What You Miss When Using Mental Math To Calculate Retirement Needs

If you want a tough challenge to address in your spare time, try pinpointing your retirement needs. Why? You’re not only trying to determine what you will need based on spending today for the future, but you also must consider what your lifestyle will be like in 10, 20 or 30 years.

This makes for a lot of uncertainty and unknowns, even if your imagination runs wild in the process.

Yet, a new report highlights a concerning trend as people calculate their retirement reality using imaginary figures. According to a recent survey of about 4,000 defined contribution plan participants 18 years and older by Escalent, 40% of respondents say they estimate their retirement savings goals off the top of their head.

Other popular methods included online calculators (30%), detailed plans with financial advisors (25%) and do-it-yourself spreadsheets (22%).

While it’s understandable that people would use mental math to estimate their retirement, it can leave you woefully short of your needs later in life.

Remember these important caveats when calculating your retirement needs.

Expect Some Lifestyle Creep

The survey found a wide swath of expectations and needs in retirement, with the average estimate coming in at $946,000. The generational differences highlight some of the concerns when estimating.

Generation Z respondents over 18 years old believed they will need just $498,000 to retire while Boomers expect $1.2 million, on average.

While many Gen-Zers don’t have to worry about retiring anytime soon, they are also likely using math based on the spending they have today. This doesn’t properly measure what you will spend to live on in the future.

Expenses increase, life gets more complicated and the number of people you care for may grow as years go on. And, as people make more money, they tend to boost their spending accordingly. Without addressing that increased spending in retirement, you could find yourself struggling – after all when you’re in your late 60s you probably won’t want to live like you did in your 20s.

The same can happen to someone that’s older, if they’re expecting their spending to decrease in retirement (which many expect), but then it doesn’t. Or if you’re not considering healthcare or long-term care needs later in life, which tend to be the most expensive part of retirement. Without thinking through these concerns, even a large portfolio can come out woefully short when needed.

But it’s hard to do such math in your head because of all the caveats you need to address.

Don’t Forget Inflation

The other thing the mental calculation doesn’t consider is inflation. This includes inflation in your expenses but also your savings and earnings. For instance, with a 3% inflation rate over 30 years, a person would need to have $1.2 million in a portfolio to have the equivalent of a $498,000 portfolio today.

Essentially, having $498,000 saved in the future would leave you living dangerously short of your needs come retirement. And those needs haven’t adjusted to your lifestyle changes over the years.

While accounting for inflation will make the number you need larger, it goes a long way in narrowing down your actual retirement number later in life.

Watch Your Assumptions

It’s important to understand your assumptions, whether you’re using your mind, a spreadsheet you develop or even a financial advisor.

This can significantly impact the expectations you have for the growth of your net worth, when you think you can step away from the job, and how long the money will last.

If, say, you use a 10% growth rate within your portfolio, will that reflect the reality of your investment experience?

For instance, $100,000 invested today with a 7% return expectation will result in approximately $761,000 in 30 years. But using a 10% rate, and it rises to $1.74 million. That’s nearly a million-dollar difference in expectations, which will result in vastly different planning and experience.

When looking outward, consider using more conservative estimates. This will allow you to be pleasantly surprised if, in 25 years, returns come in far stronger than expected.

Then you can let your imagination run wild with very real possibilities.