REASONS TO PLAN EARLY:
APPLICATIONS OF RETIREMENT PLANNING SOFTWARE:

Sandra L. Reynolds, Ph.D.
Associate Professor, Gerontology Department
University of South Florida
sreynold@chuma1.cas.usf.edu
 

As part of the retirement planning process, there are a host of choices when it comes to choosing software, both for the professional and for individuals.  In general, most consumers use retirement planning software (RPS) to gain some sense of their ability to retire with some measure of financial security.  While the retirement planning process is a complex one that should involve consultation with a professional, analyzing individual and family resources, goals, expectations, and obligations, among other factors.  RPS can be a good place for the consumer to start.  Software can help individuals to estimate the amount of funds they will need to put away in order to retire when they want and in a manner that suits themselves and their families.  Because of the complexity of the retirement planning process, the software should have the flexibility to alter various assumptions, in effect, to provide “what if” scenarios for the potential planning client to consider.   

Some critical features in RPS include programs that allow the professional to examine life cycle consumption models, probability analysis, and visual presentation capabilities.  In cases where software does not provide comprehensive information or capability, some professionals end up using multiple programs.  For the professional, ideally the desired features in retirement planning software would include: 

1)      The ability to estimate different inflation and tax rates before and after retirement

2)      The ability to plan for different rates of return on investments before and after retirement

3)      The flexibility to present different budgeting scenarios – varying income and expenses, both before and after retirement

4)      The ability to choose the order and amount of distributions from investments, whether personal or benefits-based.

5)      The flexibility to estimate retirement needs using different life expectancies     

6)      The ability to produce “what if” scenarios--the software should be able to demonstrate readily the impact of changing a single or multiple assumptions present comparisons in a comprehensible manner.

7)      The data output should be clear and in terms that the average client can understand. 

The following examples give a simplistic, but fairly clear view of the kind of guidance that retirement planning software can give a mature worker.  In this case, we have a 55-year-old person we will call John Doe.  Mr. Doe expects to retire when he is 65, and his life expectancy is 87, so he will need post-retirement income for at least 22 years.  He has assets that will provide income in retirement, currently valued at:

Equity in house                        $35,000

401K                                         40,000

Rollover IRA                             35,000

As he is not sure how easy it will be to access the equity in his home, he decides to plan conservatively based on $75,000 in assets.

Initially, he plans for an 8.0% return on his investments, and an inflation adjustment of his retirement income of 3.0%.  He estimates that $22,000 would suffice for his post-retirement income, in today’s money. 

After providing his financial advisor with all of the necessary information, he receives information that looks similar to this: 

Using this scenario, based on a complete set of information already shared with the financial advisor, this plan appears to give Mr. Doe good news regarding his future financial state.  This plan tells him that, all things being equal, the current money he puts away for retirement is more than sufficient (13% more) to meet his goals; in fact, he could cut down his contributions to $784 per month and make his goals.

However, his financial advisor advises him that counting on an 8.0% yield over the next 30 years may be overly optimistic; the advisor suggests that Mr. Doe plan instead on an average rate of 5.0%.  With nothing else changed, the plan now looks like this: 

Clearly, this news is less favorable, but probably more realistic.  By counting on a more conservative return on investments, the amount he currently puts away means that his plan will fall 30% short of meeting his goal for the future; in fact, he should be putting away $1700 per month.  Here is what his plan looks like, if he agrees to put $1700 away each month: 

Mr. Doe feels that he can afford to put $1700 away each month, but he also is worried about the projected life expectancy.  Calculating the population’s life expectancy is fairly easy, but an individual life expectancy depends on many factors other than average death rates, including genetic disposition, lifestyle and other health behaviors, and individual medical history.  The advisor and Mr. Doe decide to include one other scenario, one in which he exceeds his life expectancy by just 3 years, to age 90, requiring 25 years of post-retirement income.  His plan now looks like this: 

Going back to the original scenario, with life expectancy at 87, Mr. Doe wonders what will happen to him if he has a heart problem and he has to retire earlier than he anticipated, say, around age 60.  Using the same assumptions, but changing the length of time he would need post-retirement income, his plan would now look like this: 

Clearly, if Mr. Doe wants to plan for retirement at age 60, he will have to re-examine his plan in considerable detail, as this estimate falls short of his goals by more than 50%.  However, the advisor points out that, by the time he retires, his mortgage will be paid off and the equity in his home will be $125,000 in today’s dollars.  By obtaining a Reverse Annuity Mortgage, he can generate another $6000 of annual income, bringing him closer to the monthly sum that the current plan anticipates.

Finally, as the financial planning advisor wants to demonstrate to Mr. Doe the impact of his having waited this long to plan, he alters the plan one more time to reflect the original scenario ($1000 per month put away, 5% annual rate of return, 22 years of post-retirement income needed, etc.), but showing the difference if Mr. Doe had started planning only 5 years earlier.  Now, the Doe plan looks like this: 

This is interesting and ironic information to pass on to Mr. Doe.  More importantly, however, these scenarios--used anonymously--could provide retirement planning advisors with an excellent example to present to other mature workers, in order to encourage them to begin planning their retirement finances earlier in their careers.

His advisor reminds him that the plan is only as good as the accuracy of the information provided, in terms of his income and asset goals, his estimate of how much income he will need in post-retirement, and how well he has thought out such contingencies as long-term care needs, house maintenance, and other potential high ticket.  As such, this plan is a guideline, and he must work with the advisor to decide which way he wants to go.

Choosing the best software package begins similarly to most objectives, with defining what the client wants.  Unfortunately, planners and consumers alike find it hard to identify the perfect software program, so there is a certain amount of give and take when making the decision to purchase.  After you have identified what aspects are most important to you, evaluate what each package does, what features are important and if it will be comprehensive enough to meet current demands as well as anticipated changes.  The strength of the software comes from its ability to analyze complex sets of rules, expectations and assumptions.  Does the program go into sufficient detail and cover contingencies pertaining to financial planning as well as covering uncertainties?  Is the software user-friendly, or does it churn out useless information that makes the relevant information hard to identify or interpret? 

Not to be underestimated is the fundamental look and feel of the software.  It is important that the software be easily navigable with information being readily accessible and reports being easy to read.  Many programs do not come with a manual and a few do not provide online help; this should also be factored into your decision.

Most vendors provide demonstration opportunities to allow buyers to test-drive the product.  Since some software packages can cost thousands of dollars this is a very important factor.  For the financial advisor, an important piece of the decision is whether or not the software will integrate with other software packages that you currently use including client databases or investment software.  Having to load complex data manually into multiple programs is not cost-effective, and software that contains import/export features can save considerable time and money.

Retirement planning software can be a very useful tool, but it must be used properly.  A thorough knowledge and understanding of inflation, budgeting challenges, investment risks and returns, asset allocation, impact of taxes and qualified retirement plan distribution rules are important prior to implementing the output of the software.  While a good software package can add considerable value to an individual projecting their retirement finances or a professional helping multiple clients retire successfully, it is still only as good as the information going in as well as the ability of the user to interpret and evaluate the results.

 ACKNOWLEDGEMENTS:

The author would like to recognize the help of Money Minders Software, Inc. in downloading examples of financial planning software.  The example used is entirely fictional and represents only a fraction of the capability of the software.  Those interested in this software may access it through www.money-software.com.

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