In looking at online retirement calculators, there are a few things that stuck out to me on how we can mistakenly under estimate our retirement savings without realizing it. Now, retirement estimates (especially at younger ages) is just a rough estimate and will change drastically over time. However, to get a better handle on what it will take to retire, it is important to understand what goes into the calculations. Thus, I have chosen a few of the assumptions that can have a dramatic impact on how much we will need in retirement.

**Investment Returns – Pre-retirement**

I have always suggested taking a conservative approach in estimating future returns. At first, this was because I would rather save a little bit more than needed rather than fall a little short, especially if I had the flexibility to put the little extra away now. Thus, when some calculators start out with a 10% return before retirement, I would knock this down to 8% without giving it much thought.

In looking at the calculations further, I am now even more convinced that using a lower estimated return in a necessity rather than just out of being cautious. Even calculators that ask you how your portfolio is allocated (stock/bond mix) should be adjusted to use a lower percentage of stock.

Why is this? How you are invested today is not how you are going to be invested when you get to retirement. If you are invested in 80% stock and 20% bonds now, you may expect to receive a 9% return (assuming 10% return from stocks and 5.5% return on bonds). As you get closer to retirement, your risk tolerance is probably going to decrease. Thus, your allocation may get closer to 50% stocks and 50% bonds (probably even less in stock with some being allocated to cash or cash equivalents). Assuming 50/50 stock/bond allocation (for simplicity), the assumed rate of return is 7.75%. The difference between 9% and 7.75% may not sound very large, yet it adds up over time (especially if you are younger).

For a 35 year old who starts to invest today for retirement at 65, the difference in returns can decease the projected retirement balance by 13%, assuming a portfolio in stocks decreases steadily (assuming % allocated to stock in this calculation is 120 – age) instead of having a constant portfolio.

Investment Returns – Post-retirement

This is similar to the pre-retirement allocation. I am always a little surprised at how some calculators default to an 8 percent for its post-retirement investment rate of return. Because a bigger portion of retiree’s portfolio is allocated to cash or cash equivalents (e.g., high yield saving accounts and CDs), it is difficult to get to an 8% return, unless a large portion of the remaining portfolio is allocated to stocks. Even assuming a 30% stock, 50% bond and 20% cash portfolio (with cash assumed to earn 4%), the assumed rate of return for the portfolio is 6.5%.

Having 20% allocated to cash may sound too high, yet, if there retiree is older (age 75), it may only represent the next few years of expenses. And, even if you have less allocated to cash (30% stock, 60% bond and 10% cash portfolio), the assumed rate of return is still only 7.0%.

Salary Scale

Your future salary has a large effect on how much you can save and how much you can spend in the future (income – taxes – savings = expenses). The projected salary increases is technically based on assumed inflation rate + assumed promotion increases + assumed productivity and merit raises. However, when we sit down with these calculators, we may only think about our recent raises. For some, they may feel lucky to get inflation + 0.5%. So if inflation is 3.0%, the project salary increases would be 3.5%, in this situation. For others, they may be grateful for 3% raises.

Thus, when some people do their salary estimate, they may assume a salary increase close to inflation (3% or 3.5%). However, have you really maxed out your salary? For some, they may answer this with a definitive yes (especially if the thoughts of a future promotion are bleak). For others (especially younger employees), this may not be the case. What we forget in some cases that recent salary increases may not be as great because due to other larger raises (maybe 10 percent or more) coming with either promotions or job changes where with subsequent salary increases being smaller to compensate (get the employee’s salary back to average). Thus, if an employee receives a major raise of 10% once every 10 years (then relatively small raises after that), this is equivalent to a 1% increase every year. Thus, the meager 3.5% salary increase assumption is really closer to 4.5%.

Why does this matter? If you are basing your retirement expenses based on your spending today (assuming future salary increases = inflation or close to it), you can be underestimating your retirement expenses. If you receive a $5,000 raise for a major promotion or job switch, we may decide to save 20% of this ($1,000 a year), be taxed on 35% ($1,750 a year) and spend the rest, $2,250. If you assume your salary will stay constant to retirement, you will not recognize that your lifestyle has increased by $2,250 and thus not save for it.

Thus, even if you have not received a decent raise recently, a salary scale at least 1% to 2% over inflation should be considered.

Changing Lifestyle

In assuming retirement expenses, it is easy to overlook what will happen as we get older. In our 40s and 50s, when we have children living at home, it may be a time where we diligently cut expenses. My parents watched the number of times that we ate out because they could not afford the cost of taking out a family of 6, every week. However, as we (the children) grew up and left home, my parents had some of their income freed up and my mom went back to work. Thus, they started to eat out more because my mom hates to cook just for two and they could now afford dinner out on a more frequent basis. Others may take more vacations especially if they already have a healthy retirement fund or start bring in help to do chores (professional cleaners and lawn services) because they have a hard time keeping up with everything.

So, if you are estimating that you can live on 50% of your income due to your savings habits now especially with children, be cautious of spending creep as the drive to cut expenses diminishes as your budget situation is not quite as tight. This is important because how we spend in the 10 years before retirement is more important than how we spend now. If we get use to an upscale lifestyle after children leave the house, it is harder to cut back in retirement.

Mortality

By now, many already know that the average life expectancy is around 85 (slightly less for males). Thus, some calculators use 85 as the average age of death. However, as many also know, there is an increasing chance that retirees can live to 95 or 100. The odds are even better if married that retirement assets may need to last until at least age 95. For a married couple (both age 65), there is a 10% – 25% chance (depending on which mortality tables are used) that at least one of them will live to age 95. Thus, assuming that retirement savings only need to only last to 85 is a large gamble in my opinion because there may not be much savings left after 85 to live on other than Social Security.

Even though I did mention some assumptions where we can be underestimating our retirement income, there are a few other things that we may not be factoring in that can increase our retirement savings. In particular, older workers whose children leave home can shift a greater percentage of their income (that was used to raise children) shifted into retirement savings. Thus, if you are behind, you can look into taking advantage of additional catch-up contributions. This also helps reduce the expense creep (upgraded lifestyle) that some parents can get use to when the children leave the house.

In addition, some retirement calculators do not recognize part-time jobs that retirees may have that provide a little additional income in retirement that makes their retirement savings last longer. There is always a way to catch-up. It is just important to recognize what is reflected in the retirement calculation assumptions and what is not so you can adjust your retirement plans accordingly.