John A. Turner
John Turner directs the Pension Policy Center where he analyzes pension and Social Security policy.
When average Americans confront the complicated problem of how much to save for retirement, they often use so-called “rules of thumb,” or greatly-simplified approaches, to figure out how much to save and how to invest. It turns out that many of the computer programs created to help with retirement income planning do exactly the same thing: use rules of thumb.
Yes, some online calculators are better than we are in projecting future retirement income streams. But they still simplify the world dramatically, and in doing so, they can give you biased advice.
In this blog, I discuss some of the key problems with online retirement income calculators. Other commentators take on too-high target replacement rates, or too-optimistic assumed rates of return (e.g., the excellent study by Corporate Insight). Here, I focus on effects of Social Security’s projected insolvency, and on issues relating to purchasing annuities and rolling over 401(k) accounts to IRAs.
Not Warning of Social Security Shortfalls
Social Security is most Americans’ primary source of retirement income, so it’s important to get a good idea of how much you’ll be likely to get from the program. Consider Joyce, now age 45, who’s planning to retire in 18 years at age 63 — in the year 2034.
Unfortunately this is when the Social Security actuaries believe that the system will only be able to pay 75 percent of promised benefits.
So Joyce faces considerable uncertainty as to her Social Security benefits, since no one knows how future taxes and benefits might change. Nevertheless most (free) retirement income calculators don’t talk about this issue, nor will they warn Joyce that she might not want to retire at age 63, after all. Someone with adequate savings might even retire a year earlier, so that she could get a year of full benefits before they’re cut. But if Joyce has little saving, she might want to work longer to offset the benefit cut.
Delaying Social Security Claiming Helps You and Your Partner
To be truly helpful, a good calculator would alert you to the prospect of Social Security cuts, and it would also suggest that you will need to save more, or work longer, to offset likely benefit cuts.
Consider now the situation of George, now age 62 and thus eligible to collect Social Security benefits. Should he collect Social Security benefits or postpone collecting benefits to take advantage of the increase in benefits with postponed receipt, up to age 70? If he has a relatively high life expectancy, he’d do better postponing claiming benefits to take advantage of the benefit boost as well as the boost in his spouse’s survivor benefits. In my experience, few online retirement income calculators recommend such sensible options.
Alternative Products Could Help Fill the Gap
If benefits are in fact reduced due to future Social Security reforms, this could imply that people would benefit from longevity insurance. These are privately-provided income streams that start payouts at some advanced age such as 80. A longevity annuity could also be a good idea to cover living expenses when someone lives longer than expected.
Nevertheless, most retirement income calculators do not recommend purchasing longevity insurance. Nor do they suggest purchasing traditional annuities that start payment at retirement, which also can provide useful insurance against outliving one’s 401(k) plan assets.
What if You’re Not Financially Savvy?
Many people, realizing they’re not financial market gurus, hire financial planners. While this can avoid some pitfalls, financial planners may not provide advice that is in the best interest of the client. For example, the Council of Economic Advisers concluded that financial advice to roll over 401(k) plan assets into IRAs, costs American workers $17 billion a year in higher fees, plus the direct advisory fees levied by advisors.
In my experience, few retirement calculators alert people to the fact that rolling over their 401(k) plan to an IRA could be a costly mistake amounting to tens of thousands of dollars.
The advent of robo-advisors will surely mean more people will begin using online retirement income calculators. And my point is not to get people to avoid using these calculators, as some do provide useful information.
Rather, we must be smart when using online calculators. Since they differ widely in the results they generate, why not try several different calculators, before committing to a decision? And consult your trusted advisor about discrepancies in the outcomes.
This piece was originally posted on July 11, 2016, on the Pension Research Council’s curated Forbes blog. To view the original posting, click here.
Views of our Guest Bloggers are theirs alone, and not of the Pension Research Council, the Wharton School, or the University of Pennsylvania.