5 tips for using retirement calculators

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(MoneyWatch) Welcome back to my fourth and final post on retirement calculators. These online tools help you determine how much you'll need to save for retirement. My first post showed the wide range of contribution amounts that several different calculators would suggest for a hypothetical couple, while my second post provided in-depth results about each calculator and identified two of my favorites. The third post offered some thoughts on how best to select and use a retirement calculator that fits your needs.

This final article coaches you on how to answer a few common questions that retirement calculators ask to help estimate how much you should save for retirement.

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Tip #1: What rate of return do you expect on your retirement savings?

Some calculators ask for your input about the rate of return you expect to get on your retirement savings and the future rate of inflation, while others make these assumptions for you. The assumed rate of return is a crucial assumption that can significantly impact the answer to the question, "How much you should save?"

Your assumption for the rate of return on your retirement savings should match the method you've used to invest these savings. For a portfolio balanced between stocks and bonds, I'd use no more than a 6 percent annual rate of return, given today's low-interest environment. If you really feel lucky, go ahead and use 7 percent, but I wouldn't go any higher.

These suggested assumptions assume you're using index funds with very low expenses. If you're using mutual funds with expenses well above 0.50 percent (50 basis points), reduce your expected rate of return by the level of investment expenses you're paying. This will increase the amount you need to save, which might cause you to take a hard look at the level of expenses that you're paying (a good thing, in my opinion).

I'd use a rate of inflation that's 2 or 3 percent lower than the expected rate of return on your savings; again, use a 4 percent difference only if you feel real lucky.

If you're invested entirely in bonds, determine the current interest yield on your investments and use that rate; it might be in the 3 to 5 percent range. If you're invested entirely in savings accounts or money market funds, you're earning almost nothing, and a calculator will tell you that you'll need to save a boatload of money. This should also cause you to rethink your investment strategy.

It's definitely worth the effort to try a few different assumptions to see how they affect the results. Eventually, however, you'll need to pick one set of assumptions that you're comfortable with.

Tip #2: When do you expect to retire?

Your answer will also significantly impact how much you need to save. To state the obvious, the earlier you want to retire, the more you need to save. Make sure your calculator lets you easily change this assumption, so you can see the effect of retiring at different ages.

For most people, Social Security will be an important part of their retirement income, and maximizing this benefit is a good strategy. If you were born in 1960 or later, your full retirement age is 67; this is a good starting point for inputting your expected retirement age.

Tip #3: How long will you live?

To answer this question, instead of guessing it's a good idea to use one of the online life expectancy calculators, such as www.livingto100.com or www.bluezones.com. Then add five to 10 years to the number they give you to make sure you'll have enough resources in case you live longer than expected.

Otherwise, assume you'll need income until you're age 95; if you're married or in a committed relationship, assume you'll need income until the younger person reaches age 95.

Tip #4: How much retirement income do you need?

Many calculators ask for the amount of income you expect to need in retirement. If you are years away from retirement, you most likely won't have a good idea of your expense needs at that time, because there are so many unknowns. For example, will you still have a mortgage? Will you need to support dependent kids or parents? These issues and more will have a significant impact on how much money you need to retire.

Many analysts say you need a retirement income that ranges from 70 to 100 percent of your income while you're working; this range provides a good rule of thumb to use when you're so far away from retirement. Use a number at the low end of the range if you're highly paid and currently have a lot of discretionary income. Use a number at the higher end of the range if you don't have much discretionary income or if you want to be cautious.

Tip #5: Should you include Social Security benefits?

Many younger people think that Social Security won't be there when they retire. This is a mistake, in my opinion; as long as we have democracy, we'll have Social Security. But if you're that pessimistic, go ahead and say you don't expect any Social Security income. Of course, you'll need to save a lot more for retirement, and if you can afford the additional savings, you'll only be better off.

For most people, I'd let the calculator estimate Social Security benefits for you. If you're married, make sure the calculator includes estimates of your spouse's Social Security benefits, too.

Note that these calculators will base these estimates on current Social Security law, and there's a good chance that younger people will receive a "haircut" on their Social Security benefits due to future legislative changes. If you want to reflect this possibility, you can go to the Social Security Administration's website, www.ssa.gov, and estimate your own Social Security income based on your earnings history. Then reduce this amount by 10 to 20 percent if you want to be cautious and prepare for the possibility of future benefit reductions.

By now, I hope you realize that determining how much to save for retirement is part art, part science, and that there's no one answer that's right for you. But that doesn't justify just guessing, because most people guess way too low. Even though the calculators will suggest different amounts you'll need to save, eventually you have to make a decision to save a given amount. If you make the effort described in this post, you can move ahead knowing that you've done the best you can.

I know all of the above sounds like a lot to keep in mind -- and a lot of work -- but it sure beats being wrong and broke at age 80! It's well worth the effort to do the job right.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.

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