Retirement planning is extremely challenging for most people, as it requires you to think years or even decades into the future and anticipate needs that you've never even considered before. Many people use a retirement calculator to help give them direction on what to do now in order to reach their future financial goals. Yet before you simply plug some numbers into a retirement calculator and rely on whatever it spits out, you should be aware of common flaws that nearly every retirement calculator has. These flaws don't mean you should use retirement calculators at all, but they require you to do some extra thinking beyond whatever automated answers the calculator provides. Let's look at three of the major flaws you'll find in nearly every retirement calculator out there today.
1. Questionable assumptions about how the rest of your career will go
One of the major considerations for any retirement calculator is how much money you'll make between now and the end of your career, as well as how much of that income you'll be able to set aside toward your retirement savings. In order to keep things as simple as possible, many retirement calculators simply ask you for your current salary and then assume that you'll earn regular raises throughout the rest of your career.
Unfortunately, those assumptions are more simplistic than the situations that most workers face, especially as they approach retirement age. In many cases, issues like layoffs or forced early retirement require workers to get new jobs that often don't pay as much as they were making previously. Conversely, in many professions, added experience will earn you outright promotions and push you into brand-new salary categories, leading to pay raises that greatly exceed the typical annual raises you've earned while putting in time in a particular job.
The easiest solution is to save a bit more than the retirement calculator recommends early on, thereby giving yourself more wiggle room in case something happens later in your career. If you can't do that, just bear in mind that an unexpected career setback could leave you with less than your calculator predicted at retirement age.
2. Limited choices on what you'll spend in retirement
A surprising number of calculators link your retirement spending to how much you earn. That makes sense for those who spend nearly all of what they make during their careers. But for those who are conscientious enough to use a retirement calculator in the first place, strategies like living below your means often lead to a major discrepancy between salary and the amount spent on typical living expenses.
The good news is that calculators that make this mistake will typically overestimate how much you need to save from your salary in order to retire on time. But that isn't always a good thing, as it can unfairly discourage some workers from retiring as early as they could if they used more realistic assumptions.
In addition, most retirement calculators assume that your retirement expenses will rise at the rate of inflation. Yet retirees often find that their spending patterns aren't nearly as predictable as that. Some prefer to spend more money early in retirement, when their health allows them to enjoy activities the most. Others have more expensive needs later in life that necessitate using more resources well into the later stages of retirement. Whatever situation you face, looking into the assumptions your calculator makes is crucial to understanding whether its answers really apply to you.
3. Uncertainty about other sources of income in retirement
By necessity, retirement calculators need to make assumptions about other sources of retirement income. But with Social Security and private pensions often based on lifetime earnings, the calculations will inevitably be based on information that won't necessarily be true by the time you actually retire.
No one can predict with certainty what Social Security benefits will look like by the time they retire. By incorporating some flexibility, though, you can build in a margin of safety that will protect you in case the income you expect from retirement benefits doesn't pan out the way you had expected.
Retirement calculators can be a great way to start your long-range financial planning. Just be sure to take their limitations into account. That way, you'll avoid making mistakes that could otherwise crush your retirement aspirations.
Dan Caplinger and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.