How to read your retirement projection without getting a headache, Slowshore

Most people open a retirement projection, look at the big number in the middle, and close the spreadsheet. Either with relief, or with a knot in the stomach. Neither reaction leads to a better plan.

A projection is not a prediction. It is a calculation that shows what happens if a set of assumptions holds. Your job is not to believe the number. Your job is to understand where it comes from.

There is no single number. There are five.

Most retirement calculators highlight one result. Usually it is the projected annual income in retirement, or the total portfolio at a given age. That number is rarely wrong, but it is rarely sufficient either.

The five numbers you should know before you evaluate any result:

Starting balance. What you have right now across 401(k), IRA, Roth, taxable, and cash.
Annual spending. What you expect to spend each year, in today's dollars.
Expected nominal return. How much your investments grow each year, before inflation.
Inflation. How much a dollar loses in purchasing power each year.
Probability the money lasts. Not whether, but how likely.

If you can answer those five, you can read any retirement projection. Not just ours.

Look at the assumptions first, not the result

The most honest thing you can do with a projection is to read the assumptions before you read the result. The order matters, because a good-looking result rarely surprises the person who has already seen the assumptions.

Find the expected nominal return. Is it 7 percent per year? 6? 5? For a balance left untouched for 25 years, 7 percent gives roughly 60 percent more than 5 percent before fees and taxes. That is not a detail.

Find the inflation assumption. Is it 2 percent? 2.5? The long-run U.S. average is close to 3 percent, but the last five years have shown that shorter periods can be much higher.

Find the longevity assumption. Is it age 85? 90? 95? A healthy 65-year-old American woman has a life expectancy above 87, and roughly one in three lives past 90.

The assumptions are the projection. The result is just the consequence.

What "probable" actually means

Some calculators show you a single result: "Your savings last until age 92." That sounds precise. It is not. It is one possible future among many.

Better calculators show a probability: 92 percent chance your money lasts for the rest of your life, based on 500 simulated market paths. The technique is called Monte Carlo, but the technical name matters less than the underlying idea.

The idea is that the future is not one scenario. It is many. Some are favorable, some are harsh. By simulating hundreds of possible paths, you get a picture of how robust your plan is, not just what happens in the average case.

92 percent is not a guarantee. It means that in 8 out of 100 paths you would run short. Whether that is acceptable is a question for you, not for the calculator.

A concrete example

Take a specific case. You are 55, have $700,000 across a 401(k) and a Roth IRA, expect to spend $60,000 per year in retirement, and plan to claim Social Security at 67.

A projection might show: 78 percent probability the money supports that spending to age 92, using a 6 percent nominal return and 2.5 percent inflation.

That number alone says little. Drop the expected return to 5 percent and the probability falls to 62 percent. Add $500 per month of spending and it falls to 44 percent. Extend the horizon to age 95 and it falls to 31 percent.

None of those changes are unrealistic. They are the ordinary weather of any plan. The point of testing them is not to make you nervous. It is to find out what adjustments you may want to be ready for, if the future does not arrive exactly as assumed.

Two questions to always ask

Once you have read the projection, change two things, one at a time. This is often where you discover how sensitive the plan really is.

First question: what if returns are 2 percentage points lower than assumed? Not because they will be, but because they could be. If the plan holds up at 7 percent but falls apart at 5 percent, it is not a robust plan. It is an optimistic one.

Second question: what if I live five years longer than expected? Life expectancy is an average. A meaningful share of people live longer, so a retirement plan should also be tested against a longer lifespan. A plan that just barely reaches age 85 is not a plan. It is a timed worry.

If both questions are answered "still holds," you have a robust plan. If either makes you uneasy, you know where your attention belongs, and where you can adjust before it becomes a problem.

The calm comes from understanding the math

The point of a retirement projection is not to give you an answer. It is to help you ask better questions. Once you can point at the assumptions and explain where the number comes from, you stop guessing and start planning.

That is where the calm comes from. Not from a high number, but from a transparent one.