[UPDATE: In 2017, the highly rated financial-planning software MoneyGuidePro® became available to SMI premium-level members. It has more expansive features than any of the planning tools mentioned below. To learn more, read An Exciting New Opportunity for SMI Members: Personal Financial Planning via MoneyGuidePro®.]
When it comes to retirement planning, there is a lot of emphasis on determining how large a nest egg you're likely to need, and how much you need to save each month to reach your target amount. But another element needs to be considered: How much monthly income that nest egg will be able to provide during retirement.
This is a topic Austin explored with a detailed cover story in April 2012. He used a hypothetical couple (Jack and Sara Rogers), both age 65, who had an $800,000 nest egg. They needed $75,000 a year to live on, and wanted to increase that withdrawal amount by 3% annually to account for inflation. After factoring in Social Security and a modest pension, they would be looking to their savings to supply $52,000 (6.5% of their nest egg) in their first year of retirement.
Austin counseled caution in estimating life expectancy, choosing to make sure their savings would last 30 years. He calculated they would be able to withdraw only $40,000 (5% of their $800,000) the first year in order to have a high probability of not running out of money before the 30 years was up.
Austin did his analysis with the aid of historical market data that the average person may not have access to, plus a lot of spreadsheet number crunching. The good news is that several free online calculators can do similar analyses. Not all are equally robust, however, so we put a few of them to the test to see which seem to be the most helpful.
The Department of Labor
The U.S. Department of Labor (DOL), which has oversight for workplace retirement plans, believes many people would be surprised to learn how little monthly income their nest egg may provide. The DOL is considering requiring plan managers to print estimates on statements showing employees how large a nest egg they're likely to build if they continue on their present course, and how much income that may generate. The hope is that such estimates may shock people into saving more.
But you don't need to wait for that requirement to go into effect. The DOL's Lifetime Income Calculator is available online right now. It's simple to use. You need only five pieces of information: your intended retirement age, current amount of retirement savings, how much you save each year, number of years until retirement, and the date of your most recent retirement plan account statement.
The DOL calculator assumes a person's entire nest egg will be used to purchase a no-load annuity. Using the same data Austin used for Jack and Sara, the DOL calculator said their nest egg could provide $50,500 in income the first year, much more than the $40,000 that Austin came up with. However, that figure comes with a huge risk — it's based on only one life with no survivor benefit. Opting for the calculator's other choice, a joint annuity with a 50% survivor benefit, the calculator says the couple could initially start out with $45,700 per year, which would drop to $22,850 after the first spouse dies.
As for the nest egg's rate of return, the DOL says it assumes a growth rate equal to the most recent 10-year constant maturity Treasury securities rate, or 1.63% as of December 2012.
While it's an admirable goal to show retirement savers what amount of income various-sized nest eggs are likely to produce, SMI would never recommend putting 100% of one's retirement savings into an annuity. And if the calculator does not build any inflation adjustment into its income figures (which wasn't clear from the site), that's a significant problem.
Vanguard's Nest Egg Calculator assumes you are now at retirement age. It asks for the size of your portfolio (which you'll have to project separately if you are not currently at retirement age), how many years you need it to last, how much you plan to withdraw from the portfolio each year (factoring in an undisclosed annual inflation adjustment based on historical inflation data), and how you plan to allocate your portfolio between stocks, bonds, and cash.
It then uses "Monte Carlo simulation" to calculate the odds that your portfolio will last as long as you need it to. Such simulation uses historical market data to run hundreds or thousands of scenarios to estimate the likelihood of success. You can change the variables to run many different what-if scenarios.
After we entered all of the data for Jack and Sara, Vanguard's calculator said they should limit their first-year withdrawal to only $30,000. That would, theoretically, boost the probability of their money lasting 30 years to 96%.
Fidelity's Retirement Income Planner (with the unfortunate acronym "RIP") is similar to Vanguard's, but it reports its findings differently. It estimates that Jack and Sara's portfolio will last only until age 85 if they begin with a first-year withdrawal of $40,000. As with the Vanguard calculator, reducing the annual withdrawal to $30,000 should enable the portfolio to last until age 95.
T. Rowe Price
The T. Rowe Price Retirement Income Planner provided Jack and Sara with the most pessimistic outlook of all. It said withdrawing $40,000 per year would give them only a 51% chance that their money would last to age 95. It suggested reducing the first year's withdrawal to $31,860, which would increase the odds of success to 80%, which Price described as "a good number." Still, a 20% chance of their portfolio not lasting as long as they need it to seems uncomfortably high. Reducing their initial withdrawal all the way down to $24,000 was required to boost their likelihood of success up to 97%.
Why the big disparity?
Clearly, retirement planning is an imperfect science. There are many reasons why the calculators differ from each other and from Austin's analysis, most having to do with the underlying rate-of-return assumptions used in each approach.
Austin used historical market data going back to 1946, whereas Vanguard's period went back to 1926. T. Rowe Price didn't say how far back its data went, but said it used a long-term growth rate of 4.9% above inflation for stocks. That company also explained that its analysis included not only historical market data but its own estimates of reinvested dividends and capital gains. There were differences as well in how investment expenses were treated.
Austin was able to add some important nuances to his analysis that aren't available with these online calculators — such as changing the asset allocation to become more conservative as Jack and Sara get older, and evaluating the impact of a down market early in retirement. However, it's noteworthy that the online calculators produced even more conservative estimates than Austin's, even without incorporating those factors.
Which approach is best? It's impossible to say. The best anyone can do is plan conservatively, understand the assumptions used by each calculator (when disclosed), and rerun the numbers regularly — we suggest annually once you're in retirement. Be sure to find out how much Social Security is likely to provide and make the decision about when to begin receiving benefits with great care. And don't assume you'll be able to continue working for income during retirement. Far more people think they'll be able to do this than usually turns out to be the case.
For many people, running their retirement numbers will reveal their need to save more. If using these calculators motivates you to increase savings, spending time going through the process will have been well worth the effort.