Retirement income planning apps have proliferated in recent years, as people have sought out new tools to help them investigate how various investing and spending strategies may affect the value of their nest egg upon retirement and sustainability thereafter.
Some of these apps boast a bevy of features, implying that more features mean a better, more accurate tool. This is not always the case. Often, these features are not only superfluous but may even damage reliability.
It is, of course, also true that calculators that are too simplistic in their design may be likely to produce unrealistic results. For instance, overlooking inflation, ignoring advisory fees and investment expenses, and failing to account for the possibility of negative returns all may render the output from many common calculators worthless to the user.
However, at a certain point, additional complexity may become the enemy of reliability. To the extent that certain inputs in the retirement software may cause the user to make flawed assumptions, output reliability may again suffer. The following are four input features that are commonly regarded as desirable, but which may actually lead to “garbage in, garbage out” analysis.
1. Tax effects
On the surface, accounting for the impact of income taxes in portfolio spending calculations seems like a fairly basic and important input consideration. The problem is that many users, including financial advisors, overestimate this number, most commonly by simply entering the client’s marginal tax rate. While this factor may be accurate if 100% of the withdrawals are coming from qualified accounts, such as pretax employer 401(k)s or traditional IRAs, financial planning best practices in retirement spending dictate balancing withdrawals from after-tax savings, tax-free Roth accounts and other retirement accounts so as to minimize the client’s overall tax liability. (See Vanguard’s publication, Spending from a Portfolio: Implications of Withdrawal Order for Taxable Investors.)
Through careful planning, it may be possible for many retirees to pay little or no tax on their nest-egg withdrawals throughout much of their retirement. Because of the propensity for user error, tax calculations are a factor that may be best left off the calculator feature list.
Users who wish to account for the impact of taxes and who can accurately estimate their tax liability may instead include this figure in their spending needs along with other living expenses, such as food, clothing, housing, travel, insurance and property taxes.
2. Budgeting
Incorporating a budgeting feature into a retirement planning calculator is a fast track to killing the user experience. Most families have no idea what their itemized living expenses are each year, and forcing them to estimate them in the input section of a retirement calculator creates complexity and the potential for inaccurate guesses. Simply put, budgeting should be an entirely separate exercise.