Most of the retirement calculators available at present are crude and complicated quite apart from being almost completely speculative.

The traditional methods start by growing your present yearly salary forward to your retirement date using an assumed inflation rate plus maybe one percentage point as annual increases.  The amount they estimate that you will have at your retirement age is a guess at what you’ll be earning just before you retire.

Then an annuity rate is assumed to convert the inflated income into the inflated capital that you would need to replace that income, at that time.  An annuity rate is the percentage of income that you can expect from a given amount of capital.  So with an annuity rate of 5 percent you would need R2 000 000 in capital to provide an annual income of R100 000.  With an annuity rate of 4.5 percent you would need capital of R2 200 000 to give you R100 000 of income per year.

If we take an individual earning R200 000 per year and grow that salary by inflation of 6 percent per year plus an extra 1 percentage point for good luck for the 25 years to retirement that salary will be R1 085 487 at retirement.  If we use an annuity rate of 5 percent per year he will need R21 709 730 at retirement to replace that income in full.  However because we have no way of knowing what the inflation rate will be over that period the amount is suspect.

Apparently our person now needs R21 709 730 for retirement less the inflated value of his or her existing savings.  So now we must guess an investment rate at which existing investments have to grow to get a value to deduct from the total needed.  If this person has R600 000 in savings and we guess investment returns of say 10 per year that’ll give us R6 500 000 at retirement.  R21 709 730 less R6 500 000 means that R15 209 730 extra needs to be created over 25 years to allow the individual to retire on 100% of salary.  Of course, not being able to predict inflation with accuracy means that the above is pure speculation.

With level contributions the person must save another R12 887 80 per month to meet the target.  Not too many people can fish that out at age 40.  Particularly if they are earning R200 000 per year (R16 667 per month).  If we reduced the target to 75 percent of salary he’d still need to save R9 665.85 extra each month.  If inflation is higher than assumed and investment returns are lower, then the figures produced this way have little relation to reality.

If inflation increases by an average 1 percentage point over that period and the annuity rate is 0.5 percent less at retirement the individual would have had to save R14 000 per month.  The assumptions have a big impact on the answer, which is: How much extra to save every month.  And there are many possible combinations of the various assumptions.  This makes the answers relatively meaningless.

This all just points to the problems of long term assumptions.

If we sum that up there are four problems with this model.

1. You are guessing future inflation;
2. You are guessing future investment returns;
3. You are guessing annuity rates; and,
4. You are trying to reach a target that is the product of the above flawed assumptions.