By Carl Lachman, MBA, CFP®

An Important Question

            If you are approaching retirement or already retired, I am sure you have wondered if you have enough. Will my money last? Did I save enough for my retirement? Retiring from work and relying on the assets you have saved to support yourself is not an easy step to take and most people have at least a little anxiety about this change in their life. In order to get a little more peace of mind, many people try using some of the online retirement calculators that are available to double-check their plans.

Helpful? Maybe.

            There are thousands of online retirement calculators and projection wizards that attempt to help people know if they have enough to retire and how much they can spend in retirement. Some of these are very good, while others are terrible.

            Recently I taught a class near our office in Fullerton at a local community center about how to use online retirement calculators. I highlighted a couple of them and showed the class exactly how I would use them to help with retirement saving and spending decisions.

            Although I used specific online calculators in the class, I don’t specifically recommend any of them. After all, like most things available online, the good retirement calculators today will probably not be the good ones you should use tomorrow. So, I tried to help my class learn guidelines that they can follow in choosing and using online retirement calculators going forward.

They Are Not Perfect

            The first guideline I tried to impress on my class was that retirement calculators are not perfect. No matter how impressive they appear, they cannot predict the future and they will not give results that are perfectly accurate 20 years from now. Rather, the good calculators and projections can help to determine if you are in the ballpark. They are approximately helpful. They can let you know if you are headed in the right direction and if you are on-track. They can help you determine generally if you have saved enough, how much you can spend, and if your money will probably last.

Be Cautious

            Please be cautious when you try using a retirement calculator. They are not all the same and they sometimes use your data differently in the calculations they produce. Make sure you really understand how each calculator defines its terms and how it makes the calculations. The good calculators give explanations that are easy to find and understand. You may only need to hover your cursor over a term or an entry box to find out. Take the time to understand what is being asked and make sure you are entering the correct data in the right place.

            I know not everyone loves math, but please take some time to read the online explanation of what the retirement calculator is trying to accomplish. Some are trying to help you check to see if you have enough to retire, while others are written to help you not spend too much, and still others are trying to help you find the right investment mix. If you use the wrong calculator for the question you are asking, you will probably not get good guidance.

            Be willing to keep looking for the right retirement calculator. If the first one you find is not going to be helpful for you to use, then keep looking. So many exist online that I am confident that the one that will be most helpful for you is out there. But, it might take some work to find it.

Be Conservative

            If you use rosy inputs for a retirement calculator, it will give you rosy results. Don’t fall into this trap. Make sure you are conservative and realistic in the assumptions you enter. If you guess and are not thoughtful in your assumptions, you could be given very bad results by an online calculator. If you then make decisions based on those bad results, the consequences can be severe. I have seen retirees make poor decisions by relying on rosy retirement projections from investment salespeople that work on commission. Retirement projections can be made to say whatever you want them to say, so be careful.

            When I suggest conservative assumptions, what do I mean? Assume you will live longer than you think, like 95 or 100. Assume your investments are just okay, with a return like 5%. Assume inflation is a little higher than the long-term average, so maybe 3.3%. Don’t include your home or your emergency fund in your assets available for retirement spending. And, don’t guess on your Social Security, but get your real numbers from the SSA.gov website. In every input, pad it a little and be conservative.

Simpler Is Usually Better

            An overly complex retirement calculator could easily lead you astray. I have seen software that allowed approximately 250 inputs and had 100 pages of beautiful, colorful graphs and illustrations. It was very impressive, but it was dramatically more complex than needed or than could be relied upon. There were too many ways it could hide a bad assumption and then give dramatically bad results. You should stay away from retirement calculators that are too complex.

At the other end of the spectrum are retirement calculators that are a sort of “black box”. They are very simple, require a few inputs, and then spit out an answer without really explaining what is going on. It is my guess that most of these sorts of black box calculators are making a bunch of assumptions that are probably not applicable to your situation. Unless those assumptions are clearly delineated and match your situation exactly, I recommend you keep looking for a better online calculator.

Fewer Assumptions

            So, if too complex is not good and too simple is not good, what should you look for? Again, this may not be the best suggestion for your specific case, but in my experience the best retirement calculators have something in the range of 7-12 input boxes for your assumptions. This seems to be a happy medium.

            Additionally, the best retirement calculators allow a variety of Social Security inputs or adjustments. Although some will do all of the Social Security calculations for you, it is usually better to use your actual numbers from your official statement from the Social Security Administration. Look for a retirement calculator that can accommodate you entering your Social Security numbers.

            One way that some retirement calculators accommodate Social Security customization is simply to allow you to add various income streams in retirement. This is a good function if it is available and not too complex. If you are asked for a cost of living adjustment (COLA) or an inflation assumption for your Social Security, I recommend you use a number in the 2% to 2.5% range, to be conservative.

            The final input that is helpful in a retirement calculator is the ability to handle a lump-sum assumption. For instance, if you think that in 5 years you will sell your home and downsize, netting $100,000 of cash when the move is complete, that is a lump-sum of cash you will have in the future. A good retirement calculator usually allows you to include an assumption for a future lump-sum.

Pre-Tax Numbers

            It would be nice for a retirement calculator to produce gross and net results, which correctly predict your state and federal taxes in the future, but this is a pipe dream. If a retirement calculator is making assumptions about future tax rates and what tax bracket you will be in, then I suggest you not use it. How can the programmers of the calculator know what tax rates will be in the future if no one at the IRS or in Washington, D.C. has that answer? Future tax rates are too unpredictable to include in a projection.

            Rather, all of the numbers you enter into a calculator, and all of the numbers it gives you at the end, should be pre-tax. Then, you can use your tax payment experience to guess at your future taxes and estimate what you might have available for expenses after state and federal taxes are paid. If you are forced to do this thinking, it reminds you that all of this work just helps you determine if you are headed in the right direction. The calculator doesn’t know your future and it won’t get the numbers exactly correct. When I produce retirement projections for my clients, I do all of those projections pre-tax and then we discuss the range of taxes they will probably encounter. That is about as close as we try to get the results of the projections.

Run It Every 1-3 Years

            Because the retirement projections are estimates and we are not relying on them to be perfect, some might question if they are worth the effort. In my experience, a well designed and thoughtful projection with good assumptions is often rather accurate for a few years. It can be pretty close to what happens, but after a few years, then it usually starts being further and further from what occurs. So, we revisit and update retirement projections every 1-3 years in most cases. It is very helpful to go back, check assumptions, update balances in accounts, and produce a new retirement projection to see if the most important financial planning is still on track.

            Besides updating retirement projections every 1-3 years, these calculators are also very helpful if a big financial change occurs or is considered. If a career change happens, a large amount is spent out of savings, or if an inheritance is received, these are good times to update a retirement calculator and run the numbers again. Say, for instance, someone is considering $100,000 gift to a child or for a downpayment on a vacation home? Maybe taking that money out of the assets and updating the retirement projection will help everyone see what the impact on retirement will be. The projection may show that it will make a big or small difference. Rather than guessing at the result of the decision, update the retirement projection to get some real numbers.

I Tend to Avoid Monte Carlo Analysis

            The promise of Monte Carlo analysis suggests that we can estimate the probability of your retirement plan success by “rolling the dice” maybe 10,000 times. This sort of analysis takes part of the retirement calculator – like the investment returns – and randomly chooses a return within a range of returns each time it runs the calculator. After running the calculation with a variety of random numbers 10,000 or more times, it graphs the outcomes and shows what is most likely. This sort of analysis can be very helpful when used properly by a knowledgeable person. But, in my experience, there are relatively few financial advisors and even fewer members of the public that know how to correctly use Monte Carlo analysis for retirement planning. They usually jump to the wrong conclusions.

            The discussion of Monte Carlo analysis for retirement projections cannot be adequately covered in this article, but my suggestion is that you avoid it. Most people who rely on Monte Carlo analysis tend to think that if they run it once and get a good answer, they are done with their retirement planning, since the computer simulated 10,000 outcomes. I recommend that you use a more straightforward retirement calculator and run it once a year, updating it with your actual numbers and conservative assumptions. That will help you more than running a Monte Carlo calculator once with 10,000 simulations.

Do a Reality Check

            Before you finalize any financial decisions from your use of a retirement calculator, please step back and do a reality check. Maybe run the results by a trusted friend or advisor that has some math skills. Friends who are engineers are often helpful in this area, for instance. If you do some simple calculations on the back of a napkin, do you more/less come to results similar to what the retirement calculator says?

            Another way to check a retirement calculator before you rely on it is to input a simple situation with round numbers. Use numbers that you can double-check with your own simple calculations. If your calculations and the retirement calculator are in agreement, that is probably a good sign that you can start adjusting the inputs for the calculator to be more like your actual situation.

            There is very sound research to suggest that a 4% withdrawal rate from a 40% stock and 60% bond portfolio will successfully allow withdrawals for 30 years. It is a rule of thumb that is often mentioned with retirement projections, but it is not perfect. For you, however, it can help you do a reality check on your projection.

            How much does your projection say you can withdraw each year from your retirement accounts? If it is in the range of 3.5% to 5.5%, then it is probably in the ballpark. But if it is dramatically different then that range, say lower or higher, then you probably need to check and double-check the calculator before you rely on it.

Final Thoughts

            If used correctly, retirement calculators and projections can be very helpful in making financial decisions when you approach retirement or are already retired. They can truly set your mind at ease and help you with your decisions. But, if used incorrectly, they can also create a lot of pain. If you are going to use a retirement calculator, please consider the guidelines suggested in this article.

            And, if you are now convinced that using a retirement projection is not something you should attempt by yourself, please consider using a fee-only financial advisor to help with retirement planning. When new clients start working with our firm, one of the first pieces of analysis we complete for them is a customized retirement projection. And, after including a retirement projection in the initial financial plan, we almost always update it many times in future years, especially as they near retirement or make big financial decisions in retirement. If you would like to learn more about how we use retirement projections with our clients, please consider a complimentary meeting with us in-person or on the phone, and we will be happy to discuss it with you.