By Peter Mastrantuono
Several years ago a study of top online retirement calculators found a 60% variance in monthly income projections and a range in the suggested retirement income goal of 85%, according to InvestmentNews, a financial and investment publication.
Using a retirement income calculator can be highly valuable in providing you with a generalized and directional sense as to your current state of retirement preparedness, but achieving any real precision is elusive.
These calculators can also serve to prompt important discussions, such as the appropriate level of investment risk, if an early retirement is realistic and whether delaying Social Security makes sense, etc.
Critical Caveats to Consider
As one might expect, the quality of online retirement calculators varies, ranging from quite good to inadequate, with the value judgment sometimes relative to the stage of user’s life. For instance, an individual approaching retirement needs a great deal more detail and personalization in a calculator than a young worker who may find a basic calculator sufficient to determine his or her needed savings level.
Perhaps the most important caveat about these tools is the assumptions embedded in the calculations, and to what degree the user has latitude in changing those assumptions.
There are a handful of key assumptions that materially impact the results of a retirement calculation, with small differences leading to very different results over extended periods.
A perfect illustration is the inflation assumption. To ensure that a current retirement income goal maintains the purchasing power of today’s dollar, future retirement needs are grown at an assumed rate of inflation. So, for example, an annual income goal of $50,000 in today’s dollars would require an income of almost $105,000 25 years from now, assuming a 3% rate of inflation. Change that assumption to 4% and the income needed is over $133,000. The nearly $30,000 difference in projected annual withdrawals translates into a hugely different savings target for retirement.
Another assumption fraught with challenges is the investment return. Many calculators apply a consistent annual investment return, even though that’s not how investment markets behave. This introduces what is referred to as the sequence of returns risk, which occurs when individuals retire during a bear market or suffer flat to down markets for an extended period of time near to or during retirement. Some calculators try to account for this by using monte carlo simulations to arrive at a probability of success rate, but not all do.
Many tools provide little flexibility in changing planning assumptions, like life expectancy, when to take Social Security, inflation, and investment return. Many do not even provide for changing spending patterns in retirement (retirees tend to spend more in the early years than in later years) or the input of one-time expected expenses (e.g., a child’s wedding or grandchild’s college funding).
The Best Retirement Calculator
The best retirement calculator may be the retirement calculator you use with a trusted financial advisor. The knowledge and experience he or she brings can make for better decisions about the assumptions used in a retirement plan and broaden the discussion to important topics that calculators overlook (e.g., long-term care, legacy planning, etc.). And, importantly, by working with a financial advisor an individual has someone reminding them to revisit and revise the plan over time to reflect the inevitable changes in personal circumstances, financial conditions and the investment markets.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.
