Retirement Calculators Threaten Your 401k Plan

By Neil Plein
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Having a retirement calculator should be a good thing. It helps to perform computations and projections that would otherwise be out of reach to the common 401k participant. The intent of calculators are primarily twofold; to help a participant understand what their retirement savings goal is and to present the necessary contribution rate needed to reach that goal. Calculators are not designed to compute investment performance history, but rather, to use such information along with contribution rate to give the participant an idea of whether or not they’re on track to reaching their savings goal.

Consider your savings goal for a moment. Most calculators, without much input other than simple variables like age, salary and retirement age; can determine what your savings goal should be; how much money you’ll need to save to live on some percentage of your current income for some number of years until death based on standard actuarial tables. This is common, most people know their age, salary and usually that they want to retire at 65; so figuring out a retirement savings goal, at least through the use of a retirement calculator(s), is something which can be done with relatively little resistance or confusion (I’m omitting mentioning inflation, salary increase, etc.).

But with a goal established now what? Logic would follow that you would look at where you are currently (point A) and determine how you will get to your goal (point B). Between these two points is your path and following that path depends on growth; which comes from investment returns and contribution rate working together. Needless to say, managing these two variables is exceptionally important.

Unfortunately, for the average participant, this is the point at which their comfort with plan tools (their retirement calculator) begins to slip away. This can be observed very easily by thinking of how your own retirement calculator works.

The odds, which are overwhelming in this case; are that you log in somewhere, go to your retirement calculator and are then presented with a series of questions that require you to enter personal information manually. Examples are questions like: how old are you? What age would you like to retire at? What is your salary? How much are you contributing? What is your current retirement balance? What is your target rate of return? Now stop. Can you feel the ease with which answers entered your mind fade away on that last question? The first few questions were fairly obvious, came to your mind quickly; but do you have any idea what your target rate of return even is?

According to Warren Cormier, of the Boston Research Group, most participants don’t even know what their portfolio returns are[1], so by lacking this fundamental understanding, how would they even have a chance at grasping what their returns would need to be in the future?

If we consider the hypothetical retirement calculator example above, and acknowledge the troublesome nature of this question; how would it be answered? What data would go in? After all, this target rate of return, the growth component, is essential to understand because of its relationship to contribution rate and therefore the path which leads you to your retirement savings goal; so how do you answer this important question?

Most calculators, through the convenient aid of a help screen, provide some relief through a definition which sounds something to the effect of “rate of return you expect from your portfolio in the future.” Some help screens even provide historic rates of return from major indexes. So seemingly, this could help a participant provided they were 100% invested in one of the referenced indexes. As this is usually not the case, we can mentally focus back on that little blinking cursor in the box marked “what is your target rate of return?”

With the help screen essentially useless, there are two ways to approach answering this question (what is your target rate of return); start with the calculator by guessing some number and seeing what contribution rate the calculator provides or start with your quarterly statement by examining your rate of return (if provided) and using this as your target rate of return. Both of these approaches will lead you to the same confusing conclusion.

Consider approaching from the calculator end, guessing a target rate of return and examining the contribution rate it outputs. Now what? Well, unless this target rate of return is consistent with your current investment portfolio (an 8% target rate of return is not realistic if you’re invested 100% in stable value, for example), this will not help you and your path will be shadowed by uncertainty. The output is only as reliable as the input and the input must then be consistent with your actual investments, requiring, once again, the participant to act in the capacity of a financial expert to make that so.

Now try approaching from the other direction, starting with the portfolio return presented on your quarterly statement, if it is presented at all. Assuming it is, how is it presented? If it is annual, this is not reliable; 2008 is an example of that and surely nobody would argue that examining annual return alone would be sufficient for use as a strategic figure like target rate of return. Another example of this complexity is with popular target date funds, which target not a retirement savings amount or a particular income stream, but a target asset allocation. Since the asset allocation of these funds change over time, what rate of return would a participant use in this case?

These are the types of decisions participants face, even outside of a target date fund, to get any type of return history, you have to look at where history is presented on the quarterly statement; the 1, 3 and 5 year returns of the funds you own. If you can convert all that information into an accurate representation of your portfolio’s performance history and therefore a fairly reliable target rate of return number, then you’re in good shape, that’s all you have to do! But if you can do that, you’re also probably an investment professional.

Since approaching an answer for this great question (what is your target rate of return?) leads ultimately to confusion and uncertainty regardless of how the average participant approaches it, what does this mean? It means that there is a major flaw in the system. But this is encouraging actually, because retirement plans are just that, a system- meaning technology lies at the core, so it is in technology that the system can be fixed.

First of all, in a perfect world, participants would never have to leave their retirement calculators; they wouldn’t have to reference data or perform computations on their own; these things would be handled by the calculator. This shouldn’t be that difficult, the information already exists from payroll, so integrating it into a retirement calculator, where fields are all pre-populated with a participant’s unique information, should be an obvious advancement.

But this is merely one facet, after all, as we discussed above, most participants could input this data anyway, the investments and contribution rate are where they need the most help. So if nothing more, participants should have more comprehensive performance history available for their accounts on quarterly statements, so if they must make the leap from quarterly statement return to target rate of return, at least it will be more meaningful. Ideally, however, this would be done for them.

With personal information pre-populated, personalized investment performance history should also be calculated and pre-populated. Two problems which immediately arise from the self directed approach are that participants change their investment mixes all the time, like a target date fund (figure 1); so what return reference points should be used to calculate contribution rate with any degree of certainty?

Figure 1

Target date funds provide no return reference points for participants to use in determining target rate of return; they only provide an outlined asset allocation mix that will change over time. Source: ICI Resource Center

One solution would be to bring things to an even level for everyone, killing two birds with one stone. By using asset allocation models, rather than target date funds, participants receive the benefit of professional management and changing asset allocation over time, rather than picking their own investments; and at the same time, this approach offers meaningful data points for use by the retirement calculator. A plan with 5 asset allocation models ranging from aggressive to conservative, for example, would have 5 historic rate of return data points for the calculator to use as target rates of return for calculating contribution rate. A participant would use the historic rate of return from their asset allocation model as their target rate of return (figure 2).

Figure 2

Asset allocation models allow participants to receive the benefit of changing asset allocation over time and professional management, but also data points of performance history which can be used as target rate of return. Above return information is for illustrative purposes only. 

In this way, participants receive the benefit of professional management and changing asset allocation, like a target date fund, but rather than targeting only an asset allocation mix at retirement, asset allocation models allow the performance history to be calculated and integrated into the retirement calculator along with general census data to easily present a retirement savings goal, whether a participant is on track to reaching that goal based on their current rate of return and contribution rate or if a change is needed, which could also be presented in exact terms (you need to increase your contribution rate by X% exactly to reach your goals based on the current data). This also accommodates the latitude of lump-sum retirement decisions; rollover, work with a financial planner, annuitization and other options, at the discretion of the participant. Regardless of which option they choose at retirement, they’re going to need a lump sum to make it happen, so that should be the ultimate goal focus.

With an approach like this, the confusion goes away, because participants merely have to click one button to get an idea of their savings goal and whether their on track. Participants, who were not, would only be required to adjust a few simple human decisions; do you want to contribute more? Target a higher rate of return by moving to a more aggressive asset allocation model? Retire later or retire on less income? That’s it. By adjusting these simple variables (actual decisions a participant would have to make that could not be made automatically for them), retirement peace of mind can finally be made available to the majority of participants in retirement plans.

This approach may not be relevant to “fix” some plans, particularly smaller ones. Such plans, where sponsors and participants are satisfied, can usually attribute their success to a diligent advisor, who takes the time to meet individually with participants every step of the way to keep them on track. Most plans, however, do not have this benefit. One restriction is that this would usually be too expensive (especially in light of new fee disclosure regulatory changes), not to mention activities like educational sessions are usually poorly attended and poorly understood. In fact, Lou Harvey, CEO of Dalbar, Inc. asserts; “Continued efforts since 1996 to help participants make informed decisions through educational sessions have been futile.”

Comparatively, professionally managed asset allocation models offer the benefit of professional management to all by default. This benefit of this default can be enhanced even further if asset allocation models are built using low cost investments like ETFs; the Department of Labor stated that a 1% reduction in investment expense could impact an average participant’s balance at retirement by around 28%. ETFs have the potential to reduce a plan’s expenses by this amount and therefore offer a risk free option to increase returns by the reduce investment expense.

A “golden plan,” so to speak, which offers all of this; asset allocation models built professionally using ETF’s, automatically changing asset allocation and an integrated retirement calculator so participants who choose not to be active receive the best benefit and participants who choose to be active receive an even greater benefit- easily attainable retirement peace of mind. Without scientific basis, it could reasonably be assumed that word of such ease would be contagious within a company, spreading to those who have not engaged their plan and encouraging them to do so, increasing the potential for the plan as a whole to deliver a comfortable retirement to all. I know of only one platform that can offer all of these features.

To see an example of a FULLY INTEGRATED retirement calculator, look here for a demonstration:

To see the prevalence of manual retirement calculators which depend on a participant knowing “target rate of return,” here is a list of links to the calculators of several major service providers:


Mass Mutual®


T. Rowe Price®

John Hancock®

Charles Schwab®

American Funds®


Wells Fargo®



Warren Cormier speaking on July 13, 2011 at the Dimensional Fund Advisors
Annual Defined Contribution Conference at the University of Chicago Booth
School of Business.

Copyright © Invest n Retire, LLC All rights reserved. 20-July-2011


About Darwin Abrahamson
Darwin Abrahamson founded Invest n Retire‚ LLC (INR) in 2004. Since 1982 Darwin has worked with fiduciaries and pension administrators of qualified tax-deferred retirement plans. Darwin has written articles for several financial publications; including Financial Planning Magazine‚ Financial Advisors Magazine, and the Journal of Indexes. His articles have been syndicated by Universal Press Syndicate. Darwin wrote an article‚ Avoiding Redemption Fees in 401(k) Plans‚ for Financial Advisors Magazine in 2005. In response to a white paper published in the Journal of Indexes‚ June 2008‚ Darwin wrote a rebuttal‚ Debunking the Myth That ETFs Have No Place in 401(k)s.

11 Responses to Retirement Calculators Threaten Your 401k Plan

  1. alison farrin says:

    I picked a retirement calculator rather at random and worked my way through it. If the participant listened to the 401(k) enroller, or even skimmed the enrollment booklet, they should have a pretty good idea of how to estimate rate of return. I would think that they would be better able to guess at that, than estimate their Social Security benefit or a pension benefit.

    I attended a meeting of “Executive Women” the other night. The conversation turned to 401(k) plans and I asked where this woman’s funds were invested, i.e. what’s the recordkeeper name on your statement? No clue. Her response was that she checked her statement to make sure it had her name on it and if the balance had gone up or down. Executive level person at a financial services institution. Unfortunately, with that level of interest in the state of one’s financial position, whether they understand rate of return is FAR DOWN on the crises list.

    • Alison,

      Target Rate of Return is not likely the primary focus of most participants; it would only be of consideration to those who take the initiative to become engaged in their plan. It does, however, play an important role in the process; especially within the larger schema of defined contribution design changes. Could you argue that requiring a participant to determine their own target rate of return through the experiences you outlined (If the participant listened to the 401(k) enroller, or even skimmed the enrollment booklet, they should have a pretty good idea of how to estimate rate of return) is easier than simply having this rate of return already calculated for them? The target rate of return issue is simply one component which could be improved within new system developments; as I outline here:

      Asset Allocation Models Are The Only Way Forward For 401k’s

      • alison farrin says:

        Simply doing something increases a participant’s chances of a successful outcome. I love asset allocation models and I think they are pretty simpke to understand. Unfortunately, I have learned that when “I” do enrollment meetings, I need an emotional response to get people to figure out which asset allocation model they are comfortable in. In 2008, too many people who thought they were agressive bailed out of the market at the bottom. Subsequently, I would prefer people be more conservative in their asset allocation mix, so they will stick with it. For many others – honestly, most others, they are better of with a professional money manger who simply removes the decision from the participant’s event horizon. While I agree with you that Asset allocation models are a great way for 401k participants to choose their funds, I beleive they are best used in conjunction with a professional money manager option and the ability to simply choose your own funds

  2. Neil,

    Great article. I agree that people who actually want to reach their retirement and life goals cannot do it by themselves. Once goals are determined, most just stop there. It’s a tough concept to get through, but the bottom line is, an expert needs to be present for guidance. Some sort of approach as you mentioned above, using allocation models and be able to receive the benefit of professional management and have someone guide the financial road map as should goals change is crucial.

  3. Excellent, concise and important analysis of a systemic DC communication/behavioral issue.

  4. This article was really good. I look forward to reading another one.

  5. Well written article on how the good intentions of a services (such as a calculator) can almost immediately lose its effectiveness by not taking behavioral finance issues into consideration.

  6. Pingback: Beware of Misleading Retirement Calculators in 401(k) Plans |

  7. Planning your retirement is the most important duties that you need to do. You want to begin planning in advance to ensure that once you retire you have sufficient capital to last you through the rest of your life.The single biggest obstacle to a prosperous retirement is procrastination. More to the point while, there are a lot of investment vehicles out there which are, on average, are cheaper than the ones advisors endorse.

  8. alvin says:

    yes this all sounds good, those of us who are fulltime employed with 401k plans dont always have the time to keep up with it. its the WALL STREET THEIVES that is using our money to get rich. as soon as i can get my money out never again a 401k plan.

  9. Interesting position, you consistently come up with the most practical articles and Retirement Calculators Threaten Your 401k Plan | InvestnRetire is absolutely no exception to this rule!

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