Retirement Planning Process Overview

We know there are so many pieces to the puzzle. It's overwhelming.

That's why we have developed a simple, easy to follow process to guide you through. First, we help you understand what data you need and where to get it. Then we piece it all together and run it through our powerful calculation engine to identify all possible paths to successful retirement. And when you choose a path, we help you manage the ups and downs of life using the same time-tested methodology we use in helping pension plans and insurance companies manage uncertainty.

Real Estate and Retirement Planning Calculators

How to accurately reflect your real estate strategy when planning your retirement

Thinking of downsizing from your suburban home to a less expensive one when you retire? Planning to acquire a rental property to fund your retirement? Hoping to live part-time in your favorite vacation spot? Expecting your mortgage payments to continue into your retirement years?

These are all examples of questions you may be asking regarding your real estate strategy, which can play a critical role in your retirement planning. By real estate strategy, we simply mean your planned housing arrangements, which may or may not involve ever purchasing a home. Whether you choose to rent throughout retirement or consider one or more home purchases and sales, having an accurate estimate of how your choices will affect your retirement economy is crucial for your retirement planning.

In this article, we will highlight the most common real estate strategies. We discuss how to accurately take these strategies into account when deciding how much to save for retirement and when you can retire.

Planning to retire mortgage-free?

If your situation falls in one of these categories, then you probably have a pretty good idea of what your home-related expenses will be in retirement:

1) You plan to retire after your mortgage is paid off and live in the same home for the rest of your life.
2) You are currently renting and planning to rent for the rest of your life.

In these simple situations, all you need to do is make sure inflation is reflected correctly. Your property taxes or rent will grow with the real estate inflation in your area, while your other home expenses most likely will grow with general inflation.

Downsizing your home after retirement?

If you are a homeowner in one of the more expensive metropolitan areas, you have probably considered the possibility of moving to a less expensive area. Who wouldn't like to improve their quality of life in retirement with the net gain from downsizing?

But how much will you actually earn on the sale after sales commissions and taxes? And how much will it improve your quality of life in retirement, when spread over the rest of your life?

First of all, the money you make from the sale is subject to capital gain tax. Next, you have to subtract any outstanding mortgages on your old property, the sales commission (usually 6% of the home value), a conservative projection of how much your new home will cost, how much you'll offer as a down payment, what your new mortgage payment will be (if any), your new property taxes, and other home-related expenses.

Are you as ready to downsize as you think you are?

People commonly overlook how much downsizing they can actually handle. To avoid ending in a situation you regret down the line, try spending some time in the area where you plan to retire before you make your final decision. Talk to locals, make some friends. After a few years of visiting, do you still feel you can live there full-time for 20 or 30 years in retirement? Consider that your energy level and mobility will change with age.

There are reasons why some places are drastically more expensive than others. Perhaps some of these reasons don't apply to you or won't apply to you after you retire. But what you don't want is to save for retirement with downsizing in mind, only to find out (after you have already retired) that you don't feel like leaving your home after all.

Finance your retirement with rental income

Buying a rental property comes with many of the same considerations as buying a new home. But in addition, you also need to consider property management fees, a conservative estimate of how much rent you can expect, and a reasonable estimate of the real estate inflation in that area.

You may also consider the possibility that you won't be able to keep up with your rental business for the rest of your life. This is less of a concern if there are good property management companies in the area. But even then, there will be plenty of day-to-day decisions that only you, the owner, can make. You may consider modeling a scenario where you sell your rental property when you reach a certain age and add the proceeds to your regular savings.

If you consider renting out a part of your own residence, then also consider a stop date for your rental income. Even if you luck out with one great renter after another, there will still be considerable amount of work and inconvenience to you. It's worth knowing what would happen if you stop receiving that rental income five or ten years into retirement or the benefits if you simply rent your spare bedrooms until you pay off your mortgage.

Will you still be paying off your mortgage after you retire?

There are many reasons this can happen. Maybe you bought your first home late into your career because home prices in your area were prohibitively high. You started a family and bought a home relatively late in life. You refinanced your home during the record low interest rates following the 2008/09 financial crisis or the 2019/20 COVID-19 pandemic.

Your income needs in retirement will be dramatically different before and after your mortgage is paid off.

You cannot afford to ignore the timing of your mortgage in your retirement planning. But you don't necessarily have to delay retirement until after your mortgage is paid off. You just need a reliable plan to make sure you are able to pay off the remainder of your mortgage and save accordingly.

Snowbirding

This is a common scenario. New Yorkers dream of spending their winters in Florida or the Caribbean. Californians dream of spending their winters in Hawaii or Mexico. People with ties to the old country dream of spending a few months of the year there. Countless others have fallen in love with a beautiful spot somewhere on the globe where they wish to spend a few months every year after they retire.

Continuing to own a property back home is a great way to finance such a retirement lifestyle. If you plan to live permanently abroad, you can generate rental income and keep the security of having something to return to should you choose to come back home at some point. And if you plan to winter in a warmer climate, you can earn some additional rental income during those periods.

Regardless of whether you choose to rent out or not, you may still save on utilities and may even be able to suspend some services such as garbage collection, phone, internet, and TV for the months you are away. These details are important to factor in when you plan your retirement.

Conclusion

I have often seen people with limited means do incredible things and live the life of their dreams - all with a little planning and creativity. Regardless of your financial situation, there are probably far more possibilities available to you than you may think.

All you need to do is ensure your retirement planning is taking into account all key financial factors. An online retirement calculator that simply asks for your desired overall retirement income can be dangerously off the mark. You need a calculator that allows you to price out your real estate strategy separately and accurately.

Most large financial institutions have detailed retirement planning services using sophisticated software, usually for an additional fee. So be sure to ask what may be available at your bank.

If you are looking for a robust free option, you may also consider our free retirement calculator MoneyBee. It automatically prices out all real estate strategies discussed in this article and integrates the results into your overall retirement planning.

Inflation and Retirement Planning Calculators

Understanding Inflation when Planning Your Retirement

The difference between a reliable retirement strategy and one that could be potentially thousands of dollars off the mark is in the small details. Including a reasonable estimate for inflation in your retirement planning is one of those details that can make an enormous difference. Still, most online retirement calculators either ignore inflation or don't give it the attention it deserves.

In this article, we will explain how such simplifications can make your retirement planning inaccurate and unreliable. This can produce misleading results on how much you need to save towards retirement, and ultimately, when you can retire and what standard of living you can enjoy in retirement.

Issue #1: Assuming everything remains constant - except your investments

This common issue across most retirement calculators is best illustrated with an example. Suppose you enter the following information in the typical retirement calculator:

Desired retirement income (in today's dollars): $40,000
Current age: 35
Retirement age: 65
Life expectancy: 95
Current savings: $20,000
Assumed future investment return: 5%

Since most calculators try to keep everything in current dollars, they won't project your desired retirement income of $40,000 - it will be kept constant at retirement (30 years from now) until you die (60 years from now).

At the same time, your $20,000 of current savings will be increased with your assumed investment return of 5% to your retirement date and beyond.

Clearly something is off when your savings are inflated and your expenses aren't.

What if I subtract inflation from my assumed investment return (for example, use 3% instead of 5%)? Then inflation is taken out from both sides of the equation. Would that work?

The problem is that when a calculator keeps everything constant, it also keeps your salary and Social Security benefit constant. This implies zero growth in the national average wages, because your Social Security benefit is indexed to the average wage index. No growth in wages means there are also no productivity increases and therefore, no technological progress. If you want to be consistent, you would need to subtract a lot more than 2% from your investment return.

If this is not accurate, why do almost most banks use this approach in their calculators?

The primary goal of financial institutions is to help you better understand and manage your investments. Many of these calculators won't simply increase your investments with 5%. They will help you figure out a reasonable investment return assumption based on how you are invested and may even give you a range of possible investment results. Investments are the main focus of these calculators, and that's a very valuable service in itself. But these calculators are simply not designed to forecast your retirement income needs. For instance, they typically project stable scenarios such as wanting to withdraw a constant $40,000 a year and reflecting how your investment portfolio will change over time. To develop a realistic forecast of your retirement income needs, however, you simply need a more sophisticated calculator.

Issue #2: Not everything grows at the same inflation rate

We are not suggesting that retirement calculators need to use a different inflation rate for bread, cheese, and wine. It is perfectly fine to use a single inflation rate for all personal expenses. The issue is when this same general inflation is also applied to your healthcare costs, home-related expenses (including any mortgage payments, property taxes or rent), and any one-time events.

These special categories represent a major portion of retirees' expenses. Using the same general inflation on them creates at least two major problems:

Healthcare and real estate inflation can be dramatically different from general inflation.

While personal expenses can be expected to grow with the Consumer Price Index (where an appropriate long-term assumption can be something like 2%), fixed-rate mortgages will have 0% inflation. Your property taxes or your rent will grow with the real estate inflation in your area. Health premiums can grow by as much as 7-8% per year depending on your age and geographical area.

Healthcare and home expenses often have large declines and spikes over time.

You cannot plan when you get sick or when your home needs urgent repairs. However, there are many changes in your healthcare and home expenses which can be anticipated in advance. For example, your home expenses will drop off significantly once your mortgage is paid off. Your health premium can be extremely high if you retire before 65 and buy health insurance on your own (and Obamacare doesn't pay for it). Then it can drop as low as zero when Medicare kicks in, if you don't purchase any additional coverage. It is also very likely that your out-of-pocket expenses will start increasing as you age.

Since there are so many moving parts and since everyone's situation is different, healthcare and home-related expenses simply have to be projected separately. Calculations need to reflect your individual timing and preferences and use the best available data-driven projection models.

Issue #3: Inconsistent Social Security benefit projections

Similar to everything else, your Social Security benefit should also be projected based on the best available data and assumptions. There are two parts to that:

Know how much your benefit will be when you retire

Your future Social Security benefit estimate needs to reflect a reasonable assumption for your future salary growth, future changes to the average wage index and, if you are a high-income person, future changes to the taxable maximum. The good news is you can get exactly this kind of benefit estimate for free from the Social Security Administration's Quick Calculator or Online Calculator. Just make sure you select future dollars (not current dollars). The future dollars estimate reflects your assumed future salary growth and the SSA's best assumptions about future growth in each relevant economic variable.

Please be aware that most retirement calculators that calculate your Social Security benefit use a current dollars approach where everything is kept constant, so you are better off using the number from the SSA's calculators.

Know how your benefit will grow after you retire

Your calculator needs to reflect a reasonable assumption about future cost-of-living adjustments to your Social Security payments. If your calculator is sophisticated enough to apply inflation to your expenses, it should apply inflation to your future Social Security payments as well.

The Social Security Administration publishes its own long-term assumptions for these cost-of-living adjustments (2.4% in their 2020 Trustee Report). However, if your retirement calculator doesn't allow you to specify a separate inflation for your Social Security payments, it is fine if it uses your general inflation assumption instead (say, 2%). You will be underestimating your future Social Security payments, meaning you will likely get a little more money each month than you planned for.

Conclusion

There's an abundance of data and research available to make a reasonable, inflation-adjusted projection of all major components of your financial reality. The Social Security Administration publishes an annual report with long-term assumptions regarding everything that affects your Social Security benefits. The Bureau of Labor Statistics publishes a wealth of annual and historical data. The healthcare exchanges provide health premium information for each age and ZIP code. There is no excuse for a retirement calculator not to provide a thoughtful and complete projection of all of your expenses and benefits in retirement.

If you would like to see these principles implemented in practice, you can try our free online retirement calculator, MoneyBee. In addition to projecting each major component of your financial life with its own inflation, it also provides research-based defaults for many of these assumptions.

Social Security and Retirement Planning Calculators

The Right (and Wrong) Ways to Factor Your Benefits into Your Retirement Planning

For generations, American retirees have relied on their Social Security benefits as a major source of retirement income security. But will these benefits still be around when you retire? And if so, what is the correct way to factor them into your retirement planning? These are some of the questions we will explore in this article.

Will there even be Social Security by the time you retire?

We have all heard that our Social Security system is expected to run into serious financial difficulties in the not-so-distant future. Americans are getting older. As a result, within a few years, benefit payments to retirees will exceed the Social Security tax revenues. The 2020 OASDI Trustees Report projects this to happen as early as 2035.

However, as Steve Vernon explains so well, the Social Security tax revenue will still be sufficient to pay 79% of benefits even when that happens. Taking this into account, the worst-case scenario is that benefits will be reduced by 21%, not disappear.

It is possible to avoid any benefit reduction entirely, if the Social Security tax rate is increased appropriately. Currently, employees and employers each pay 6.2% in Social Security taxes. If that rate is increased to around 7.5% for both employees and employers, benefits would continue at their current levels beyond 2035.

If a 1.3% tax increase is sufficient to ensure continuation of safety net benefits, it seems hard to imagine that Congress would instead opt for a politically explosive benefit reduction. Moreover, this won't be the first time the Social Security tax rate has increased. The rate increased from 1% to the current 6.2% gradually between 1950 and 1990. Given this trend, an additional 1.3% increase over the next 15 years is by no means out of the ordinary. The tax increase may be even smaller if other statutory changes are made as well, such as raising the taxable maximum (so the wealthy pay more into the system), changing how the cost of living adjustment is calculated (without taking it away), etc. These are all reasonable options, so resorting to major benefit reductions seems quite unlikely.

The right way to project your Social Security benefit

If your Social Security benefits are not going anywhere, what is the right way to include them in your retirement planning? Getting accurate Social Security estimates is not difficult. Using the right numbers in your retirement planning is where things get tricky.

The Social Security Administration (SSA) offers a set of highly accurate and free calculators. They all take into account all the details that go into your actual benefit calculation. The main difference between them is how they handle your earnings history:

Quick Calculator estimates your past earnings based on your current salary (although, you can actually overwrite the historical pay used).

Online Calculator lets you enter your earnings history manually (from your Social Security statement).

My Social Security Retirement Calculator pulls out your actual earnings history automatically but requires online registration and a rigorous verification process.

All of these calculators deliver the most robust and reliable estimates of your benefit - provided you supply your correct earnings history.

One calculation. Two answers?

The SSA calculators produce two sets of results-measured in current dollars and future dollars. Picking the right set for your retirement planning purposes is where many people and, unfortunately, many retirement calculators, get confused. And the choice makes no small difference - the future dollars estimate can easily be twice as large as the current dollars value!

The current-dollar estimate helps you understand the value of your future benefit

Your current dollars results illustrate how much your Social Security benefits are worth in today's dollars or how much you would receive if both your salary and the national wage index remain fixed forever. Therefore, unless you are within a couple years of retirement, this number is far below the actual dollar amount you can reasonably expect to receive.

Put simply, if your current dollar Social Security benefit estimate is $20,000, it means that your actual benefit at the time you retire will be enough to afford what $20,000 can afford today.

If you were given the actual amount you can be expected to receive (the future dollars estimate), you would have no way of knowing how much that number is worth and what it could buy at the time you retire. However, while the current-value estimate seems like a great number to have for your own understanding, it is NOT the number to use for retirement planning, as we explain next.

Accurate retirement planning using future dollars

Your retirement planning is only as accurate as the projections it makes of all the pieces of your financial reality. Each piece has its own reasonable growth rate. For example, each of the following should be increased as suggested:

- Your savings with a reasonable investment return
- Your personal expenses with a reasonable consumer price inflation
- Your salary with a reasonable earning growth rate
- Your fixed-rate mortgage payments should be kept flat (and then reduced to zero when paid off!)
- Your healthcare costs should be projected with a reasonable healthcare price and age inflation
- Your home value and property taxes with an appropriate real estate inflation for your area

Your Social Security benefit should also reflect a best estimate projection of each of its building blocks - exactly what the future dollars estimate from the SSA calculators does.

We cannot simply assume that the individual growth rates average out to a perfectly uniform and simple number. We all have a unique basket of the items listed above, and that basket changes over time. A robust and reliable retirement planning tool should use future dollars projections for each major component, based on well-researched assumptions, and then let you plug in the future dollars estimate from the SSA calculators.

Unfortunately, almost all current retirement calculators either ignore inflation altogether or apply a flat inflation assumption to everything.

Retirement calculators that ignore inflation altogether

Ignoring inflation altogether is a common problem with many retirement planning tools, including some sophisticated tools used in-house by large banks. Such calculators only project your savings forward with investment return but ignore how your living expenses, medical costs, and housing expenses will change over time.

Why? The vast majority of retirement calculators focus on investment analysis. They are created by investment experts to help you understand how much you can expect to earn on your retirement savings, based on your risk tolerance (and assuming you use their investment products and services). Since setting a reasonable investment return assumption is one of the most important aspects of retirement planning, many of these calculators can be very helpful.

However, if they ignore inflation altogether, you are probably better off using them for just that - for investment analysis. When it comes to your overall retirement planning (for example, when deciding how much you need to save and when you can retire), you need a more reliable tool that reflects inflation.

Retirement calculators that use a single inflation rate for everything

Even a simplified adjustment for inflation is far better than keeping everything in current prices. Combined with a future dollars estimate from an SSA calculator, you can get a quick ballpark estimate of your retirement planning results. However, you should be aware that this calculation is still seriously flawed. Not every part of your financial reality can be expected to increase at identical rates. In fact, the SSA's calculator uses different growth assumptions for every component of the Social Security benefit calculation - and so should your retirement calculator.

What about cost-of-living adjustments to your Social Security benefit?

The future dollars estimate you receive from the SSA calculators tells you how much you will receive in Social Security benefits the day you retire. This number will further grow every year after you retire to keep up with cost-of-living increases. Since these increases are not included in the number from the SSA calculators, your retirement calculator needs to apply them for you.

If your retirement calculator uses the same inflation rate for everything, make sure it applies that rate to your Social Security payments as well. The best approach is to use the SSA's own assumption for future cost-of-living adjustments.

Can you use the numbers from your Social Security statement?

Not really, unless you are just about to retire. Your Social Security statement uses a current dollars approach, which means that it assumes that neither your earnings nor the average wage index will increase past the statement date. Thus, unless you are within a couple years from retirement, your Social Security statement is likely to grossly understate your projected benefit at retirement.

However, there is one piece of valuable information you can get from your statement: your Social Security earnings history. These are the numbers you can plug into the SSA's Quick Calculator or Online Calculator to get an accurate projection of your Social Security benefit.

Nobody knows the future! So why fuss about assumptions?

Uncertainty doesn't mean we should not and cannot make reasonable forecasts about the future, based on the best available data and models. The correct way to manage uncertainty is to make reasonable, well-researched assumptions and then update your calculations on a regular basis to reflect actual data. This approach allows you to make timely adjustments to your plan along the way.

This process is not perfect, but it is good enough for insurance companies and retirement systems to manage uncertainty. It will likely work well for you, too. In fact, while these organizations are often required to fund any short-term shocks immediately, you have the luxury of spreading their impact over the rest of your life!

Can you add up your and your spouse's Social Security benefits?

Unfortunately, many retirement calculators don't allow you to enter your spouse's Social Security benefit separately from your own. You are forced to add your and your spouse's benefits and enter them in the single slot provided.

That should work, right?

Not exactly. Even though you can get a good future dollars estimate from the SSA calculators for you and your spouse separately, simply adding them together assumes you will retire at the same time and commence your Social Security benefits at the same time. This is rarely the case. Even if you retire at the same time, you may choose to start receiving benefits at different times. For example, many people wait until age 70 to start cashing in on their benefits. In that case, even a one-year age difference means your calculations will be off by an entire year of Social Security income.

Adding your Social Security benefits together also assumes that your spouse will live for exactly as long as you. In reality, one of you will likely die before the other, and the survivor will get a survivor benefit on top of their own benefits.

And while on the topic of spouses, do consider the "spousal benefit" that your spouse may receive on your account (it will be listed in your results from the SSA calculators). This is the benefit your spouse can be paid if higher than their own earned benefit. This is particularly important for couples where one spouse has a limited earnings history.

Conclusion

We know this article sets a very high bar for retirement calculators. As actuaries who work on long-term financial projections for insurance companies and retirement systems (such as Social Security), we would not even be allowed to publish a projection that did not follow all of these principles, and possibly many more.

Considering the imperfect world in which we live, you may consider using a calculator that applies inflation (even if using a single rate for everything) and then enter the future dollars estimate from any of the SSA's calculators. This should get at least the Social Security part of the model working reasonably well.

If you are looking for a reliable and free option, you may also consider our free retirement calculator, MoneyBee. It implements all the principles discussed in this article. It estimates your future dollars Social Security benefit automatically for each retirement age scenario, separately for you and your spouse, exactly matching the SSA calculators. It projects all other major components of your financial reality with their appropriate growth rates.

Including Spouses in Retirement Planning Calculators

Avoid common mistakes that can derail the retirement planning of a married couple

Most of us will have a special someone to share our retirement years with. But factoring someone else into your retirement planning can also make it more complicated to get an accurate projection of your retirement finances. Reflecting your spouse's information when planning for retirement is critically important. Doing so will affect your expenses, benefits, and taxes in retirement, as well as the time span for which you need to plan.

In this article, we will help you understand the key factors a married couple needs to be aware of in order to obtain the most reliable and accurate retirement planning strategy possible.

Age-Related Expenses

Couples tend to think of most of their expenses in terms of a family unit. But there are certain age-related expenses that need to be projected separately for you and your spouse. Aside from aging, regulatory factors come into play here, too.

Healthcare is a good example. Your healthcare costs are likely to change significantly with age, so an accurate projection of your healthcare costs must take age into account. Most of us can start receiving Medicare at age 65. If you or your spouse retires before age 65, buying health insurance on your own can be very expensive and your retirement planning needs to reflect that. Since most spouses are of different age, this requires a separate projection for you and your spouse.

Taxes

Your marital status affects your tax brackets, deductions, and exemptions, as well as the deductible limits to Individual Retirement Accounts (IRAs). What this means is that even if one spouse doesn't earn any income, the very fact that you are married and filing your taxes jointly will affect your tax payments significantly. For example, as a married couple you can deduct $500,000 of the capital gain from the sale of your primary home, whereas single people only can deduct $250,000.

When you turn 72, you are required to start withdrawing a certain amount from your tax-deferred retirement accounts. This required minimum distribution needs to be determined separately for you and your spouse, based on your respective ages.

Spouse Benefits

If your spouse is also working and saving towards retirement, you need to include and project their savings in your shared retirement plan as well. When your spouse plans to retire should also be factored into the math. For example, if one spouse continues to have some income after the other retires, this may significantly reduce the amount you need to draw from your retirement savings.

If your spouse never worked or worked significantly less than you, they may still be eligible for a Social Security benefit, thanks to the spousal benefit on your account.

Should one of you pass away before the other, the survivor will be eligible for survivor benefits from the deceased spouse's account. In other words, the survivor will get a portion of the deceased spouse's pensions from prior employers and Social Security benefit, on top of their own.

Spouse Life Expectancy

Statistically speaking, there is a high probability that one of you will outlive the other by several years. On average, husbands in the United States are 2.3 years older than their wives. At the same time, women live on average 5 years longer than men. This means that on average, wives survive their husbands by more than 7 years. You want to make sure you will have enough savings to last for the expected lifespan of the last survivor. Not reflecting your respective ages and life expectancies in your retirement plan can cause financial difficulties for the survivor just after losing their spouse. Therefore, it is worth making sure these aspects are well accounted for.

Conclusion

There is practically no scenario where spouses can be ignored in retirement planning without throwing the entire calculation off. Unfortunately, it is usually only the more sophisticated paid retirement calculators that account for that level of detail. These tools are often used by large financial institutions to provide retirement planning services to their customers for a fee.

If you are looking for a robust and free option that reflects the age, life expectancy, retirement date, income, savings, and tax implications of your spouse, you can consider our retirement calculator, MoneyBee.

Taxes and Retirement Planning Calculators

How to prepare for and minimize the impact of taxes in retirement

For most Americans, taxes are significantly simpler in retirement than during our working careers. This doesn't mean, however, that you can ignore them altogether when planning for retirement. You will continue to pay state and federal taxes after you retire, and they will still be an important part of your financial life. However, many of the tax rules that will apply to you during retirement are very different from the tax rules that apply to your employment income. Therefore, you can neither ignore taxes after retirement nor simply estimate them based on your current taxes.

In this article, we will review the most common ways in which your taxes in retirement will differ from your pre-retirement taxes:

Social Security benefits

The good news is that only a fraction of your Social Security benefit will be subject to federal taxes. No more than 85% of your benefits can be taxed, and many people pay no federal tax at all on them. Where you stand in that spectrum will depend on the level of your benefits, your marital status, and the amount of any other taxable income.

In addition, chances are you won't pay any state taxes on your Social Security benefits. Most states do not tax Social Security benefits at all, including high-tax states like California and Hawaii. Of course, some states, like Texas and Florida, have no income tax to begin with. Only the following states highlighted in gold may tax some of your Social Security benefit.

Even these states generally follow the federal rules, which means that only a fraction of your Social Security benefit will be taxed, if any. Some of these states add additional credits on top of the federal rules, which means that an even smaller portion of your benefit will be taxed.

Withdrawals from retirement accounts

When you retire, a large portion of your income will come from withdrawals from your savings. But you need to be careful, because the taxes you will pay on these withdrawals will depend on the type of account you are drawing from:

Pre-tax retirement accounts (such as 401(k), 403(b) or similar employer plans, traditional IRAs, SEP IRAs, or rollover IRAs) - Since you never paid taxes on this money, your entire withdrawal will be subject to regular income tax. In addition, if you withdraw money prior to age 59.5, you will also have to pay a 10% penalty on the amount withdrawn. To make things even more complicated, once you reach age 72, you will have to withdraw a minimum amount each year (called the "required minimum distribution"). This means that you may need to withdraw more than you need and get taxed on it.

Roth IRAs - Since the money you deposited to this account had already been taxed, you don't have to pay tax when you withdraw it. The big selling point of these accounts is that you also don't have to pay tax on the interest you have earned! However, if you make a withdrawal prior to age 59.5, your earned interest may actually get taxed depending on the amount of the withdrawal.

Regular after-tax savings - These are your regular savings, outside of any special tax-advantaged retirement accounts. Since this money has already been taxed, there will be no further taxes charged when you make withdrawals. However, the portion of that withdrawal that is attributable to interest earned is taxable.

Capital gain from a home sale

Many Americans choose to sell their home in expensive urban areas after they retire and move to a less expensive area. Downsizing is a great way to fund your retirement, as it may generate a significant amount of cash. However, Uncle Sam (and your state) will want their share of the proceeds from the sale, too. There are two ways in which the tax on these proceeds may differ from regular employment income:

Lower tax rates: For federal tax purposes, it will be taxed at long-term capital gain tax rates (up to 20%), which may be significantly lower than regular income tax rates (up to 37%).

Large deductions: If the home was your primary residence, you can deduct $500,000 from the capital gain if married, or $250,000 if single. While this deduction is for federal tax purposes, it reduces your adjusted gross income, so you may effectively get the same deduction for state tax purposes as well.

Moving to another state

Many people consider moving to a state with a lower cost-of-living after retirement to make their savings stretch further. If you choose this strategy, it is crucial to consider the tax implications, too. This decision would make it tricky to estimate your post-retirement taxes from your pre-retirement taxes. The different tax rules between states require a brand new tax projection based on the tax regulations in your new home state. Tip: Some people move to a different state when they retire precisely to save on taxes.

Mortgage interest

Your mortgage payments might be the same amount every month, but in the eyes of the federal and state tax authorities they are not. If you have a fixed-rate mortgage, the interest portion of your payment (and the corresponding tax deduction) will be smaller every month. When your mortgage is paid off, the tax deduction will disappear completely. So while your mortgage payments remain fixed, you tax payments may actually increase. It is important that your retirement plan takes this into account to avoid unexpected tax increases during retirement.

Is estimating your taxes in retirement even possible?

Obviously, it would be unrealistic and impractical to perform an exact tax calculation for each year in retirement. There's no way to know in advance every tax-relevant detail. Even if you did, would you really want to fill in a TurboTax-type questionnaire for each of your 30 years in retirement?

That said, with the right tools, a reasonable tax approximation at both the state and federal levels is indeed achievable by making some conservative simplifying assumptions. This approximation can also be attained without an overwhelming number of technical questions.

Yes, life rarely goes exactly as planned and many people are skeptical about long-term projections. In our opinion, the right way to address uncertainty is by re-running your retirement calculator periodically, even after retiring, to reflect your actual financial situation. This way, you can make timely adjustments to your plan as unexpected changes happen. But uncertainty doesn't mean that we shouldn't use the best available data and models to develop the best possible projection of our future financial needs.

Taxes are no exception to this rule. To the extent possible and practical, a retirement calculator can and should make a reasonable estimate of your taxes in retirement. At a minimum, your retirement calculator should reflect the current tax brackets for federal and state purposes, increased with inflation. Then it can apply the basic tax rules for the items most common in retirement, as discussed above:

Social Security benefits

Withdrawals from retirement accounts

Capital gains from home sales

Mortgage interest

Employment income during retirement

That should cover most bases for most people. By necessity, your calculator would have to make some simplifying assumptions by ignoring some of the "bells and whistles" surrounding these rules. Some simplifications may be acceptable for retirement planning purposes, as very long financial projections—such as planning decades of retirement—are practically impossible to get 100% accurate.

But how do we decide what to ignore? Our proposed approach is to ignore tax rules only if they meet all three of these criteria:

Tax reduction: Does this rule always decrease taxes, if applicable?

Relatively small: Is the impact of ignoring this tax rule expected to be relatively small in most cases?

Onerous to user: Does this tax rule require additional inputs from the user?

The only tax rules mentioned in this article that meet these criteria are the special credits applied by states that tax Social Security benefits. These credits lower your taxes, they are unlikely to have a significant impact for most people, and they would potentially require a lot of additional questions for the user. For those reasons, ignoring them simply means that your retirement income may be slightly higher than projected by your retirement calculator. Other special credits and exemptions at state and federal level may also satisfy these criteria.

Tax rules NOT to ignore

If a tax rule fails one of the following criteria, it may be too risky or unnecessary to ignore it:

Tax increase: Ignoring a rule that may result in higher taxes (such as the 10% early withdrawal penalty), can put you at risk of running out of money in retirement. Even though you diligently re-ran the calculator periodically and followed its recommendations to the letter, your calculation will only be as good as the calculator. If a tax rule results in higher taxes for some people and lower taxes for others, it probably should be reflected by your calculation. A retirement calculator should not knowingly put even a small number of users at risk of unexpected tax increases.

Too conservative: We don't want to ignore any significant tax reductions (such as the fact that California doesn't tax Social Security benefits). By ignoring such major tax reductions, you may have to delay your retirement for too long until you have saved up much more money than you actually need.

While some conservatism is always warranted, large intentional departures from accuracy in the calculations is not the way to do that. Instead, you may consider using more conservative assumptions regarding your investment return, life expectancy, etc.

Note that the wording of the question includes "in most cases". It is impossible to guarantee that a rule will always be relatively small for everyone. This is why full disclosure of any simplifications is so important. This gives you, or your tax adviser, a chance to determine if any tax rules that have been ignored may be too conservative in your particular case.

No additional inputs required from user: If a tax rule doesn't require any additional inputs from the user and is just a matter of a programmer's time (such as the required minimum distribution), it should probably just get done, unless perhaps its complexity vastly outweighs its materiality.

Conclusions

Taxes are a tricky area for retirement calculators, especially considering that many are offered by financial institutions that simply wouldn't want the legal liability. This is probably why even advanced calculators used by financial advisers at top banks estimate your future taxes based on a guesstimate provided by you.

At the same time, your taxes will be very different in retirement and likely change significantly over time. Any reasonable approximation would be far more accurate than ignoring taxes or assuming some ballpark figure based on your current taxes. Such reasonable approximation is indeed achievable by using carefully selected criteria for deciding what tax rules can be safely ignored. The goal is to remain conservative enough to avoid unpleasant surprises while not getting overwhelmed with too many technical questions.

One possible implementation of the principles in this article can be found in our free retirement calculator, MoneyBee. It automatically projects all income sources for you and your spouse and then figures the (approximate) federal and state tax you will owe in each year in retirement. Please note that neither our calculator, nor our firm, MyVal Center, provide any tax advice.

Healthcare and Retirement Planning Calculators

How to retire with peace of mind that your healthcare costs will be covered

When can you retire? The uncertainty about healthcare costs in retirement causes many to worry about when they can afford to retire or postpone their retirement, just to be on the safe side. We are all painfully aware that healthcare costs in the US are already very high and continue to skyrocket. The dual effect of increasing costs and requiring more medical services as we age often pushes us to delay retirement as much as possible. And retiring before you can receive Medicare is often completely out of the question.

However, with the right forecasting tools based on concrete data, you can get just the right amount of certainty and clarity you need to make an informed decision. While no financial forecast can be 100% accurate, you can get a reliable and conservative estimate on when it may be reasonable to retire.

The cost of post-retirement healthcare

Our fears usually stem from the risk of catastrophic medical expenses. But keep in mind that is exactly what health insurance is there to cover. Retirees in the US spend on average twice as much on health insurance premiums than on out-of-pocket medical expenses. This means that most of your healthcare expenses can be planned out in advance with reasonable confidence. To the extent that health premiums can be projected using data-driven models, you can get a reasonably accurate prediction of the majority of your healthcare costs.

Out-of-pocket expenses can also be forecasted--you just have to leave a little extra room for the extra potential volatility. This is because these costs are less predictable compared to the relatively stable cost of healthcare premiums. However, a reasonable forecast is definitely achievable here as well, if based on well-researched, age-related patterns, and medical cost trends. We will discuss below how to factor any large one-time out-of-pocket expenses you may be anticipating in retirement.

Let's take a closer look at each of the major components of your healthcare expenses in retirement. For each component, we will show how a retirement calculator can forecast it into your retirement years reasonably well. This way, you can plan your retirement based on rational, well-researched analysis, rather than fear.

Pre-Medicare health premiums (if you retire prior to age 65)

If you retire before Medicare kicks in, you will probably want to buy health insurance on your own. As you can imagine, this can be quite expensive. Here's what the 2020 monthly healthcare premium would look like for a 61-year-old retiring in one of these areas under the second cheapest silver plan from an exchange (silver plans have middle-of-the-road coverage):

City	Premium (per month, per person)
Sonora, CA	$1,391
San Francisco, CA	$1,262
Santa Barbara, CA	$1,192
San Diego, CA	$813
Honolulu, HI	$1,035
Miami, FL	$990
Stamford, CT	$1,338
Charlotte, NC	$1,002
Des Moines, IA	$1,447

These prices might be a bit steep for most people looking to retire early. These prices are even more unreasonable if you are married to a spouse who is also age 61, as you will be paying twice the amounts above. These premiums will grow every year with healthcare age inflation (older people pay higher premiums) and healthcare price inflation (the cost of medical services goes up with time). You can see how the cost of health insurance can quickly become out of reach for the average American family.

Now the good news — and there is some!

First, our couple will have to pay these high premiums for only four years until they turn 65 and Medicare kicks in. For those who have enough saved up for retirement, four years of this kind of healthcare expenses might be manageable.

Second, we still have Obamacare, which can pay for some or all of your pre-Medicare health premiums. There's a common misperception that this is a program for the poor, but it was definitely not designed that way. A person making nearly four times the poverty guideline can still benefit from it. How much you get from Obamacare depends on your taxable income.

If the couple in our example has enough after-tax savings to live on until age 65 (and they delay starting their Social Security benefits at least until age 65), their taxable income between ages 61 and 65 will be zero and Obamacare will pay their entire health premiums during that period!

In order to be eligible for this benefit, they will have to purchase their health insurance from an exchange (which may have fewer options than private insurance) and their benefit cannot exceed the cost of the second cheapest silver plan.

However, this is a small price to pay for over $100,000 worth of total benefits over the course of four years.

So how would that work in a retirement calculator?

A good retirement calculator should be able to automatically look up your benchmark premium. This is the premium of the second cheapest silver plan you would get from an exchange in the area where you plan to retire, if you bought one today. Good calculators will also let you override it, if you plan to get a more generous coverage. Then the calculator should automatically project this current dollar premium forward with age and price inflation.

The age inflation is easy to extract from the current premiums. Here are the 2020 benchmark premiums in Des Moines, IA for ages 61-64:

Age	Premium (per month, per person)
61	$1,447
62	$1,480
63	$1,520
64	$1,545

This gives the following age inflation rates (for this geographic area):

Age	Age inflation (per year)
62	2.3%
63	2.7%
64	1.6%

The future healthcare price inflation can be based on historical data, which is abundantly available. According to the Bureau of Labor Statistics, medical costs increased on average by 3.45% per year between 2000 and 2020. This may be a reasonable assumption for the future of healthcare price inflation.

Combining these healthcare age and price inflation assumptions, a retirement calculator can tell, with a reasonable degree of confidence, how much your pre-Medicare health insurance will cost, if you retire before you turn 65.

Post-Medicare health premiums

Medicare, which usually kicks in at age 65, provides decent coverage for retirees. Some people choose to go even further and purchase additional coverage on their own (Medicare Supplement). According to this 2018 report by the US Bureau of Labor Statistics, the average expenditure on health insurance among people older than 65 is $221 per person per month. This is quite a drop from the $1,545 a 64-year old would have to pay in Des Moines, IA prior to Medicare.

Medicare Supplement premiums are the same across all ages (no age inflation) and need to be projected with just healthcare price inflation (see above).

Out-of-pocket medical expenses

Both before and after age 65, you will have some medical expenses that are not covered by your insurance — copays, deductibles, and non-covered procedures. Using the same 2018 report by the US Bureau of Labor Statistics, and a fitted mathematical model of our own, we derived the average out-of-pocket expenses for each age. Here are a few sample ages:

Age	Out-of-pocket (per person, per year)
20	$291
30	$431
40	$591
50	$699
60	$996
70	$1,108
80	$1,324

This means that the average 80-year-old spends only $110 a month on out-of-pocket expenses, or about half what the same person would spend on health premiums. Again, people purchase insurance precisely to avoid large and volatile out-of-pocket expenses, and that seems to be working.

Your out-of-pocket expenses will grow with both healthcare prices and age inflation. While the healthcare price inflation is the same across all medical expenses (premiums as well as out-of-pocket expenses), your retirement calculator needs a separate assumption for the age inflation in your out-of-pocket expenses. Using the same model, we derived the following age inflation rates for out-of-pocket expenses:

Age	Age inflation (per year)
Under 20	4%
20 to 29	4%
30 to 39	3.2%
40 to 49	1.7%
50 to 59	3.6%
60 to 64	4%
65	-13% (due to Medicare kicking in)
Over 65	1.8%

A good retirement calculator should be able to look up the average out-of-pocket expenses for your current age and allow you override them with your own current out-of-pocket expenses. Then it should be able to project these expenses to your retirement years with reasonable, data-based assumptions for price and age inflation.

What about those $30,000 non-covered procedures we hear about all the time?

"I'm afraid that if I budget only $1,000 a year for out-of-pocket expenses, it will take me 30 years to save $30,000 for my non-covered procedure — and that's if I have no other out-of-pocket expenses during those 30 years."

First of all, from the data we are looking at, such major out-of-pocket expenses seem to be much less common than we think, especially among people covered by Medicare. That is not to say that your out-of-pocket expenses will match even the best of forecasts every year, but the deviations are very unlikely to be that large.

That said, it is always a good idea to be prudent and conservative in our assumptions about the future. We suggest you start by looking at what procedures are covered by Medicare or by a good Medicare Supplement insurance. If you still think it's likely that you will have a large non-covered procedure (because of family history, pre-existing conditions, or simply for peace of mind), you may want to set up a "special event" in your retirement calculator. A special event is a large one-time expense that will cost an amount decided by you. This way, the extra expense can become a part of your retirement plan and you can ensure the funds will be there if you need them. A good retirement calculator should also allow for special events, adjusted with inflation, precisely for this kind of situations.

Conclusion

While the uncertainty surrounding medical expenses will always be there, there is plenty of data available to help us develop a reasonable projection of these expenses. In some years you'll go above this projection, and in some years you'll land below. It may average out, it may not. That's why it's important to update your calculator periodically (yes, even after you retire), so that any gains or losses can be spread over the remainder of your life and you can make timely incremental changes to your plan.

Unfortunately, despite healthcare being such an important part of a retiree's economy, healthcare costs are rarely forecasted by retirement calculators using data-driven, age-adjusted models. In fact, many calculators lump your healthcare costs in your overall desired retirement income, which they ask you to input. But how would you know what retirement income you'll need, especially given that healthcare expenses vary so much with time?

If you're looking for a free retirement calculator that incorporates the forecasting methodology laid out in this article, you can try our online calculator, MoneyBee. It also automatically estimates any Obamacare subsidy you may be eligible for in each year after retirement, if you retire prior to age 65.

How Much Income Will You Need in Retirement?

Replacement Ratios Myths and Facts

How much should I save for retirement? When can I retire? How should I invest my retirement money? These are some of the key questions of retirement planning, and the answer to all of them depends on how much income you will need in retirement. That is why an accurate and reliable projection of your cash flows during retirement is critical.

Unfortunately, virtually every free retirement calculator uses an oversimplified approach to estimate your retirement income needs.

Think of it this way: If a financial advisor only asked you about your current income and not about your individual situation - home-related expenses, mortgage(s), children's college, state of residence, or any special events coming up - would their advice be any good? Of course not. This is exactly the problem with most retirement calculators. They determine your income needs in retirement simply based on your current income and some national statistics, without taking your individual situation into account.

For example, the calculator may suggest that a reasonable retirement income for you will be $70,000, based solely on the fact that you currently make $100,000. Similarly, they may suggest a retirement income of $27,000 for someone currently making $30,000. With that assumption, they will work out how much you need to save and when you can retire

What is a replacement ratio?

When a calculator only asks for your current income in order to estimate your retirement income needs, they most likely use the concept of replacement ratios. The replacement ratio is a person's gross income after retirement, divided by his or her gross income before retirement.

There has been considerable research into what would be an adequate replacement ratio - the ratio that allows you to maintain a comparable standard of living before and after retirement. The theory is that some of your pre-retirement costs will drop off (commute, mortgage, children, etc.) and new ones will be added (higher medical bills, more travel, etc.). Researchers have identified various rules-of-thumb to help decision-makers design large retirement systems for corporations, state and local government, or entire countries. The goal is to ensure that their retirement benefits will provide adequate retirement income to full-career employees, on average.

But most people are not "national averages" - they are real, living people.

As an actuary who has designed large retirement systems (partly using replacement ratios as well as many other factors), I want to explain the problem with using replacement ratios for individual retirement planning. When used for large groups, this approach is useful. Some individuals will need a lower income during retirement while others will need a higher income, but it all averages out as a group.

However, this approach quickly starts falling apart when used in retirement planning for an individual. The chance that you will need exactly, say, 70% of your pre-retirement income after you retire is minute. You might need to pay higher or lower healthcare costs than the average. You might still be supporting more or less children than the national average. You might still carry a mortgage at the time of retirement. And you might be living in a larger or smaller home in a state with higher or lower living costs than the average. For all these reasons, the chance that you will get a reliable estimate from such a calculation is very small.

Most free calculators are teasers, with more detailed and accurate tools being available to paying customers of financial institutions. The problem is that this distinction is often overlooked, and too many people rely on free calculators. The result of these teaser estimates can be dangerously misleading.

Retirement has its ups and downs, too

The second major issue is that replacement ratios assume your retirement income needs will be level over time. This is almost never the case, even if we ignore inflation.

If your mortgage is not paid off at the time you retire or you are still supporting your kids, you will need a much higher income in the first few years of retirement than in later years. If you retire before age 65 and purchase health insurance on your own, you may need an income that exceeds your pre-retirement income, until Medicare kicks in at age 65. Taking into account the unique timing of these and other major events for each individual is of critical importance.

You don't want to run out of retirement savings because the average replacement ratios in the United States didn't allow for your major expenses!

What if you downsize when you retire?

Another glaring issue with replacement ratios is the underlying assumption that you will maintain the same cost of living before and after retirement. Many people are able to lower their cost of living in retirement, while preserving or improving their quality of life. Why not invest in making your home more energy efficient? Move to a small condo in your favorite vacation spot now that the kids are long gone? Get away from the expensive urban area? All these choices show that your retirement income needs are not necessarily a function of your pre-retirement income.

No retirement calculator can exactly predict the future

Even with the best of calculators, you will still need to update your calculations on a regular basis. Every time your situation changes, your retirement plan needs to change, too.

However, regular re-calibration won't do much if the calculator has a systematic bias or ignores a major piece of your financial reality. If a calculator thinks you will need $70,000 overall income in retirement (just because you currently make $100,000), while in reality you will need $120,000 in the first five years, $90,000 in the following five years, and $75,000 afterwards, it won't matter how often you re-calibrate. Its assessment of your retirement preparedness will always be dangerously off the mark.

How to get a safer retirement income estimate

If using replacement ratios for retirement planning is an alarming oversimplification, do you then need to project every single expense in retirement, down to the most minute detail?

No. That would not only be unrealistic and impractical but it would also give you a false sense of security. Future changes always have the potential to throw off even the most thorough predictions. In my opinion, the best path lies in between these two extremes.

All required major expenses should indeed be projected as diligently and accurately as possible. These include home expenses (e.g. your mortgage), healthcare costs, child-related expenses, special events, and taxes. By factoring these projections, you can have peace of mind that the important pieces of the puzzle will be taken care of.

Next, a good retirement calculator will tell you how much free cash you can enjoy each month in retirement for personal and optional expenses (groceries, going out, having fun, vacations, club memberships, etc.). Going into more details than that will only unnecessarily complicate things. This gives you a ballpark number on how much you can spend per month, after taxes and required expenses, but leaves you the freedom to spend it as you wish.

Conclusion

It is tempting to use our current income needs as a guide to our income needs in retirement, or use national studies on adequate replacement ratios. Either of these approaches can produce very misleading results. A retirement calculator needs to reflect your individual situations with all major moving parts modeled explicitly and accurately.

The importance of using a robust retirement calculator becomes clearer the closer we get to retirement, but by then we have limited time to make additional savings. The earlier you start using the right calculator, the more options you can create for yourself and your family.

If you are looking for a more robust and free option, we have implemented the principles in this article into our free retirement calculator, MoneyBee. It calculates all achievable combinations of what percent of pay you save each year, when you retire and what your monthly free cash will be in retirement (after taxes, home-related expenses, healthcare, dependents and special events).