Estimating Retirement Income Needs – A Waste of Time?

August 12, 2008

Emily Brandon over at the U.S. News & World Report’s Planning to Retire Blog recently wondered if online retirement calculators were helpful or useless. In her post, Emily references a post by Salon’s Heather Havrilesky titled Perspire to Retire!, in which she basically blames online retirement planning calculators for screwing up her retirement plans:

…one day I decided to try out an online retirement calculator, just to reassure myself that we were well on our way to not just a secure financial future but also a rosy one. I plugged in my age (38), my current retirement savings (respectable), my desired income upon retiring (50K) and a few other figures, and pressed “calculate” with a little smile on my face, ready to be praised for my prudent savings and congratulated on the happy, golden years ahead.

Instead, I read these words:

“To retire with an inflation-adjusted retirement income of $50,000 for 20 years would require $3,075,744.65 in savings by the time you retired at 65. You need to save an additional $47,613.58 each year to reach your retirement goal.”

Sweet Jesus. Three million dollars? Forty-seven thousand dollars a year? How is that even possible?

I don’t know what numbers she was plugging in because I got nowhere near the numbers she claims the calculator gave her—no matter how much I played around the with calculator. I did notice the retirement calculator’s default inflation rate is 4%, which seems a bit high based on the long-term historical average. I even plugged her info into my retirement planning calculator and I got nowhere near her numbers.

Anyway, I don’t think retirement planning calculators are useless. Just because they say people need to save more than they think they do, doesn’t make them bad. I mean, would you rather have a false sense of security rather than the truth? People NEED TO WAKE UP and realize that retirement will be more expensive than they think it is—especially if they want to do more than hang out at the local bingo joint.

I guess my point is: don’t let them get you down. Save as much as you can and DON’T WORRY ABOUT IT!

19 responses to Estimating Retirement Income Needs – A Waste of Time?

  1. I think the best purpose they serve is to open people’s eyes. There are so many variables that go into what someone will need for retirement that even the most complex calculator won’t provide accurate numbers. But, I think it’s good that someone plugs in their numbers only to stare at the screen in disbelief.

    Hopefully it is in this brief moment they decide that they need to consider saving even more. Sure, they might not ever save up to the amount the calculator says, but the more they can save, the better.

    So I think you’re right. Save as much as you can, and don’t get caught up into what someone or a website says you need to have. The worse that can happen is you save more than enough and can live even better or give it away to charity or to your heirs.

  2. If Emily would read Kotlikoff and Burns’ new book, Spend ‘Til the End, she would find that she is absolutely correct that trying to estimate retirement income needs is a waste of time. As they point out, what she most likely wants to do is equalize her discretionary spending power over her lifetime.

  3. As retirement calculators go, I’ve always been impressed with firecalc. It seems to be the one that makes sense to me, and has a pile of variables that you can play with to see how you would have fared over the past periods.

    I think where that calculator is going wrong is that it assumes all investments are in a taxable account which reduces the returns drastically. If you invested in a tax efficient manner the number that you need to save each year drops dramatically.

  4. Dave,

    I’m working my way through “Spend ‘Til the End” and I’m not so sure I agree with what they say. I think people need to use balance with their planning.

  5. “I did notice the retirement calculator’s default inflation rate is 4%, which seems a bit high based on the long-term historical average.”

    4% is on the low side in my opinion. 4.5% to 5% would seem more appropriate for retirement planning. If you were retired for the past 35 years, you would have experienced average inflation of over 4%. Moreover, it may not make sense to plan based on extremely long averages because higher and lower periods went into creating those averages. It’s more important to consider what the likelihood of experiencing an unfavorable period would be.

    As far as retirement calculators go, most do not take into account variable investment returns and timing of cash flows. Generally, longer time horizons and higher return expectations result in a wider range of possible outcomes, making them less accurate.

    As an examples, if you start saving an a bull market and retire at the beginning of a bear market, you could have a favorable “average” return for one of these calculators to work but still run out of money. Most calculators do not account for any bad-timing scenarios, which commonly derail people’s retirements in reality.

  6. Factors determining lump sum:
    Current Age – 38 (given)
    Retirement Age – 65 (given)
    Desired Income – 50k (given)
    Live to – 92 (assumed)
    Inflation – 4% (assumed constant)
    Post retirement ROR – 6% (assumed constant)
    Total needed: 3.014M (<1% off)

    As you mentioned, inflation may be a little high, but to get to 50k/yr retirement funds w/o depleting principal, you’ll need a good chunk of change, so I buy this number

    Now, where it gets fun.

    How much has she “respectably saved”
    Assuming 8% ROR held and 28% tax bracket she has saved roughly $30k. To this generation, that is a “Respectable” amount of savings.

    She can either tighten her belt and get serious if she wants a trust fund to pass on, admit that her retirement will involve lifestyle or principal reduction, or both.

  7. J,

    I thought the same thing as you as far as the “respectable savings” goes but I didn’t want to hurt the author’s feelings. That said, although $30,000 is more than a lot of people have, I would hardly call it “respectable.”

  8. It may be a crap shoot thrying to determine what you might need in retirement, but you should try to shoot for something!

  9. Heather Havrilinsky is a humor writer who uses exaggeration for effect, which I suspect is what she did here.

  10. I used the metlife retirement age calculator and it told me that I should start to taking social security when I’m 78 (but the calculator really isn’t designed for me – the lowest age it will let you enter is 40).

    I agree with Jeremy and JLP – these calculators aren’t useless. They get people thinking about retirement income needs, and they also serve as a tool that drives conversations (and business) to financial professionals.

    In my experience, career agents, wholesalers, advisors, and financial planners all love these things because most complex financial products cannot be sold online – you have to actually talk to someone. These calculators serve as door openers.

  11. I practice David Back’s concept from his book Automatic Millionaire. In it he says in order to retire comfortably or a millionaire by the time you reach your retirement age, you need to automatically deduct a certain percentage from your monthly salary (10%-20%) straight to your retirement fund. These retirement fund can be invested in a mutual fund and hopefully, thanks to compounding you’ll reach more than a million by the time you’re 60 or above.

    The key here is “automatic”, you may want to inform your accountant do automatically deduct it from your salary and transfer it your retirement fund. You know the saying, you don’t spend what you can’t see.

    Fix My Personal Finance

  12. yes, I agree the post, people who are not having awareness about retirement life they have to be careful, retirement income is very important that time we couldn’t able to do lots of work for earn money, that time some people having some health problem also we need money to meet these all, so be careful to plan about your retirement income

  13. I agree that you just need to save what you can and don’t worry about it. Life’s too short as it is and there are too many things to worry about already. Besides, by the time I retire, the retirement age will be 80-something. (I’m guessing, but with the way things go, I wouldn’t be surprised if I’m still working well into my 70s.)

  14. I’ve played around with creating my own ret calculator in Excel (based on ripping off the model my fin’l planner uses). In messing around with the variables, one thing becomes abundantly clear: I will either die penniless or obsenely wealthy depending on some very small variances in assumptions for inflation, returns, taxes, withdrawl rates, etc. What that tells me is that Monte Carlo simulation is probably the best way to appraoch the question, so that you get confidence intervals taking into account all the possible scenarios. I haven’t figured out how to do that in Excel yet.

    At any rate, what I really think is that the key to a successful retirement is creating balance, flexibility, and safety nets. I think you will need a mix of income sources & invmnts, some cash reserves, some insurance, etc. And you will need a good enough mix so that a disappointment or shortfall in one area can be made up with adjustments in another. In addition, non-monetary issues like family situation, community resources, etc. play a big role. Who might be dependent on you, and who might you be able to depend on, will greatly impact your resources or lackthereof.

    I think the “looming retirement crisis” is somewhat overblown. While it is true that many, many boomers are little prepared, I think the bottom-line is that people will have to work longer than they think, live at a lower standard than they think, and ultimately shift the burden to their family/children.

    For better or worse, I think most people (that being those people who do not read AFM) subconsciously figure their [adult] kids will be their ultimate retirement vehicle if all else fails. I see it over and over again – its the 2 ton elephant in the room that most PF writers don’t talk much about. When people say they are not going to worry about it… [fill in the blank: “the lord will provide, I’ll manage somehow, its too depressing and I can’t think about it, thats why I play the lottery, maybe I’ll get an inheritance, etc”.] what they really mean is that “I will probably become a burden to my children who will have to jepordize their own financial futures because I did not take care of my own though I would never actually allow such a harsh reality thought to enter my thick skull”.

  15. Miguel,
    I saw a presentation from a financial planner who had put together a probability-based retirement planning spreadsheet that used Monte Carlo simulation. This was at a Crystal Ball user’s conference (Crystal Ball is a software program that integrates with Excel and enables you to put probability distributions into individual cells and run Monte Carlo simulations.)

    He had a pretty slick setup that used probability distributions for things like expected return from stocks and bonds, inflation rate, and so on. After seeing that, I’m not impressed with most retirement calculators I run across. Of course, he was charging big bux to put your numbers into his program, but he was able to say things like “this investment program will have a 95% probability of meeting your retirement income needs”.

  16. I’m pretty sure she’s just inventing numbers for comic effect.

    From the article: “Someone who has saved a million dollars by age 38 should be congratulated for being able to live off $50,000 a year in 20 years, with enough left over to buy a car?”

    The math here is obviously wrong, since someone with $1,000,000 who could live off $50k/yr could essentially retire immediately. A 4-5% withdrawal rate is usually considered pretty safe.

  17. This is really inaccurate analysis. In today’s environment $50,000 could be generated from less than a million bucks, with funds left over for reinvestment.

    Check my many articles on investing for income.

    Steve S

  18. For a retirement income of $50K PER MONTH the numbers are plausible.

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