As a CFP® whose work focuses on retirement planning, it is very common that I sit down with individuals and couples who have started their retirement process by turning to online retirement calculators. They are often very concerned and confused when a calculator on one site gives them a very favorable answer and a different calculator gives them a completely different one. Why the disparity? Aren’t these just simple mathematical formulas? Most retirement calculators use similar mathematical models to derive their results, but the variables that are used in those formulas may be very different, creating a wide swing in results that can be downright scary.
After reviewing several retirement calculators from various online websites, the inputs typically asked for are some or all of the following:
- Age/Date of Birth
- Current Income
- Current Nest Egg Value
- Savings Per Month
- Other Income Sources in Retirement (Pensions, Social Security, Annuities, etc.)
- Retirement Age
- Expected Rate of Return
- Income Needed in Retirement
- Expected Inflation
Although I am confident nobody knows the future with any degree of certainty, I do think most people could answer the first six questions with a fair degree of accuracy. However, it is items 7, 8, and 9 which can create such variability in the results of these calculators. Let’s see why:
- Expected Rate of Return – Although we can use history to guide our expected rate of return based on our current investments, there are several problems with doing this for retirement calculations. First, finding an average return may be easy to do, but it is just that, the average. Your actual return could be significantly more or less based on taxes, fees, expenses, and good old-fashioned luck. A 2% swing in the expected return of your portfolio can create a large swing in income in retirement. Second, your portfolio should change and grow more conservative as you age. No financial calculator I have seen accounts for lower returns later in retirement due to a more conservative portfolio.
- Income Needed in Retirement – Although this looks like a variable that can be easily estimated, the truth is that your income needs will change through retirement. Most retirees find their household expenses fall significantly as they age (with the exception of medical) and their lives slow down. Assuming a 90-year old will spend as much as a 65-year old is a mistake that can greatly affect your numbers. It is important to account for declining spending and most retirement calculators do not. This will create an overestimation of savings needed.
- Expected Inflation – This is perhaps the biggest concern of all. Inflation is an extremely important factor in retirement and this one variable may have the biggest impact on your online calculator results. We all know that costs go up over time. What was the price of a stamp 20 years ago? A movie? A gallon of milk? If we plan for a 20-year retirement and don’t account for inflation, we will be pinched by ever rising prices, especially of large expenses like property taxes. Many online retirement calculators do not even ask for an expected inflation rate and will use their own assumption of anywhere from 2-4%. However, that variability can make a huge difference in your results. A 4% inflation rate can devastate a retiree whose income is mostly pension based and remains fixed for the entire length of the retirement. This can create overconfidence in the early years of retirement and a crippling shortfall of income in the later years.
Online retirement calculators are good resources as a guide, but it is important that retirees and potential retirees understand their limitations. They are only as good as the variables entered and many of those variables are unknown. A good fee-only retirement planner will perform a calculation based on your specific circumstances and will stress-test those results against many “what-if’s”, such as investment underperformance, high inflation, and many other unknown factors. The cost of a retirement planner is more than offset by the cost of a mistake in an assumption at the beginning of retirement. That mistake could cost you the comfortable retirement you have worked so hard for.