One of the best retirement planning tools is a retirement calculator. In fact, you can build a retirement calculator at home using easy-to-find materials. These calculators can be as simple as a line graph and a value of X. However, calculators that can take into account market performance and inflation will help you see the purchasing power in future years. A more complex tool will tell you when you will reach the age where a withdrawal rate of savings becomes impractical. The most advanced retirement planning calculators will even take into account future tax rates and government pension plans.
The problem with most retirement planning calculators is they are only as good as the data they can obtain from the government. The government has a poor track record when it comes to being accurate with information it provides to the public. So, most modern retirement planning calculators rely on past data or data that is either assumed to be accurate or extrapolated from other data. This approach is sound in the sense that it allows you the ability to project future data based on past data. But, in this situation is falls short.
With the government still failing to provide us with a valid cost of living adjustment (COLA) since 1998, we must take a more complex approach to retirement planning. If the retirement planners cannot account for the COLA as a future event, the future purchasing power of savings will be severely impacted.
When the government did provide a COLA for the first two years of 1999, the retirement calculator did not account for the fact that a COLA would be applied to all employee contributions in the following years. The most important event the calculator did was to use the previous year's salary as a starting point for retirement planning calculations, and extrapolate the past into the future.
If you were to look at your present salary and then look at your projected future salary and extrapolate from there, you can see that the future will look very different. A more accurate way to approach retirement planning is to look at the present and look at your desired retirement goal, and then look at current salary and extrapolate the past into the future. This takes the time horizon of the process into consideration.