6 Things Retirement Calculators Get Wrong

This story, by Mark Miller, originally appeared at CBS' Moneywatch.com

The report analyzed 12 retirement calculators created by financial services firms, software companies, nonprofits, and government for consumers and financial planning pros. All but one of the six consumer calculators were free: the Fidelity Retirement Income Planner, the AARP retirement planning calculator, MetLife calculator, U.S. Department of Labor and the T. Rowe Price Retirement Income Calculator. ESPlanner, created by Boston University economics professor Larry Kotlikoff, starts at $149 per year. Unlike the freebies, ESPlanner gathers more detailed data, making its forecasts more reliable.

The free online tools, as a group, had a host of problems. "These tools take a project that is fairly complex and boil it down to something simple," says John Turner, an economist and co-author of the report. "They don't ask you to consider a lot of important variables." Some free online calculators can, however, provide a decent starting point for your retirement planning, as a MoneyWatch test found.

To get better results when you run your own numbers, look for the features MoneyWatch blogger Steve Vernon's recommends, and watch out for the following six areas where retirement calculators may be getting it wrong.

1. Social Security Projections

Most retirees get a third or more of retirement income from Social Security. Yet many retirement calculators don't gather the detailed information needed to project these benefits accurately, Turner says. "They often project Social Security income using a bare minimum of information: typically your current earnings, your age, and the year you expect to retire," he says. Although the size of your Social Security payments will vary depending on when you decide to start collecting the checks, Turner found that many calculators don't analyze this choice in enough detail.

So to get the best guess for your Social Security benefits, use the Social Security Administration's free online retirement estimator, which will give you a personalized projection using your actual earnings history.

Another problem: Turner found that many of the calculators low-ball the increases you'll get from Social Security's annual cost-of-living adjustment (COLA), which is pegged to the Consumer Price Index. "Typically, the inflation assumptions are hidden from the user," he says. "But a few do reveal to you that, for unknown reasons, they use a COLA that is less than the inflation rate."

2. Rate-of-Return Assumptions

Three of the free calculators used pre-set future investment rate-of-return assumptions that you can't change, and their percentages varied widely. One, created by the U.S. Department of Labor's Employee Benefits Security Administration, assumed a 5 percent average annual return from 401(k)s; several others assumed 10 percent.

If a calculator won't let you choose your anticipated rate of return, either be sure you're comfortable with its assumption or walk away.

The best calculators let you put in what-if scenarios, and run the numbers using alternative rate-of-return projections. Going this route can let you see how much you might have at retirement using both conservative and aggressive scenarios. While no one can predict the market's future rate of return, the long-term after-inflation rate of return on stocks has averaged 6.8 percent per year. But odds are you are not invested entirely in stocks, and the fixed-income portion of your portfolio is likely to produce lower returns. So when you're plugging in numbers, base it on your asset allocation, and consider that as you get closer to retirement, you'll want to reduce your stock exposure and boost your bond exposure. A conservative portfolio might yield more like 4 percent a year.

3. Life Expectancy

It's impossible to know how long you'll live, of course. On average, 65-year-old men can expect to live another 17 years, and women another 20 years. Some calculators, the study found, automatically input life expectancy figures. But they fail to account for differences by race, income, and gender. And they also don't take into consideration that you or your spouse might live longer than the averages. "The probability that one [spouse] will live beyond the average is pretty high," says Kirk Kreikemeier, a financial advisor and actuary who served as an advisor for the SOA study.

If a calculator forces you to make a longevity prediction, base it on your family history and your health. If you're married, use different life expectancy numbers for you and your spouse, since women tend to live several years longer than men. Several sites help you predict life expectancy; no guarantees, but try the calculators at Real Age, Livingto100 or the University of Pennsylvania's Wharton School.

4. Housing Info

The calculators make very different assumptions about what you'll do with your house at retirement. "Some assume you won't liquidate your home; others assume you will sell and downsize," Turner says. Very few of the tools analyze the impact on your finances of carrying a mortgage into retirement.

Among the free calculators reviewed, only the U.S. Department of Labor calculator lets you plug in home equity when calculating your retirement assets.

When forecasting your finances in retirement, make your best guess about how much you'll be paying for a mortgage or rent, whether you'll tap your home equity and any income you might receive from selling your home.

5. Inflation Forecasts

When it came to inflation, the calculators barely wanted to be bothered. None of the free calculators - and few of the professional tools - listed inflation as a retirement-planning risk. Some of the tools let you plug in just one percentage forecast, even though inflation can fluctuate widely over time. Others put in their own default inflation rate, ranging from 2.3 to 4.6 percent. That spread can make a huge difference in how much the purchasing power of your assets will shrink over a 25-year retirement.

Say you have $1 million and plan to retire in 10 years. With 2.3 percent annual inflation between now and then, your $1 million would be worth $796,606 at retirement. It would erode to $637,798 if inflation averages 4.6 percent, according to Inflation.data.com.

Stick with retirement calculators allowing you to input alternative inflation scenarios, and run the numbers in a couple of ways. You never know.

6. Spouses

Few of the free calculators helped couples forecast retirement income for a surviving spouse. They rarely let users enter separate information for both spouses and run numbers with differing life expectancies for them, for example. When the calculators recommended annuities for retirement income (most didn't), none suggested buying one with a survivor's benefit. Some of the calculators allow for separate entry of data for each spouse, but even these typically assume that both people retire at the same time. Spousal issues regarding Social Security benefit claims can be complex - beyond the capability of any online calculator.

If you're married, calculate retirement income needs for you and your spouse together and separately, using different life expectancy scenarios. This will help ensure that the one who lives longer won't run out of cash. "Doing the 'what-ifs' can help you see just how differently things can turn out," says Turner.

Mark Miller writes the weekly syndicated newspaper column Retire Smart, contributes to The Huffington Post, and blogs at RetirementRevised.com.

More on MoneyWatch:

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•How to Choose the Right Retirement Calculator
•Are You Saving Enough to Retire?
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•Retirement Income: New Way to Collect Checks