As people near retirement, many have either completed a financial plan or spent some time with a retirement calculator. While this is a great process, the results may be a little off. The problem is likely the assumptions used within the plan.
Every financial planning software program or retirement calculator begins with facts like how much money you make, what you have already saved, your current age, and when you plan on retiring. But that is only half the equation.
The real make or break items in your retirement calculations reside in the assumptions. One such assumption is the rate of inflation.
Typically, financial planners choose an inflation rate of between 2.5 and 3.5 percent. Until now, that was okay. The problem: In the future, the inflation rate could be significantly higher. Using the wrong inflation rate could be the difference between having enough money during your ultimate life vacation and running out early. The latter situation could be devastating.
Rate of return is another questionable assumption. It used to be that financial advisors could assume a 6 percent return for shorter-term investments and 10 percent for longer-term investments. Over the last decade, that spread has become more like 4 and 8 percent. But, after the recent market gyrations, it may be more prudent to think of applying rates around 3 and 6 percent. Again, I know this sounds a little scary. And yes, using these assumptions may show you that it’s necessary to delay retirement several years. However, it is very important to be ultra-conservative in your calculations.
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Another area to approach more conservatively is your government pension and/or Social Security payments.The federal and state governments are having difficulty making ends meet. This has been a problem for some time. As a matter of fact, this will be the first time in three years that Social Security payments will increase from a cost-of-living adjustment.
Additionally, many boomers are wondering whether Social Security payments will begin at a later age. Some still are worrying that it simply will not be around when they retire. Regarding government payments and your retirement analysis, thinking more conservatively may be to your advantage.
Finally, a major question in people’s retirement plans should be taxes. With the huge amount of government spending and the super committee about to announce ways to cut expenses by over $1 trillion, higher tax rates are only a matter of time. Making an educated guess of the new tax rates is very difficult, but extremely important. Assuming a tax increase of between 10 and 20 percent is probably wise.
As you can see, a financial plan can unlock the door to your retirement, and making the proper assumptions gives you the key to that door.
Good luck and happy investing.
Kelly Campbell, CFP® and Accredited Investment Fiduciary, is founder of Campbell Wealth Management, a Registered Investment Advisor in Alexandria, Va. Campbell is also the author of Fire Your Broker , a controversial look at the broker industry written as an empathetic response to the trials and tribulations many investors have faced as the stock market cratered and their advisers abandoned their responsibilities to help them weather the storm.