Weighing Retirement Calculator Options

By Patty Kujawa

Oct. 4, 2010

With all the uncertainty about retirement readiness, figuring out how much employees have accumulated for retirement is becoming a big deal.

The Profit Sharing/401k Council of America’s (PSCA) September survey of 931 plans with 8.6 million participants showed 30.7 percent of plans offer some type of retirement calculator. That’s up 8.6 percentage points from 2005.

It’s part of a push plan sponsors are making to ensure employees are better educated during these uncertain times, says the PSCA’s president, David Wray.

“Participants come to the (defined contribution) system very unprepared,” Wray says. “Companies have definitely stepped up education assistance to participants, and this is one way they are doing it.”

Experts say coming up with an exact retirement nest egg is very difficult considering all of the variables needing to be combined. And while retirement calculators are giving many users a good start in figuring out their financial needs, several experts say these programs need to better address key planning issues.

Certain factors, such as rates of return on investments, life expectancy and Social Security estimates, could be handled better so users can get a more accurate picture of their finances.

John Turner, director of the Pension Policy Center and author of several studies on publicly available retirement calculators, says these sites should send users to the Social Security Administration’s website to calculate their benefits based on their own earnings history. Social Security is one of the key factors in determining a total retirement package, and many of the free sites Turner studied use a worker’s most recent earnings to determine Social Security benefits.

Using the most recent Social Security earnings could be really off for younger workers because it doesn’t account for earnings growth over time, says Kirk Kreikemeier, actuary and director for a retirement calculator study conducted by the Society of Actuaries. Going to the Social Security website would be “a fairly simple step that would go a very long way in getting people to get the proper estimate,” Kreikemeier says.

But when a user goes to a secondary site, they might not return to the retirement calculator provider’s website, says Stuart Ritter, vice president and financial planner for T. Rowe Price. While it’s true users could spend more time inputting better, more detailed information like Social Security, most calculator providers don’t want to risk losing a user because of lost interest or lack of time.

“Some people want a quick, ballpark answer,” Ritter says. “A lot of people don’t want to take an additional step.”

Turner’s research shows many calculators ask users to figure a rate of return on their investments. Several sites allow people to enter whatever they want, including annual return rates of 20 percent. The percentage that people input is used to calculate the lump sum, and there have never been multiple consecutive years where a 20 percent return on investment would be considered the norm, Turner says.

“Unsophisticated users typically overestimate rate of returns,” Turner says. “It’s possible they could do much worse than what they put down.”

And many calculators assume people will live until 95—even though the average U.S. life expectancy is about 78 years—so the life expectancy component of the retirement equation gets skewed as well, Kreikemeier says.

Turner and Kreikemeier prefer calculators that use a Monte Carlo approach to return on investments. While it’s known for its swanky gambling casinos, the term “Monte Carlo” is also a mathematical tool that implements a random sampling of numbers to get an approximate answer. In this application, Monte Carlo assumes no one can predict future markets, so it takes into account thousands of different scenarios, including previous historic bull and bear markets to come up with a possible average rate of return.

T. Rowe Price has used the Monte Carlo approach since 1999. The program explains the technique, but doesn’t detail rates of return. Users go through five main steps, answering questions including age, annual income, expected retirement date and other possible sources of retirement income—including Social Security. The data are compiled, and the user receives a results page showing a projected monthly estimate of assets and a projected monthly amount that might be needed. Users can readjust specific factors and get a second set of results.

Turner says Monte Carlo is a large part of the retirement equation because it considers probable ranges of return, and not a straight average rate. More online calculators are starting to incorporate this method, he adds.

“If you put in a fixed rate, say 7 percent, it seems like a reasonable average but it’s possible you could do much worse than that,” Turner says. “The Monte Carlo approach recognizes that.”

Turner adds that while improvement is needed, online calculators have come a long way and are a good starting point for many workers.

“I’m hoping to be helpful in improving calculators,” Turner says. “I recognize calculators face really difficult issues.”

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Patty Kujawa is a freelance writer based in Milwaukee.

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