Financial planning software can be a useful tool to create a retirement savings plan. But many computer programs fail to adequately account for several major retirement risks, according to a new review of 12 financial planning computer programs commonly used by consumers and financial professionals by the Society of Actuaries and the Actuarial Foundation. “The results from any program should not be used as the sole input for decision making for retirees or prospective retirees,” the study concludes. Here’s a look at the major problems with retirement planning software the study identified.
Unrealistic rates of return. Many programs use rates of return that are optimistic, either due to program defaults or allowing individuals to overestimate their investing savvy, the review of the five free Internet calculators for consumers, one paid calculator, and six programs designed for use by financial planners for their clients found. Estimated stock market returns varied widely among the computer programs. For example, one calculator uses a 10 percent rate of return for equities, while another software package has a 5 percent default rate for equities and a maximum allowable rate of 7 percent. The programs also failed to account for common errors that inexperienced investors tend to make, such as trying to time the market or selling low and buying high, which causes many people to underperform the market.
Failing to account for fees, taxes, and inflation. Many of the software packages didn’t factor investment and administrative fees into retirement calculations, which causes the programs to overstate net investment returns. The programs also differ in their treatment of taxes, with some consumer programs understating taxes. The default inflation rate varied across the examined retirement calculators from 2.3 percent to 4.6 percent.
Underestimating life expectancy. The computer programs had vastly different ways of determining the length of retirement that needs to financed. One program had all users plan for a 30-year retirement. Another calculator specified that retirement would last until age 95. And a third software package had users estimate their own life expectancy. All these approaches can be problematic if you live significantly longer or shorter than expected. The Society of Actuaries recommends using a calculator that takes into account age, gender, and health risks when attempting to calculate how long you are likely to live. “The software should provide results for living to various ages beyond average life expectancy, which an individual has a 50 percent chance of outliving,” says Kirk Kreikemeier, a financial planner who oversaw the study.
Social Security benefits not factored in. The Social Security benefits workers are entitled to were often not adequately accounted for in the computer programs. Some software packages calculated Social Security benefits based on the person’s birth year, expected retirement age, and a single year’s pay. This method doesn’t account for fluctuations in earnings over the 35 working years the Social Security Administration uses to calculate your payout. Workers can obtain a more accurate Social Security benefit estimate at ssa.gov.
Home equity treatment varies. Most retirees have at least some equity built up in their homes. The retirement calculator's treatment of home values ranged from assuming that the house is illiquid to assuming that home equity will be used to help finance retirement expenses. Pick a computer program that allows you to specify whether you are willing to sell or borrow against your home to meet retirement expenses.
Life events are difficult to account for. There are a variety of other retirement risks that are difficult to incorporate into a computer program. For example, you could end up retiring earlier than expected due to a layoff or business closure. Or you could develop a health problem that renders you unable to work and necessitates expensive medical care. Typically one spouse also passes away before the other, but the retirement planning software programs differed in assessing how much income a surviving spouse needs. One computer program calculated that a couple needs 1.6 times as much as a single person due to economies of scale, but most of the others assumed that a surviving spouse could get by on half as much income as the couple needed.
Most investors are skeptical about retirement calculators. A related telephone survey by the Society of Actuaries found that 55 percent of current workers say they have little or no trust that these tools provide an adequate assessment for retirement planning. Only 10 percent of of the employees have ever used financial planning software.