Who needs a financial planning tool? If you're reading this, you do, and you're not alone. The majority of households don't have a comprehensive financial plan (they should), primarily because they don't have a planning tool capable of helping them to create one. This means that they are relying on guesses, assumptions, and/or generic benchmarks and rules of thumb for their financial planning. That's not good. Would every household benefit from having a financial plan? Absolutely. There is no better way to understand what you can, should, and should not do to achieve financial security, and to be as prepared as possible for retirement. But to create such a plan, you need the right tool for job.
While it is possible to create a financial plan on your own, it's certainly not easy to do. Accurately accounting for decades of personal financial variables, tax liability, Required Minimum Distributions (RMD's), potential life changes, health care costs, Social Security benefits, etc. can be an exercise in frustration. They are all inter-related, so making a change to one directly affects everything else. It's hard enough to do your own taxes one year at a time, never mind calculating your taxes for the next 30 years together with a complex mix of other variables, all at once. Here's one situation that will have you running in circles: savings withdrawals from a traditional 401k/IRA are taxable, so to withdraw a specific amount needed for expenses, you have to also account for the taxes on the total withdrawal. But how can you know how much the tax will be until you know the total amount of the withdrawal? Which comes first, the chicken or the egg?
Unless you're a math whiz and have experience building complex formulas, creating a reliable financial plan on your own is not likely to end well. To figure it all out correctly, most people need a little help, which is where a financial planning tool comes in.
But can't you just use an online calculator? No. Full Stop. You would be better off (almost) throwing a dart at a spinning wall of random numbers from 20ft. away. While there are hundreds of calculators available, ironically, mostly on financial sites, all of them omit essential information and rely on generic assumptions, which makes them incapable of providing a meaningful answer for your unique situation. They are no better than toys, with the information they provide being inaccurate and misleading at best. And that's being kind.
• They don't ask enough information about your personal finances to be able to calculate any semblance of a reliable result. How do you adjust for changes in income, changes in expenses, buying/selling a house, spouses retiring many years apart, etc.?
• They don't account for taxes, particularly on retirement savings distributions or the unique tax laws for Social Security income (yes, up to 85% of it can be taxable). Taxes have a significant impact on your long-term results, so they need to be accounted for properly, year by year (every year will not be the same).
• If your income is more than your expenses (hopefully) they don't account for the difference.
What happens to that money?
• If your income is less than your expenses how do they prioritize the order of savings used? They only ask for a total of your "retirement savings" not how much is in a 401k, cash, long-term investment, etc. Again, no accounting for taxes.
• They don't specify if "household income" is gross, or net. How can you enter the % of income to replace if this isn't clear? If it's gross (it usually is), how are they accounting for taxes and pre-tax items (e.g., health care, 401k, HSA, etc.), which are needed to determine how much net income is available to pay expenses? They aren't.
• They ask for a single investment return %. Using an average percent for every year can significantly inflate your results. Yes, really. $1M invested using the S&P 500 actual results for the past 20 years would become $4.88M. Using the S&P 500 average return of 9.75% for every year for 20 years would become $6.43M. Big difference. How will you make up the $1.55M difference? You can't predict future market returns, but being able to enter varying returns will provide a more realistic result.
The bottom line is that financial calculators are completely inadequate. You can't afford to act, or rely, on information that leads you in the wrong direction. It's like asking for directions to Paris and being told to go East (or West?). It may or may not be directionally correct, but even if it is, that's nowhere near enough information to help you to reach your destination. Why take that chance? Not to mention that a single number answer, or probability percent, that calculators provide is not a plan. How does it help you to achieve that number? Using a proper financial planning tool will keep you from trying to save more than you really need, or worse, finding out too late in life that you did not save enough.
Here's an example using retirement calculators from Bankrate.com and Nerd Wallet vs. a comprehensive financial planning tool, using the following random entries:
• Age: 55
• Household income: $130,000
• Married
• Current Savings - $600,000
• Retirement Age: 62 (it didn't ask about my spouse)
• Annual retirement savings: $19,500 (15% of income)
• Retirement Income Need: $75,000/year
• No income increases before retirement (keeping it simple)
• 28 years of retirement (life expectancy of age 90)
• Assumes 2.9% inflation
• 5% return on investment before retirement, 3% return during retirement
• Social Security - Bankrate had no entry for a specific amount, only asking if I would receive it. Wow!
Nerd Wallet - allowed a $3k/month entry for "other income" which doesn't help with unique Social Security rules and
taxation, but it is something.
No acounting by either for a Social Security annual COLA.
• No entry for Federal or State taxes.
The Bankrate calculator states that you would have ~$760k at age 62, and savings would run out at age 88.
The Nerd Wallet calculator states that you would have ~$1M at age 62, and savings would run out at age 83.
How did Nerd Wallet start with $240k more than Bankrate at age 62 using the same information (or why was Bankrate's savings so low at age 62?), and then run out of savings 5 years earlier? Which would you trust, and how would you know if either is correct? How much more savings might be needed was also in question, with one calculator suggesting an amount 3x more than the other.
Entering the same information into a financial planning tool and trying to keep the data "apples to apples" as much as possible, the results state that you would have ~$935K at the beginning of retirement (in between the 2 calculators), but that savings would run out at age 80, or 8 years earlier than the Bankrate calculator and 3 years earlier than the Nerd Wallet calculator. This is largely (but not completely) due to the fact that neither calculator seemed to account for Social Security correctly, or the $130k in taxes due from age 62 to age 80 ($285k would be needed for taxes from age 62 to age 90). In the end, almost $1.49M would be needed at age 62 to get to age 90 without running out of savings,
or 15% to 45% more than either calculator estimated.
Imagine being retired and then realizing that you would run out of money at age 80, because retirement calculators underestimated the savings needed to get you through to age 90 ..... by anywhere from $200k to 500k! Scary.
The moral of the story - there's no comparison between calculators and a true financial planning tool. You need the right tool for the job, and financial planning, especially for retirement, is not the time to try to get by with inferior equipment - the consequences are far too serious. If you want to create a reliable financial plan (and you do),
a true financial planning tool will help you to get it right.