*You run out of money*. That’s the fundamental event that most retirement calculators try to predict. If there’s a strong probability that your money will last your lifetime — congratulations — you’re financially independent! But, if not, then you need to keep working, or generate retirement income, or curtail your lifestyle.

There are many possible layers to the analysis. You can do a simple back-of-the-envelope calculation with just a few inputs. Or you can spend days collecting your personal data, researching growth, inflation, and tax rates, and then set up a sophisticated model that predicts your ending net worth to the dollar. Either analysis extreme, or a middle-of-the-road approach, can have its place, depending on your circumstances.

So what are your options, and what are the costs and benefits of the retirement analysis? How do you decide how much time and effort to put into yours? In this article I explore a graduated series of retirement calculations, from the simplest rough estimate, to the most sophisticated model currently possible. Along the way, we’ll see how much time you need to invest for each kind of analysis, and review its limitations.

In the end, you’ll be able to choose the retirement analysis or calculator that’s right for you, whether you’re early in your career and saving hard, late career and approaching the retirement decision, or finally retired and planning your withdrawals….

## Burn Rate: Simple Division

Don’t discount the value of the simplest possible analysis. Many significant projects have begun with a simple sketch on a napkin. And many an error has been caught, or direction checked, with a simple back-of-the-envelope calculation. Sometimes, that’s all you need.

A decade ago when I was closing in on financial independence, I checked my progress with a variety of metrics. Finally they all added up to financial independence. Nothing in the intervening years has changed my view. In fact, our financial health has only improved during early retirement.

So, at this point, I’m over that initial finish line and coasting down the off ramp. There are diminishing returns to me of performing a detailed retirement calculation on a regular basis. I’m less concerned with optimizing my finances these days than just spot-checking that nothing major has changed with my economic assumptions. And for that, a rough, back-of-the-envelope estimate is sufficient, maybe even preferable.

Let’s start with some very simple division. Say you’ve saved $1,000,000, and you need about $60,000/year to live on, in addition to whatever pension or Social Security or retirement income you’re receiving. (These are made-up numbers; feel free to use your own.) So we divide $1,000,000 by $60,000/year and see that your money will last about 17 years.

If you already know your *net worth* and your annual *living expenses*, then this calculation will take you only a few seconds. If you don’t know those important numbers, then it could take much longer. But knowing those critical parameters is vital to any financial planning, so this is an opportunity to roll up your sleeves and figure them out.

This simple “burn rate” calculation is valuable because it is so quick — you can usually do it in your head. It is a useful benchmark that you can measure frequently. Also, by ignoring the growth of your investments, it’s generally *conservative*. I think of it as a “worst case scenario.” That said, it is extremely rough. It ignores a host of potentially important factors including your investment performance, inflation, market volatility, current valuations, and taxes.

## Real Return: Growth – Inflation

Next we’ll add a bit more sophistication to our retirement model by considering investment *growth* and *inflation*. The facts are that, on average, your savings will grow some each year, and inflation will increase your expenses.

Over the past century, stocks averaged about 10% growth annually. Let’s add that growth factor to our previous scenario. So we have $1,000,000 growing at 10% annually. That’s $100,000/year in income. With only $60,000/year in living expenses, your portfolio would last forever!

Sounds great. *It’s also wrong.* For starters, we forgot about inflation. Let’s call that 3.5%, a bit more than the historical average, considering what the government is up to these days.

We also forgot that your whole portfolio probably isn’t in stocks growing at 10%. Let’s say your combined portfolio of stocks and bonds grows at 7.5% annually. (Expecting such growth rates going forward may be delusional, but that’s another discussion.)

So, let’s run those numbers again: $1,000,000 growing at 7.5% minus 3.5% (4% real return) annually. In the first year, that portfolio produces about $40,000 in growth. But you are withdrawing $60,000/year in living expenses, so that draws the portfolio down over time. It turns out that your money will last about 28 years in this scenario.

How do we know? For this you’ll need a spreadsheet or a low-fidelity retirement calculator. Otherwise, performing the annual calculation of adding growth and subtracting expenses for every year of a retirement is extremely tedious. If you’re on Android, you can use our Can I Retire Yet? – Free. Or, for more options and other devices, see our list of Best Retirement Calculators.

**Note**: If you’re a do-it-yourselfer, you can also perform this calculation with a simple spreadsheet you can set up in just a few minutes: In Excel, use the FV (future value) formula with a positive annual payment (your living expenses) and negative present value (your savings). Then use the Goal Seek function to solve for the number of periods — the years your savings will last. This gives you a quick answer for a simple decumulation scenario.

Whether you use a simple free retirement calculator or do the analysis yourself in a spreadsheet, this calculation should take less than 10 minutes. The great advantage is that it lets you really focus on the three key variables in the retirement equation: growth rate, inflation rate, and life span. In most retirement analyses, these dwarf all the other inputs.

But this analysis doesn’t allow you to easily analyze transitions such as work to retirement, or taking Social Security, so it isn’t a full-blown retirement model. It also doesn’t incorporate market volatility, current valuations, or taxes.

If you’re in the lowest tax brackets, you might get away with ignoring taxes. Otherwise the living expenses number should include an estimate of your taxes owed. But that gets increasingly difficult to do accurately as your assets grow and you get into later retirement scenarios involving Social Security and RMDs (Required Minimum Distributions).

So with this type of calculation, you get a simple compass for your financial direction. And much of the time, that’s all you need. Yes, more sophisticated tools are available, but they require more effort, and will consequently get used less often. A compass in your backpack is much more useful on the trail than a GPS you’ve left at home!

## Market Volatility/Sequence of Returns

The simple formulas presented above are essentially what you’ll find in many low-fidelity retirement calculators. These calculations are useful as a rough guide, but contain some potentially critical inaccuracies. For starters, they completely ignore the *sequence* of investment returns, assuming that *average* returns are all that matter.

They aren’t. You can drown in a pool that has an “average” depth of four feet. And, you can run out of money in a stock market that returns 10% annually, on average – if those returns start below average, and don’t increase until too late in your retirement! There is a mathematical penalty for volatility. The problem is especially pronounced when you are withdrawing from a portfolio regularly, as for living expenses in retirement.

Most low-fidelity retirement calculators assume steady growth rates, year in and year out. But that’s not how the economy or your money works. When you are adding to, and especially when you are withdrawing from, a portfolio, deeper mathematical analysis shows that you will wind up with dramatically different sums, depending on the *order* in which returns, or losses, accumulate.

Some higher-fidelity calculators try to model the fluctuations of the markets by incorporating *Monte Carlo* algorithms into their calculations. You input statistical measures of the *range* of possible values for important parameters like inflation and investment returns. The calculator then picks random values from those ranges, combining them into hundreds, thousands, even millions, of variations. It sounds very comprehensive, but it turns out that markets aren’t actually completely random. And the randomness they do exhibit is not the kind of randomness most often used in Monte Carlo calculators.

So if steady growth and Monte Carlo-based simulations can be misleading, what about using actual market *history*? This approach has many strong adherents. But while it is better than some of the alternatives, there are still serious flaws. For starters, it assumes that the future will be like the past. Yet the modern world, with its complex systems, has the potential for chaotic behavior. Who can really say we’ve already seen the best or worst possible outcomes?

A less academic but much easier way to account for volatility is to simply shave a few percentage points off the absolute returns you use in an otherwise low-fidelity analysis. Though I have not seen authoritative research on choosing this factor, the numbers I generally see the experts pick are in the 1-3% range. So, if you choose to subtract 2% from average returns to account for market volatility going forward, your results may be as defensible as those from more sophisticated analyses.

If you choose the more sophisticated approach, then assuming you aren’t designing your own model for market fluctuations, the extra time to perform this analysis boils down to your learning curve for using a high-fidelity calculator that incorporates Monte Carlo or historical analysis. You’ll need to learn how to input or choose some additional options, and how to interpret the results, which may now be couched in terms of probabilities rather than explicit numerical answers. On the low side, figure an extra hour of your time, up to several days on the high side. If you don’t want to invest that, you can use the simple shortcut described in the last paragraph.

*Overconfidence* is the chief limitation of any Monte Carlo or historical analysis. Not even a CFP with 30 years of experience can accurately predict your future. Just because the calculations are more sophisticated, doesn’t make them correct. Both Monte Carlo and historical approaches still contain serious flaws. The chief of which, in my view, is that they are overly *conservative* in the vast majority of cases. If your primary concern is to not run out of money, they can be helpful. But if you have lifestyle flexibility and are more concerned with running of time, they can be misleading.

It’s best, in my opinion, to run multiple retirement analyses using all the available methods, compare and contrast the results, then chart your own personal course.

At this point, even though we’ve added in growth plus inflation and accounted for market volatility, we still don’t have the most accurate possible retirement calculation. We still haven’t considered current market valuations or taxes….

## Current Market Valuations

All the analyses we’ve discussed so far share another potential flaw, if they use a generic *starting point*. Because, in fact, your retirement doesn’t start at an “average” point in time. It starts on the actual historical date that you retire.

And how is the market valued on that day? It follows from common sense that if you retire at the start of a bull market (my fortunate situation), things will go better for you than if you retire at the end of one. If you’re going to predict the future based on the past, you should try to take into account your starting point. That’s why market valuations matter. But how do you quantify that gut instinct into a retirement calculation?

Retirement researcher Wade Pfau has used historical return data to show that safe withdrawal rates for portfolios are highly correlated to the level of the stock market at the time of retirement. One of his many papers on the topic is available here. It concludes that there is “favorable evidence based on the historical record for long-term investors to obtain improved retirement planning outcomes (lower savings rates, higher withdrawal rates) using valuation-based asset allocation strategies.” By “valuation-based” he means looking at the value of the market when you retire and during your retirement.

Taking current market valuations into consideration with your own retirement analysis is not a trivial task. To my knowledge, there is no retirement calculator that makes this as easy as clicking on a button. Further, most of the research I’ve seen on the matter involves either investment strategies for optimizing your portfolio (the subject of Pfau’s paper referenced above), or revisions to safe withdrawal rates, which are essentially a rule of thumb that can be used in place of a retirement calculator. So, if you are serious about incorporating market valuations into your retirement planning in more than a qualitative way (“the market seems high, so I’d better not splurge this year”), then you may have some research and reading on your hands.

Alternatively, similar to our discussion in the last section, you could use a simple average return analysis but adjust historical average returns by a percentage point or two depending on whether the market seems under or over-valued when you retire. Though CAPE or P/E 10 can be helpful in this determination, I know of no precise formula for adjusting average returns based on current market levels. It’s a judgment call.

Finally, there is one more variable we have yet to include. And that is one of the potentially most unpredictable over time, because it includes a political element. I’m talking, of course, about taxes….

## Taxes

Shocking as this will sound against the backdrop of financial planners and pundits who consider tax planning of supreme importance, I’ve *ignored* it for much of my financial trajectory. During my working years, we kept our expenses low, lived in a median house, drove modest vehicles, saved a ton of money, and maxed out retirement contributions. That was it. In retirement now, we’ve been living in the lower tax brackets where taxes are not one of our major expenses. I haven’t even been convinced that it’s worth the bother to perform a Roth conversion yet.

That said, if you are very wealthy, or later in retirement, taxation could be a more significant issue for you. If your income pushes you into higher tax brackets or impacts your Social Security taxation, some analysis and planning may be in order. Then there are RMDs, the government’s rules requiring you to withdraw and pay taxes on your retirement savings at a certain point. My analyses show that later in retirement, even relatively modest income levels can be pushed into higher tax brackets due to those distributions. Again, if you want to optimize your money, some tax planning may be in order. Though I still tend to believe such planning is a *luxury* — an indicator that you have enough money to worry about. In other words, it’s a good problem to have, and not one that’s likely to threaten your ability to keep a roof over your head or put food on the table.

Trying to analyze your future tax situation in retirement by hand is virtually impossible. The rules are complex and predicting how they might change in the future is even more complex. This is a job for software created by those with time to focus on the problem. However, relatively few of even the highest-fidelity retirement calculators offer detailed tax calculations. The only ones I can personally recommend are our Can I Retire Yet? – Pro and Pralana Gold. Fortunately, the calculations are automatic. Once you mastered the learning curve of the calculator itself, there is no additional overhead to getting accurate tax projections for your retirement future.

That said, understand that even the most sophisticated models are still just models. Having been personally involved in creating the tax calculations for Can I Retire Yet? – Pro, I can say that numerous assumptions and simplifications are still required, even with the most sophisticated tax analysis. Understand that large swathes of the future are essentially unknowable, especially when it comes to the behavior of voters and politicians and bureaucrats who impact the tax code.

## Diminishing Returns and Life Expectancy

With that, we’ve incorporated just about all the conceivable numeric factors in a retirement calculation. We started with simple division and proceeded through growth and inflation rates, market volatility and valuations, and taxation. We also talked about the tradeoffs involved with your time and the accuracy of calculations along the way.

In theory we are now very close to an “accurate” retirement number. You can get more accurate calculations by investing more time, to a point. The more data and considerations you incorporate, the more opportunity for variability and error as well. In chasing retirement planning accuracy, you may reach a point of diminishing returns.

In the end, you can analyze your savings and come up with a number for how many years it will last that is as accurate as humanly possible. But then there is one absolutely critical remaining factor that we’ve been ignoring so far:

Just how long will *you* last? Without the context of your own *life expectancy*, the longevity of your retirement savings is only half of the picture.

And here we are up against another essential unknowable. Any retirement calculation that requires you to know the exact time of your death is, by definition, an abstract, academic exercise. That’s fine for insurance companies — which can rely on the laws of statistics governing large groups of people — but unreliable for an individual.

What should you do, given that none of us can know with great certainty how long we might live? Stay tuned for future articles on life expectancy calculators and annuities….

Meanwhile, as you pursue more accurate or sophisticated models of the future, it should be with a healthy dose of realism. In the end, no retirement calculation can predict the future. All it can tell you is which direction you’re headed.

*“…with all our planning and building and looking ahead to try to outguess the future,
we find ourselves still at the mercy of the weather.”
*Stewart Udall

* * *

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Looking forward to future article about longevity insurance (LI).

With LI, you can effectively cap your planning at age 85 (or some other pre-determined age at which your LI payouts begin for the rest of your life), and work with a defined period for planning the spend-down of the majority of your assets. Then you can use TIPS ladders and other non-directional assets to cover your basic expenses, or even all of them, until LI payouts kick in. Goes a long way toward reducing uncertainty.

Thanks Robert. This article I wrote a while back might be helpful: https://www.caniretireyet.com/annuity-shopping-time-buy-deferred-income-annuity/. The issue I’ve seen with longevity insurance is that it’s not usually inflation-indexed. And trying to predict and plan for inflation over those long time spans re-introduces some risk, unfortunately.

Excellent info as always, Darrow!

Thanks Tyson.

I love reading your blog. Very informative and always on point, at least my point anyway.

I have used pralana and caniretireyet to make sure that my own retirement spreadsheet is within some reasonable guiderails. Taxes become significant at 70 for me since our IRAs are large (but I guess I’d rather have the tax problem than no enough assets). As far as market returns, I use a random calculation for market returns between -2% and 4% to stress test the plan. I’ve capped end of life at 85 since both spouse and myself have chronic, deteriorating health conditions (no LTC for us!?).

Look forward to your next blog.

Interesting, thanks for the details and kind words Stu. Long may you run.

Good stuff Darrow, thank you. I am reminded of the Yiddish cliche “Man plans, God laughs.”

No less than Rob Arnott suggested the simple division in a Financial Times column in 2008: “I propose a much simpler paradigm. Look at actuarial tables to find your life expectancy. Divide your liquid assets (stocks, bonds and cash) by that figure, and don’t spend your savings by more than that sum. Do not include your house, which you can’t spend…Don’t we want to allow for an 8 per cent return on our assets, which seems to be a common assumption, to plan our spending? No, for several reasons. First, net of inflation and taxes, our personal investment returns will be dismayingly close to zero….Second, the cost of living keeps getting higher…Third, spending returns before they’ve been earned is dangerous…Finally, we should keep working until that ratio of liquid assets to ‘years left’ is more to our liking.”

Darrow – Thank you for yet another insightful and very balanced perspective. It’s great to hear from someone who is very strong on the math and fundamentals, yet understands the inherent limitations of predicting the unpredictable future with fancy and precious models.

I have two questions:

1 – I have run my numbers through many retirement calculators – most recently Flexible Retirement Planner and Personal Capital’s new retirement planner. They give me a 95%-99% success rate if I retire next year, using some conservative assumptions about return rates and spending. I’m curious how much confidence you would put in these success rates if it were your decision to retire next year on these numbers? Would this be all you need to feel good, or would you do additional analyses?

2 – You stated above “Both Monte Carlo and historical approaches still contain serious flaws. The chief of which, in my view, is that they are overly conservative in the vast majority of cases.” This is a very interesting comment – would love to better understand why you say this and what support you have for this assertion?

Again, many thanks for all your great work. I really appreciate it.

Hi MK, thanks for the feedback. Not being a professional advisor, I try not to pass judgement on the specifics of somebody else’s plan. I can say that I retired 7+ years ago now without that level of confidence, but with a lot of lifestyle flexibility, and things have gone well for us. Though, as we all know, I was fortunate to retire early in a bull market.

In general, when you do Monte Carlo or historical simulations, you’re planning retirement around a worst-case market scenario. But most of the time that doesn’t happen. I don’t have the exact research at the tip of my fingers, but this paper gives some of the flavor:

“By emphasizing a portfolio’s ability to withstand a 30- or 40-year retirement, we ignore the fact that at age 65 the probability of either spouse being alive by age 95 is only 18 percent. If we strive for a 90 percent confidence level that the portfolio will provide a constant real income stream for at least 30 years, this means that we are planning for an eventuality that is only likely to occur 1.8 percent of the time. And even that figure assumes that clients are unable to make adjustments to their spending later in retirement. So by relying on standard historical or Monte Carlo simulations to determine a safe withdrawal rate, clients may be unduly sacrificing much of their desired lifestyle early in retirement.”

Thanks Darrow, lots to think about, but mostly I am reminded of the “how long will I last” component and that just made me firm up my bucket list! Getting the Pleasureway tuned up!

Cheers and thanks for the time you make to write these articles…..super helpful

Thanks much Nancy. We still love our Pleasure-Way! Happy adventuring to you…

Congrats and thanks for another informative and practical article, Darrow! As an early retiree (engineering too:) with a general skepticism of “financial planners/experts”, I appreciate how you distill financial info in an engaging and thoroughly readable style.

You mentioned that you’re not proponent of a Roth conversion … yet. Are you going to write an article that will describe the ideal candidates for such a conversion? With the U.S. federal government debt at levels so deep that it seems rather unfathomable to ever be balanced, it seems inevitable that taxes can only go higher. During this honeymoon of pre-RMDs and relatively low taxes, I would love to hear your analysis about Roth conversions.

Your blog is my fav retirement subscription and I always look forward to your posts. Keep up the great work!

Thanks for that Lori. Great to hear from another early retiree engineer! I covered most of the issues in my Roth article of several years ago. I don’t have too much to add at this point. Personally, I would

probablycome out (slightly) ahead financially by doing Roth conversions, but I’m just not convinced the difference is worth the hassle in my case. Taking on costs now based on what we think tax rates will do decades hence feels speculative to me. Others may have different financial situations or opinions.Oh, I missed that one; I’ll read up on it. Thanks for your Roth article link!

Darrow: This article is a very good and concise analysis of the range of retirement calculators. I read a great deal on retirement and financial independence, and don’t know that I have seen such a summary. My wife and I are 4.5 years into our early retirement journey (retired at 49 years old). We also have benefited from a strong and growing economy and equity markets. Our experience has been that building flexibility into our financial life and plans has been very important so far, and I think will be key to our long term success. The other key is having a spouse or partner that is on the same page in regards to short and long term objectives, and whom has a flexible mindset. I look forward to your future posts. Perhaps you might want to consider the following topics for future posts: 1) How to build financial flexibility into one’s life post retirement and 2) Planning for long term care and long term care costs.

Thanks Ed and congrats on your early retirement! I agree with your key points. Sounds like we’re living the same experience. And thanks for those post suggestions. I’ve put #1 high on my list, good idea. As for #2, it’s not the complete story, but see these posts I wrote on Long-Term Care Insurance in 2015: Beyond the Sales Pitch, and Why We Aren’t Buying It.