Retirement calculators are the crystal balls of the financial planning world. Plug a few inputs into the box online and out pops an alarmingly detailed financial snapshot of your future.
Those inputs could be just three numbers — your age, household income and current monthly savings rate. For example, a 35-year-old with an annual household income of $85,000 and $100,000 in savings can find out that she’ll need $4,958 a month in inflation-adjusted dollars to maintain a similar lifestyle in retirement. But at her current 10% savings rate — the percentage of income she’s contributing to her retirement accounts, such as her 401(k) and IRA — she’ll come up short of that monthly amount by $1,285 if she wants to retire at age 67.
Don’t worry: Our fictitious saver needn’t be relegated to a retirement of ramen noodle dinners. A little tinkering in the calculator shows how she can make up for the shortfall with a few small adjustments, such as bumping up her savings rate by a couple of percentage points.
That’s the power behind the algorithmic tea leaves — or, more precisely, the retirement calculator below. Anyone can see how his or her financial future could play out in less time than it takes most people to calculate the tip on a dinner tab.
Want to see your financial future?
Apparently, not everyone’s clamoring for a glimpse of the financial soothsayers’ predictions, though. Nearly 60% of Americans surveyed say they haven’t ever tried to calculate how much money they’ll need to live comfortably in retirement, according to a retirement confidence poll by the nonprofit Employee Benefit Research Institute.
Peek behind the velvet curtain of a retirement calculator and you’ll see that it’s not a magic formula but common sense and informed assumptions.
Of course, it’s scary to face the unknown future. Except for one thing: It can be known, to a large extent.
The dollars-and-cents reality of the present — how you spend and save today — can be applied directly to how your future spending and saving play out. Peek behind the velvet curtain of a retirement calculator and you’ll see that it’s not a magic formula that determines your retirement readiness but common sense and informed assumptions. For example:
Future spending: Your current income and spending patterns are a good indicator of your future needs. And today’s spending translates into tomorrow’s income needs.
Most calculators assume you’ll need to replace 70% to 90% of your pre-retirement income. That number is derived from several conjectures, including:
- Expenses that end, such as supporting kids, paying a mortgage, some taxes and, of course, saving for retirement
- Expenses that may emerge, such as increased medical costs and retirement hobbies
Adjust accordingly. For example, if you plan to move to a pricier locale in retirement, you’ll want to nudge up that assumed spending amount.
Future income: Will your current investments provide enough to live off of in retirement? That’s the million-dollar question and the one that people tend to sweat the most.
Remember, retirement doesn’t mean a full stop to income generation. True, you’ll move some percentage of your portfolio into safer (slower growth) investments after you retire so that the money you need for, say, the next five years’ expenses isn’t exposed to stock market volatility. However, a good portion of it will continue to be invested in assets that will keep growing.
If you’re the entrepreneurial type, you may continue to pull in a few bucks from a hobby or part-time work. Don’t forget about Social Security but find out how much you can rely on it to supplement your future budget from the Social Security Administration’s benefit calculators.
Two of these factors — whether you work in retirement and when you decide to take Social Security — are largely in your hands, and the latter can greatly influence how much money will come in when you retire. Each year you postpone taking Social Security benefits beyond your full retirement age will yield an 8% increase in your benefits paycheck, up to a maximum increase of 24% for those born in 1960 or later.
Other factors to consider
Some other factors that impact the future include those often preset in retirement calculators.
Inflation: The worth of those future dollars will depend on the rate of inflation. The long-term average typically falls between 2% and 4%. Retirement calculators also use this average to estimate your income growth leading up to retirement, with the assumption that incomes rise at the same rate as the cost of living.
Although you might not have much personal sway over the ways of world economies, when it comes to the rate in which you save and invest those raises and bonuses, you are the supreme leader.
Investment growth: If people are asked to fill in the rate of return on their investments over time, the best they can do is base it on historical precedent — average annual returns over time.
The market has had some really stellar years lately, but there also have been some real stinkers. Opinions differ on future market performance, but assuming returns in the 5% to 6% range will put typical investors on the more conservative side of average — if you’re more wont to play it safe and skew toward the safer investments such as bonds. About 7% to 9% is considered within reason for more aggressive investors.
You’ve saved a pile of money. How do you know that it’ll be enough?
Withdrawal rate: You’ve been told to save this pile of money to sustain you in your golden years. How do you know that it’ll be enough? You mathematically back into it.
This is where the withdrawal rate — the amount of money you withdraw from an investment portfolio each year expressed as a percentage — comes in. This number needs to be high enough to provide a reasonable income, along with any other nonportfolio income sources, without putting you in danger of running out of money before you run out of life.
Based on reams of research done on withdrawal rates, the oft-used rule of thumb — and retirement calculator default — is that retirees can withdraw 4% of their portfolio each year, adjusted for inflation, without fear of running out of money.
The withdrawal rate rule-of-thumb is just a starting point. If your retirement savings coffers are starting to get low due to a few years of lackluster stock market returns or if a few frugal years have left you with extra padding in your checking account, adjust accordingly.
The future isn’t up to chance
Don’t like what you see when you plug in the numbers to calculate your future lifestyle? No need to settle for what the algorithm spits out. Now you know what goes into a retirement calculator and, therefore, know what’s in your power to change.
You get to decide many things, including where you’re going to live in retirement, whether you’ll continue to work part time, when you’ll start collecting Social Security and how aggressively you’ll invest any excess money you make before retirement.
Nothing is set in stone, so play with the possibilities to see which of the above inputs most affect the outcome and how the shifts in today’s spending, saving and investing decisions can help you change the course of your future for the better.