The Hidden Benefits of Using a Retirement Calculator

Here’s what you need to know about online retirement calculators, which purport to take your personal information and tell you exactly how much money you’ll need down to the dollar: they are wrong. Flat out wrong.

The truth is, there isn’t a calculator on earth that can tell you how much money you need for retirement,  no matter how many factors you plug in: spending, life expectancy, rate of return, inflation. There aren’t any financial advisors who can, either. The best anyone can do is estimate, because there are so many unknowns. You can’t predict how long you’re going to live, how the value of the dollar will change and how much your investments will grow. There’s no way to foresee unexpected expenses or peek into the future, where you’re working much longer than you had planned.

Two elderly people use a calculator

Image Source: Getty Images

But that doesn’t mean these retirement calculators are completely worthless. Here’s a brief overview of how to use these online tools to get the best estimate possible and how to interpret the results that these handy resources spit out.

How do retirement calculators work?

Retirement calculators typically look at the same data. Key factors include:

  • Your life expectancy
  • Your expected retirement age
  • The rate of inflation
  • Your expected investment rate of return
  • Your expected retirement expenses

The trouble is, each of those factors is unpredictable. So calculators do the only thing they can do: estimate based on historical data. For example, many basic retirement calculators assume a 3% annual inflation rate, because that’s what you get when you average year-over-year inflation from the 1920s to the present. But actual inflation rates vary wildly each year. In 1979, the inflation rate was more than 13%. While spikes this severe are uncommon, even a single percentage point can impact how much you need for retirement savings.

If you estimate you’ll need $40,000 annually for living expenses over retired 20 years and you figure in a 3% annual rate of inflation, you’ll determine that you need about $1,075,000 in total. But change the average inflation rate to 4%, and you now need $1,191,000 — an additional $116,000. Not exactly peanuts.

Some calculators automatically input a 3% annual inflation rate. If the historical average turns out right, you might get an accurate measurement. But historical data can’t accurately predict future trends; if you just take the retirement calculator at its word, you could end up with far less than you actually need.

A similar scenario could play out if your calculator automatically assumes the rate of return on your investments. If it figures high, you may think you’re on track for your retirement goals, but if your portfolio then underperforms, you would soon realize that you’re not as prepared as you thought.

The best retirement calculators enable you to play around with inflation and rates of return, to get low and high estimates of how much you might need. And you’re always free to manipulate the numbers for your life expectancy, retirement age, and living expenses in retirement. Calculating a low estimate and a high estimate and then planning using that range is a good way to improve the likelihood that your planning and saving is on target with what you’ll really need.

Some calculators may take more data into account than the information listed above. Some include average healthcare costs . Medical cost inflation often outpaces the standard inflation rate, so calculating this separately will provide a more accurate estimate. Some tools also enable you to factor in the income you’ll receive from Social Security and pensions.

Make the most of retirement calculators

You can pretty much guarantee that any retirement calculator will give an inaccurate estimate, but there are still many advantages to using them. You can try different scenarios to see how certain changes play out, which can help you perfect your retirement planning. You’re able to see how your savings goal will be impacted by different events such as working longer, changes in spending, or living even longer than you expected.

It’s best to try a few calculators; adjust the inflation rates and investment rate of return up and down. If you want to be conservative, aim for the highest estimate you receive. It’s always good to have a cash cushion because you never know when an unexpected expense might arise or when your retirement portfolio may take a hit. Plan for retirement using a range of a low estimate and a high estimate, so that you fall somewhere in the happy, comfortable middle. Not too poor, not too rich, but just right.

Don’t get complacent once you have your first range of estimates from a few retirement calculators. Run the calculations again every few years. New historical data may indicate a different average rate of inflation or investment returns than you had calculated previously. Keep adjusting your retirement savings goals to keep up with the latest information and pay attention as previous unknowns impacting your retirement become certainties.

No matter what you do, planning for retirement is always going to be a shot in the dark. Retirement calculators can help, but only if used the right way. Recognize them for what they are — a flawed estimate– and periodically reassess your goals to stay on track. Most importantly, getting familiar with using these calculators and habitually going back to them will keep retirement planning in the forefront of your mind, a hugely important benefit.

5 Simple Tips to Skyrocket Your Credit Score Over 800!
Increasing your credit score above 800 will put you in rare company. So rare that only 1 in 9 Americans can claim they’re members of this elite club. But contrary to popular belief, racking up a high credit score is a lot easier than you may have imagined following 5 simple, disciplined strategies. You’ll find a full rundown of each inside our FREE credit score guide . It’s time to put your financial future first and secure a lifetime of savings by increasing your credit score. Simply click here  to claim a copy 5 Simple Tips to Skyrocket Your Credit Score over 800 .

The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Zeen is a next generation WordPress theme. It’s powerful, beautifully designed and comes with everything you need to engage your visitors and increase conversions.

Wealth Empire Newsletter
Register now for free updates and alerts

Subscribe By

Note: I have the ability to revoke this permission at any time and ask for the removal of my personal data collected by contacting us or simply clicking Unsubscribe.