Why Your Retirement Calculator Might Not Tell the Whole Story

I got to thinking about the retirement calculators that automatically pop up when I check my retirement account balances. In my case, I always get a message that says, "You are XX% on track toward your retirement goals." 

When you check out an online calculator, you can use them, but remember that a retirement calculator could miss the boat for a number of reasons. 

How Retirement Calculators Work

How exactly do retirement calculators work? Always remember that a retirement calculator functions as a computerized algorithm. It estimates your investments' future growth and expenses based on what you input into your computer. You input your expected retirement age, current savings, current investment returns and more. The retirement calculator will calculate your estimated retirement returns based on your current rate and inflation, among other things. 

Some calculators require more sophisticated information and other calculators make assumptions about certain data.

Take a look at these reasons why calculators might not tell the whole truth.

Reason 1: They might not take fees into consideration.

When you check out any old retirement account online, it'll spit out a number that says, "You'll have $1.6 million by the time you retire. But what about the fees involved? 

Check out a few fees you'll likely pay over the years, whether you choose to invest in a retirement account or general investment account:

• 401(k) fees: These fees get passed to you, the plan participant, by your employer.
• Brokerage account fees: Brokerage account fees involve fees to maintain an account, trading strategy research fees for the brokerage and access to trading platforms.
• Commissions: Your broker charges you commissions when you buy or sell certain investments. 
• Expense ratios: Many funds charge annual fees as a percentage of your investment in the fund.
• Load funds: Some mutual funds charge a fee paid to the broker or salesperson who sold the fund.
• Management fees: Management fees involve a percentage of assets under management, which you pay to your financial advisor or robo-advisor.

These fees can really add up over time. For example, let's say you invest $100,000 and the account earns 6% a year for the next 25 years. Let's say that it's a perfect world and you don't owe any fees. You'd end up with over $400,000.

Now, let's place this scenario in the real world, where you will pay actual fees. Let's say you pay 2% per year in total fees like the ones above. After 25 years, you'd only have around $250,000.

When you invest in a traditional 401(k), you must also add the distribution to your taxable income for the year. It gets taxed at your ordinary income tax rate. For example, your withdrawals will take a hit no matter what tax bracket you find yourself in. For example, let's say you fall in the 28% tax bracket. You only get 72% of the money you invest after the IRS takes its amount.

Most retirement calculators can't come up with the full range of fees you'll pay for all of these different scenarios.

Reason 2: They're based on many variables — but not human variables.

A retirement calculator doesn't know how long you'll live, how much you'll need in retirement and how much you'll spend overall. Sure, a retirement calculator will estimate inflation and returns.

However, it can't compute when you decide to borrow $25,000 from your retirement account 20 years into your career. It can't examine your risk tolerance or the times you change your monthly 401(k) contribution because you feel a little pinch during the month. 

Depending on its level of sophistication, a retirement calculator might be able to calculate a lot of details, but most don't go into as much detail as, say, pulling money out of your account during any given timeframe. 

Reason 3: They're based on a flat rate of return.

Retirement calculators can only use a flat rate of return, which you provide. However, how can you possibly know all the details on the rate of return during any given year, much less over 10 or 20 years? 

Your portfolio will likely suffer a low point in the market over the years, but of course, a retirement calculator doesn't take bear markets into consideration. Repeated negative returns can have an effect on your overall portfolio.

Reason 4: They may over- or underestimate your needs.

Think about how much Social Security will kick into your overall retirement. Will your spouse still work a part-time job while you fully retire?

Don't freak out when the retirement calculator says, "You'll have a $500,000 shortfall" without considering all the angles in your personal financial situation. When you don't consider adding to all the calculations, a typical retirement calculator could be overestimating how much you should be saving.

You should know how your individual retirement accounts consider your taxes, income and qualification limits for pulling together your full financial plan. 

Bottom line: Without factoring in all of the variables (again, the human variables), you might get bad advice from a retirement calculator (of all things!) about what you should do about your retirement savings amount. You may want to consider meeting with a financial advisor to align your goals accordingly.

Should You Use a Retirement Calculator?

Yes, you should use a retirement calculator because it gives you a nice estimate. However, remember that an algorithm doesn't know you — how much you like to garden, vacation, spend money on your kids. It doesn't know how long you'll live and how much money you'll need for 20 years or more. 

Take a retirement calculator for what it is: An estimate and a good starting point. However, if your retirement calculator says you'll only end up with $200,000 in savings, you probably want to get a move on and possibly call a financial advisor. A financial advisor can add a dose of personal customization and detail to your unique retirement situation and plan. A professional financial planner can advise you based on your own very specific goals.