Carlo simulations which incorporate client information such as income, tax rates, savings, college and other expenses, retirement needs, social security, and pensions. IWFE models tax rules for most taxable and tax-deferred investment accounts, such as 401(k), IRA, Roth IRA, and Variable Annuities. Tax rules are applied throughout the process, including minimum required distribution (MRD) rules that apply to some tax-deferred accounts.

IWFE performs 500 individual simulations of the client’s current portfolio based on its asset allocation and the market assumptions used to create the plan. For each year in the simulation, the following steps are performed:

This process is repeated for the target allocation. Results are presented at the 10th, 50th, and 90th percentile levels.

Expected Retirement

Employment Income

Social Security

Pensions

Insurance Benefits

Account Contributions

Retirement Needs

Education

Miscellaneous Expenses

Treatment of Cash Outflows

(1) Taxable Accounts

(2) After-Tax IRA
   Roth IRA
   
Roth 401(k)
   After-Tax 401(k)
   Variable Annuity
   Qualified Tax Deferred
   Non-qualified Tax Deferred

(3) Pre-Tax IRA
   Pre-Tax 401(k)
   403(b)
   457 Plan

Calculation of Taxes During Wealth Forecast

Every year in the wealth forecast, IWFE estimates taxes on yield and capital gains during the wealth forecast for taxable accounts. To compute taxes on yield, the Engine determines if the yield is in the form of an equity dividend or a fixed income coupon.  Federal dividend tax rates are applied to equity dividends and federal marginal ordinary income tax rates are applied to fixed income coupons. To compute capital gain taxes, IWFE first assumes that a percentage of the portfolio is sold each year in the forecast. Then the long-term capital gain rate is applied to these estimated realized capital gains.

In some instances, income from Social Security amounts is subject to taxation. This occurs if total income from all sources exceeds certain federally-defined levels and depends on filing status.

As noted earlier in this document, the most current tax laws are applied to these returns.

Forecast Results

A total of 500 individual Monte Carlo simulations are performed using all of the information entered in the plan. These individual runs are sorted separately by ending balance for each year, in order to determine the value of the portfolio at different percentile levels within the distribution of the runs.

Results are presented at the 10th, 50th (median), and 90th percentile levels for the target allocation, and the 50th percentile level for the current allocation. Percentile levels are the inverse of confidence levels. The 10th percentile represents a scenario in which the performance of the allocation is much lower than expected. The corresponding confidence level for the 10th percentile would be 90%. In other words, you should expect to meet or exceed the performance of the 10th percentile forecast about 90% of the time.

Wealth Table

The Wealth Table presents, for a specific percentile level, the beginning balance, total additions, withdrawals, investment growth, and ending balance for each year of the simulation. It is important to note that because of the way the individual simulation runs are sorted separately each year, that the values displayed for a particular percentile level for one year are likely from a different run from the previous year. For example, when viewing the 50th percentile, the values for year 2024 might be from run #372 because that was the run that fell in the middle when the runs were sorted by year 2024 ending balance. The values for year 2025 might be from run #148. Because of this, the beginning balance for one year, as displayed in the Wealth Table, will differ from the previous year’s ending balance.