How Retirement Calculators Work

Disclosure: This article is written for entertainment purposes only and should not be construed as financial or any other type of professional advice.

Every once in a while, I happen upon a retirement calculator online and check to see whether I have saved enough money. Generally, results indicate that I am on track for a reasonable retirement; in some cases, my score illustrates that I have saved too much already.

I’ve socked away a lot of money through early stock investing, frugal living, and good fortune. But that doesn’t mean I’ll skate through retirement without having to pay much attention to my finances. Still, plugging numbers into a retirement calculator helps me to stay calm about the future and consider actions that could improve my retirement planning.

Retirement planning tools can be helpful in getting started and considering where I might improve. Here’s a look at retirement calculators, the methods they use to formulate recommendations, and their benefits and limitations.

Retirement Calculators at a Glance

Retirement calculators vary in their complexity. But they all serve a similar purpose: dispense action-oriented tips to guide me in achieving a well-financed retirement.

Here are several retirement calculators to explore:

How Calculators Formulate Recommendations

Retirement calculators determine whether my current savings rate is sufficient to support living expenses in retirement.

They gather input that includes financial information I enter and assumptions about factors that affect my finances. They use financial formulas to project the value of my nest egg at retirement and determine whether my investments will support my intended lifestyle — typically based on whether I’ll need the same as or more or less than my current income.

Recommendations may indicate that I’m a) on track for retirement and should stay the course with my current plans or b) not on track and need to save a specific dollar amount to achieve my retirement goals.

Basic Components of Retirement Calculations

Some retirement calculators ask me to fill in the blank for as few as five or six items while others allow me to enter data for 10 to 20 fields.

The main components to assessing my retirement readiness are:

  • current age
  • age at retirement
  • current income
  • expected income and living expenses, generally in comparison to my current income
  • the amount saved already
  • the amount (or income percentage) I’m saving now

Assumptions of Retirement Calculations

Many calculators make assumptions about finances and spending power in retirement, which may be indicated in the fine print. For example, they may predict that my investment returns will be 6% or the inflation rate will be 3% annually.

These guesses are necessary to calculate how savings could grow and sustain my financial needs, but they may or may not reflect my retirement reality.

Here are categories of common assumptions:

  • life expectancy: this figure, combined with my age at retirement, helps forecast the number of years my retirement savings should generate income
  • Social Security benefits: calculations may or may not take Social Security income into account
  • inflation: the inflation rate may or may not be factored in results; this number could be significant both while saving for retirement (possibly boosting income and thus savings in terms of absolute amounts) and during retirement (reducing the value of my investments and the spending power of my withdrawals)
  • investment growth rate: this rate represents the anticipated average yearly growth of my investments prior to retirement when accumulating wealth and during retirement when investments may continue to advance even as I withdraw money for living expenses
  • income growth rate: this rate equals the growth of my salary and/or income from merit raises, promotions, and growth in business profitability — which affects my ability to save more of my income for retirement

Some calculators allow me to predict these numbers myself. For example, I may guess how many years I’ll live in retirement or estimate the inflation rate.

It’s good to know what these assumptions are, so if my situation or economic conditions deviate from original expectations, I’ll know how to adjust retirement preparedness actions.

Retirement Things Not Considered

Most retirement calculators don’t consider all aspects of my financial life. Here are a few items that may be omitted from calculations:

  • pensions: income from a pension can reduce the amount needed to accumulate in investments; though many people don’t have pensions, about 15% of private-sector employees and 75% of public-sector employees are covered by a pension
  • income in retirement: similar to a pension, income from a part-time job or business can supplement earnings from investments
  • major one-time expenses or windfalls: periodic anomalies, like a grandchild’s tuition bill or a large inheritance, often aren’t considered in standard calculators, which rely on predictable, consistent income streams and living expenses
  • taxes: taxes can affect expenses significantly but can be difficult to forecast

Many retirement calculators seem to assume that I’ll rely solely on investments to produce income in retirement. Notably, Financial Mentor’s Ultimate Retirement Calculator considers various sources of post-retirement income.

Benefits and Limitations of Retirement Calculators

A retirement calculator can give me a general idea of whether I’m saving enough for retirement. It can also provide a tool for examining “what-if” scenarios.

Start by Examining Results for Usefulness and Consistency

I was curious about the usefulness of calculations and the range of results. So, I experimented with the calculators mentioned earlier using a common set of inputs (when possible) and compared the recommendations.

Here are the figures I plugged in:

  • Age: 50
  • Retirement Age: 65
  • Life Expectancy: 105
  • Annual Earnings: $90,000
  • Retirement Savings Annually: $22,000
  • Retirement Balance to Date: $600,000
  • Investment Return: 6%
  • Inflation Rate: 2%

Here are the results:

  • Fidelity scored my readiness at 120+ (with a score of 100 or more indicating preparedness)
  • Bankrate indicated that my savings plan was “on track” as long as I saved at least 8% of my annual earnings
  • MSN Money indicated that my current plan would allow me to meet my goals
  • Vanguard indicated that I may have enough money at retirement to generate my desired income
  • Financial Mentor produced a spreadsheet showing a possible savings surplus

All of the retirement calculators indicated that I was on track to fund my retirement at my current savings rate. Specific results differed because the requested inputs and assumptions varied.

Consider Caveats and Commentary

I enjoyed (really!) learning about the caveats and commentary presented by the publishers of retirement calculators. These are found in the “fine print” and similar sections generally positioned below your results.

Here are cautions to consider when depending on calculations:

  • investments may decline in value
  • higher returns may mean higher risk and greater loss
  • investing in index funds won’t return the index returns due to investment fees
  • pensions may not keep pace with inflation
  • I may have higher costs than anticipated due to health care expenses and other expenses you haven’t yet imagined
  • tax rates are subject to change

From a more positive perspective, certain calculators offer insights that could help me achieve greater retirement readiness. Practical recommendations include automating savings, allocating investments to stocks to capture growth when I’m younger, and working past the traditional retirement age (enabling me to save more prior to retirement and spend less over fewer years in retirement).

Depending on one’s retirement planning to date, this information could be just as helpful as the recommendations about appropriate savings amounts.

Understand Benefits and Limits of Retirement Calculators

Retirement calculators can guide me in making basic preparations, but they rely on the accuracy of the information that is not completely knowable.

Some numbers, such as my age and the current value of my retirement accounts, can be pinpointed with accuracy. Others, such as investment returns, inflation rates, and life expectancies, are impossible to forecast with certainty. These influence results so it’s appropriate to be thoughtful (and prudent) about choosing them and helpful to understand how they affect calculations and planning recommendations.

Through this exercise, I’ve learned I shouldn’t home in on a number and halt planning after I get a desirable result from one or more retirement calculators.

I should use them to perform what-if scenarios. For example, by changing my inputs, I can see what happens if I … retire later, earn lower than hoped-for investment returns, save more monthly, lower my living expenses, experience greater than anticipated inflation, or generate a small income in retirement. Looking at these calculations can help me to stay the course in saving for retirement and be creative in planning for the future.

Retirement calculators can give general guidance regarding my current savings rate and demonstrate how certain financial factors influence my future. They can’t predict with 100% accuracy how much I must save to live as I please in retirement. I’ll use these tools to aid, not replace, more traditional planning.

5 responses to “How Retirement Calculators Work

  1. You say, “your investment returns will be 6% or the inflation rate will be 3% annually”. Do you think this is right? I always estimate 1 to 2%. Do you think I’ll be in trouble estimating so low? The economy has been so bad lately.

    1. I’m not predicting investment returns or inflation rates. I am stating what a retirement calculator’s assumptions may be — you can check assumptions of retirement calculators by looking at default numbers (prefilled information) and/or reading the fine print.

      It’s helpful to look at the quote in context:

      “Many calculators make assumptions about your finances and spending power in retirement, which may be indicated in the fine print. For example, they may predict that your investment returns will be 6% or the inflation rate will be 3% annually.

      These guesses are necessary to calculate how your savings could grow and sustain your financial needs, but they may or may not reflect your retirement reality.”

      You’ve got to fill in the numbers to do the calculations. Then, you’ve got to figure out how realistic the assumptions are. That’s what’s tricky about retirement planning.

      As for me, I’m trying to plan my finances around what I think could happen and then adjust for worsening scenarios like a high inflation rate and below-average performance in investments. My main point is that you need to understand your own and retirement calculator assumptions in order to use them wisely.

      Thanks for reading!

  2. I would say that the results of your test case are wildly optimistic. When I run your numbers through the retirement calculator at ORP says that your maximum annual spending will be $62,000. ORP assumes that your savings are in a 401k with withdrawals reaching into the 25% tax bracket. (ORP computes your personal income taxes). You cannot sluff over taxes in retirement planning. You omitted Social Security benefits which are fundamental to any modest plan such as this one. Soc Sec provides an annuity income and more importantly, insurance against longevity risk.

    1. Thanks so much for commenting and pointing to the ORP tool. It is definitely more detailed than most of the calculators I referenced. And I love that you can specify whether assets are held in Roth vs. traditional accounts.

      In some cases, the other calculators consider Social Security benefits but don’t allow you to enter your particular number. The main thing I wanted to illustrate is that there are many assumptions that the calculators make — so it can be helpful to be aware for these assumptions and then adjust planning based on reality (which may or may not be relevant to the assumptions).

      In regard to taxes, as I mentioned in the article, they are important but can be difficult to forecast — unless you take a very detailed view (it’s something I’m doing but didn’t cover in depth in this particular article on how retirement calculators work). Going back to the ORP tool, being able to segment assets based on taxation is helpful. Thanks again for pointing it out.

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