Accuracy of this Calc with regard to Inflation Rate?

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sheople2
Posts: 8
Joined: Thu Aug 25, 2011 10:16 pm

Accuracy of this Calc with regard to Inflation Rate?

Post by sheople2 » Thu Aug 25, 2011 10:33 pm

Would anyone be willing to plug in my following numbers below and see if this calculator seems accurate?

One confusing thing about this model, is that certain numbers don't seem to be advanced by the rate of inflation, but instead remain constant. How can that be if they ask you to plug in inflation rate? When I click into "detailed view" numbers look constant through all the years.

(SSDI income only. Used 54 as "retirement age" because that may be when I stop adding money to savings.)

Current Age = 44
Retirement Age = 54
Life Expectancy = 75
Inflation - Average = 3.5%
Inflation - Std Dev = 2.5%
Investment Tax Rate = 0%
Income Tax Rate = 10%
Taxable Portfolio Value = 105K
Tax Free Portfolio Value = $49,200
Min IRA/401k Withdrawal = Age 54
Taxable Annual Savings = 8K
Investing Style = Risk Averse
Annual Retirement Income = 17K
Retirement Income Start Age = 54
Annual Retirement Spending = 28K
Spending Policy = Stable

Probability of Success = 97%

Thank you.

jimr
Posts: 566
Joined: Thu Feb 28, 2008 6:48 pm

Re: Accuracy of this Calc with regard to Inflation Rate?

Post by jimr » Fri Aug 26, 2011 8:50 am

Hi,

I think the confusion is due to the fact that all values are shown in today's value dollars. So an amount that exactly keeps up with inflation will be shown as staying constant (eg real value never changes) throughout the years.

I do see a couple potential issues with those inputs. I noticed you set "Min IRA withdrawal age" below the default. Does that imply that you'll take a steady stream of regular withdrawals for life? If so, it's important to know the exact rules about how that works to avoid getting hit with a penalty.

Another potential issue is that it looks like you start withdrawing from your portfolio at age 54, when you stop adding to your portfolio. From your post, that doesn't sound right. If you plan to just stop adding to your portfolio, but not take withdrawals for a few years, you might want to increase your retirement age to the age when you'll actually start withdrawing funds from your portfolio. To do this, charge the retirement age and then zero out the "Taxable Annual Savings" on the main input area and instead enter it in the "Additional Inputs" popup window using a start and end age (eg start at age 44 and end at age 54).

Finally, I wonder about using a 0% tax for investment income. Usually with a portfolio the size of yours there would be at least some state tax on your investment earnings, unless, you live in a state that doesn't tax interest, dividends, and capital gains.

Jim

sheople2
Posts: 8
Joined: Thu Aug 25, 2011 10:16 pm

Re: Accuracy of this Calc with regard to Inflation Rate?

Post by sheople2 » Fri Aug 26, 2011 10:18 pm

Hi Jim,

I've read your first paragraph several times and I'm sure it's clear to anyone else who reads it, but not to me. Can you explain it a simpler or different way? Are you saying that all of the final amounts I'm seeing are before-inflation amounts? Since I filled in the fields for inflation on the main page (not in the additional inputs section) shouldn't the calc be showing me after-inflation -- and for that matter, after-tax amounts?

I showed my results to a mentor I know and he said, "It looks like this model assumes that you are just taking out 28,000 every year 10 years from now. What? Shouldn’t that number first be advanced by the rate of inflation between 2011 and 2022? Then shouldn’t expenses rise at the rate of inflation which you assume to be 3.5% for the rest of the scenario? Using the simple Rule of 72, a 3.5 percent inflation rate means that costs double in 20 years. His model seems to show drawdown to be constant."

I agreed with him and that's why I'm still confused.

If it says for instance "portfolio value at retirement is $292K" do I have to multiply that number by 2 on my own to get the amount I really need to shoot for in order to account for 20 years into the future (since things in 20 years will ? Or is the calc saying that the number is actually $292K?
______________________________

I think the calc forces you to put in Min IRA withdrawal age, doesn't it? It won't let me finish if I leave it blank. I have a ROTH, so there is no minimum. I don't really know when I'll be withdrawing. Any suggestions for an input and exactly where to put it?

I didn't know what "investment tax rate" input meant, so I left it at 0. Yes, my state does tax interest etc. Any suggestions for an input? My current Income Tax Rate is zero, but I chose to use 10% for that input, thinking that it may change in the future and that might be a decent average. ?

Also, are the Investing Style - Risk Averse input percentages that the calc defaults to, low enough for me? Note that when I saw Return - Average at 6.5% I assumed that was before inflation, so if I use 3.5% inflation that makes my real return about 3%. Is that correct? My portfolio may only return an average annual of 2% real (50% CDs, 50% stocks). If I should have chosen Custom and the real return is 2% what inputs might I use for Return - Average and Return - Standard Deviation?

Thanks for your patience.

jimr
Posts: 566
Joined: Thu Feb 28, 2008 6:48 pm

Re: Accuracy of this Calc with regard to Inflation Rate?

Post by jimr » Sat Aug 27, 2011 11:01 am

sheople2 wrote:I showed my results to a mentor I know and he said, "It looks like this model assumes that you are just taking out 28,000 every year 10 years from now. What? Shouldn’t that number first be advanced by the rate of inflation between 2011 and 2022? Then shouldn’t expenses rise at the rate of inflation which you assume to be 3.5% for the rest of the scenario? Using the simple Rule of 72, a 3.5 percent inflation rate means that costs double in 20 years. His model seems to show drawdown to be constant."
The values shown in the planner are constant-value 2011 (today's date) dollars. In nominal dollars, the withdrawal for expenses in 10 years will certainly be more than $28k (at 3.5% it would be around $38K). But that $38k will have the same purchasing power as $28k does today. Future value nominal amounts are sort of meaningless and are hard to compare from year to year because you need to do math in your head to figure out how much purchasing power a given amount will represent. For example, with 3.5% inflation, $28k today is the same as $38k in year 10 and the same as $54k in year 20. But what does $54k really mean 20 years from now? Saying something will cost $54k in 20 years is meaningless unless you can intuitively know what a dollar will be worth in 20 years. Most of us can't intuit that, yet we intuitively understand the value of a dollar today. That's why I show all amounts in today's value dollars, even though all the calculations in the planner are definitely taking inflation into account.
If it says for instance "portfolio value at retirement is $292K" do I have to multiply that number by 2 on my own to get the amount I really need to shoot for in order to account for 20 years into the future (since things in 20 years will ? Or is the calc saying that the number is actually $292K?
You would need to adjust that value to turn it into a nominal amount. However, in reality, shooting for an exact nominal dollar amount years in the future isn't a sound goal. The problem is that that target number will be ever-changing over time. So it's better to target a savings goal to use for the next year or two. Retirement planning is best done as a "one year at a time" repetitive process. Retirement planning tools, including mine, are not robust enough to tell you everything you need to know to create a set-and-forget 20 year plan. That's why I think of the planner as a decision-support tool rather than a prediction tool. If the planner can help you make good decisions over the next 1 year, it's probably done all that it can. Long term planning has to be a plan-implement-evaluate-adjust-repeat type of process.
I think the calc forces you to put in Min IRA withdrawal age, doesn't it? It won't let me finish if I leave it blank. I have a ROTH, so there is no minimum. I don't really know when I'll be withdrawing. Any suggestions for an input and exactly where to put it?
I'm not a tax expert, but my understanding is that Roth IRAs still have a minimum withdrawal age and withdrawals before that incur a 10% penalty. There are exceptions to this, so you'll have to do your own research. The min age input is supposed to match IRS rules and the default value of age 60 is a "safe" value (unless I'm confused about the Roth withdrawal rules). The way the planner is coded, if you need to take withdrawals from retirement accounts earlier than the minimum age, it adds in the 10% penalty fee that the IRS charges.
I didn't know what "investment tax rate" input meant, so I left it at 0. Yes, my state does tax interest etc. Any suggestions for an input? My current Income Tax Rate is zero, but I chose to use 10% for that input, thinking that it may change in the future and that might be a decent average?
The investment tax rate is the tax rate that you pay on investment growth. Each year, any growth in the portfolio is taxed at this rate. This approach is a simplification of reality and so the rate you choose should be a best-guess estimate. The planner doesn't know about differences between cap gains and dividends and interest and just taxes the net growth by this amount. 10% is probably a workable estimate but you really would have to use some online tax planners to get more precise.

The income tax rate is the tax rate charged on non-investment taxable income that you earn in retirement.
Also, are the Investing Style - Risk Averse input percentages that the calc defaults to, low enough for me? Note that when I saw Return - Average at 6.5% I assumed that was before inflation, so if I use 3.5% inflation that makes my real return about 3%. Is that correct? My portfolio may only return an average annual of 2% real (50% CDs, 50% stocks). If I should have chosen Custom and the real return is 2% what inputs might I use for Return - Average and Return - Standard Deviation?
It seems like you understand this correctly. Using a rate of 2% real would definitely be safer and you could do that with the custom setting by using a 5.5% avg return (assuming 3.5% inflation). You'll have to decide whether you should reduce std deviation or just leave it as is, which would be more conservative.

These return/std dev values are just guesses and in reality, your guess is probably as good as mine. In fact, it can be interesting to try different return/std dev values (using custom) and see how much changes in those values impact the plan's chances for success. This is called sensitivity analysis, and it's a great practice in any planning exercise.

Hope that helps. Don't hesitate to ask more questions. I'm sure others using the planner have similar questions, so having this q&a posted here is likely to help others as well.

Jim

sheople2
Posts: 8
Joined: Thu Aug 25, 2011 10:16 pm

Re: Accuracy of this Calc with regard to Inflation Rate?

Post by sheople2 » Thu Sep 01, 2011 11:20 pm

Hi Jim,

Thanks for your patience. You said above,

"Another potential issue is that it looks like you start withdrawing from your portfolio at age 54, when you stop adding to your portfolio. From your post, that doesn't sound right. If you plan to just stop adding to your portfolio, but not take withdrawals for a few years, you might want to increase your retirement age to the age when you'll actually start withdrawing funds from your portfolio. To do this, charge the retirement age and then zero out the "Taxable Annual Savings" on the main input area and instead enter it in the "Additional Inputs" popup window using a start and end age (eg start at age 44 and end at age 54)."

I clicked into Additional Inputs and I've no idea how or where to indicate that I'll be saving 8K from year 44 to 54. Can you be very specific?

Thanks.

jimr
Posts: 566
Joined: Thu Feb 28, 2008 6:48 pm

Re: Accuracy of this Calc with regard to Inflation Rate?

Post by jimr » Thu Sep 01, 2011 11:48 pm

sheople2 wrote: I clicked into Additional Inputs and I've no idea how or where to indicate that I'll be saving 8K from year 44 to 54. Can you be very specific?
Sure. Look in the bottom half of the additional inputs window at the "cash flows" section.

Set the Cashflow Type to "Taxable Savings"
Set the start year to "Age 44"
Set the end year to "Age 54"
Set the annual Amount to "$8000"
Then click on the Add button.

Then run the planner. Take a look at the "Detailed View" tab to verify that the New Investments column for rows from age 44 to age 54 shows your $8k investment.

One caveat for this is that the planner assumes that that $8k savings amount will be increased each year to keep up with inflation.

Hope that helps,

Jim

sheople2
Posts: 8
Joined: Thu Aug 25, 2011 10:16 pm

Re: Accuracy of this Calc with regard to Inflation Rate?

Post by sheople2 » Sat Sep 03, 2011 10:44 pm

1) Still very confused. I went there. Under Cashflow Type their is no "taxable savings" (?)
What other title should I use? I tried it under Misc Income (no cola).

2) Also, Is it OK that I have my SSDI income under Annual Retirement Income on the main page? Or should it be in the additional inputs section? My numbers vary wildly depending on where I put it...

3) I changed the IRA age to 60. Fine. But since I'm technically in retirement now at age 44, I changed my Retirement Age to 44 also and then changed Retirement Income Start Age to 44 (?). That brings my simulation into fail mode. Given my situation, what would you recommend I use.

I also took your advice and changed my Investment Tax Rate from 0 to 10%.

Obviously, this neat calc is only as accurate as the inputs that we give it.

Thanks.
Last edited by sheople2 on Sat Sep 03, 2011 11:37 pm, edited 1 time in total.

jimr
Posts: 566
Joined: Thu Feb 28, 2008 6:48 pm

Re: Accuracy of this Calc with regard to Inflation Rate?

Post by jimr » Sat Sep 03, 2011 11:34 pm

Maybe there's something strange going on with your version of Java or your browser that's causing you not to see all the choices.

The drop-down boxes all have scroll bars on the right hand side and you'll have to scroll down to find the choices you need.

Here is a screenshot from just after I clicked Add:
Capture.JPG
Are you still not seeing these choices in your browser after scrolling down?

Jim

sheople2
Posts: 8
Joined: Thu Aug 25, 2011 10:16 pm

Re: Accuracy of this Calc with regard to Inflation Rate?

Post by sheople2 » Sun Sep 04, 2011 8:14 pm

Hi Jim,

Yes, I just got it. Sorry about that. I see it now. That worked.

Moving on, is it OK that I have my current SSDI income under Annual Retirement Income on the main page? Or should it be in the additional inputs section under social security? My numbers seem to vary wildly depending on where I put it...

Also, I changed the IRA age to 60. Fine. But since I'm technically in retirement now at age 44, would it be correct to use Retirement Age as 55 & Retirement Income Start Age as 55? That's a year after I stop contributing to my savings and that seems to be when the spending is triggered which I think is correct. When I put those inputs at 44 that brought my simulation into fail mode. Given my situation, what would you recommend I use?

Also, I'm using a Custom - Average Return of 5.5% (with a 3.5% inflation rate with a 2.5% dev rate.) What is an accurate input for the Return's -Std Dev?

...And if it says Portfolio Value at Retirement $293K is that the actual number I'm shooting for to save up to - or am I looking to save 293 x 2 = $586K? Is multiplying by two correct or is it 2.5 that I use to multiply with?

Thanks for your patience.

jimr
Posts: 566
Joined: Thu Feb 28, 2008 6:48 pm

Re: Accuracy of this Calc with regard to Inflation Rate?

Post by jimr » Mon Sep 05, 2011 8:01 pm

sheople2 wrote:Moving on, is it OK that I have my current SSDI income under Annual Retirement Income on the main page? Or should it be in the additional inputs section under social security? My numbers seem to vary wildly depending on where I put it...
Hmmm. They shouldn't vary at all if you're exactly substituting from one place to the other. I wonder if the difference is because of taxes? Or perhaps due to start and end date? On the main page, any income is assumed to start at the retirement year and end at the end of plan.
Also, I changed the IRA age to 60. Fine. But since I'm technically in retirement now at age 44, would it be correct to use Retirement Age as 55 & Retirement Income Start Age as 55? That's a year after I stop contributing to my savings and that seems to be when the spending is triggered which I think is correct. When I put those inputs at 44 that brought my simulation into fail mode. Given my situation, what would you recommend I use?
If I understand you correctly, I think using 55 is fine. The key is to check in the detailed output tab to make sure the inflows and outflows are happening in the years you expect them to happen.
Also, I'm using a Custom - Average Return of 5.5% (with a 3.5% inflation rate with a 2.5% dev rate.) What is an accurate input for the Return's -Std Dev?
Unfortunately this input is a wild card. No one really knows what values to use, so the best you can do is to try some reasonable numbers and then try to increase or decrease them a bit and see how doing so affects the results. Sorry I can't be more help than this, but estimating future returns is really just a guess.
...And if it says Portfolio Value at Retirement $293K is that the actual number I'm shooting for to save up to - or am I looking to save 293 x 2 = $586K? Is multiplying by two correct or is it 2.5 that I use to multiply with?
I assume you're multiplying to account for inflation? If that's so, I'm not positive what the multiplier should be exactly[/quote]
The $293k number is the value in 2011 dollars, so the real number you're shooting for will be larger. How much larger depends on the inflation rate and the time. I think before we said that at 3.5% inflation $28k turned into $38k over 10 years, so that's a rough guide. It looks like we could have less than 3.5% annual inflation over the next ten years, but in truth, it's anyone's guess.

Jim

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