How our retirement calculator works

Overview

This retirement calculator is an educational tool designed to help you understand where you are on your path to financial security in retirement. The tool produces numerical results that are derived from the information that you provided to us about: (1) the amount you currently have saved for retirement; (2) the percent of your income that you currently are contributing to your retirement savings; and (3) the income you would like to have in retirement. Specifically, using Monte Carlo simulations, the tool calculates an amount that “you may have” in retirement (at a 75% confidence level) and an amount that you would need to save (in addition to your current savings plans) to accumulate sufficient assets to generate the income that you have indicated you would like to have during your retirement (again at approximately a 75% confidence level).

The information produced by this tool is not intended to be investment advice and is not a substitute for a sound financial plan. It is not a recommendation that you take an particular course of action. We do recommend that you consider speaking with a Northwestern Mutual financial representative, who can provide you with assistance in developing a comprehensive financial plan to help put you on the path to financial security over your lifetime.

We describe in more detail below the way in which your numerical results were calculated using the information that we obtained from you, including descriptions of the assumptions that we made and the Monte Carlo simulations that were performed. We also describe the limitations applicable to a tool of this kind. We encourage you to review all of this information carefully so that you understand the nature and limitations of your results.

This retirement calculator was developed by the Northwestern Mutual Life Insurance Company and is offered for use by Northwestern Mutual Investment Services, LLC, a registered broker-dealer and member of FINRA and SIPC.

IMPORTANT: The projections or other information generated by this tool regarding the likelihood of various outcomes are hypothetical in nature, do not reflect actual investment or life results and are not guarantees of future results. Results may vary with each use and over time. Other investments not considered may have characteristics that are similar to or superior to those being analyzed.

Things That We Assume

When we run the Monte Carlo simulations to generate your numerical results, we make certain assumptions regarding things like taxes, income growth, rates of return, and other factors relevant to an assessment of your progress toward financial security in retirement. A description of the assumptions and data that we use is provided below.

Current After-Tax Income: We assume that you pay a total of 35% of your salary in state and federal taxes. Accordingly, to estimate your current after-tax salary, we take the amount that you told us that you earn and multiply that amount by (1-.35), or 0.65.

State of Residence During Retirement: We use the zip code that you provided to us to identify the state in which you live, and we assume that you will continue to live in this state throughout the entirety of your retirement. This affects certain tax assumptions that we make regarding the taxation of your distributions during retirement.

Mortality: We ask you to tell us whether you are male or female because this impacts your life expectancy. If you prefer not to tell us your gender, we assume that you are female. This results in a more conservative evaluation of your retirement readiness because females have a longer life expectancy than males. Mortality events are simulated using data from the American Academy of Actuaries, and Society of Actuaries.

Likelihood of Disability: We use the 2013 Individual Disability Insurance valuation tables from the American Academy of Actuaries to determine the odds of you becoming disabled or to project the average length of what a disability might be for you. Disability rates are based on age, gender, and occupational risk. Simulated disability events may be permanent. All disability events preclude expected salary for the duration of the event and may cause liquidation of retirement assets to meet spending needs.

Occupation: We assume that your occupation is one that presents a low risk that you will become disabled before you reach your retirement age.

Disability Insurance: We assume that you do not carry disability insurance.

Retirement Contributions: For purposes of calculating your numerical results, we assume that you will continue to contribute the same percent of your income to retirement savings up until the date of your retirement. We assume that your contributions are made in 12 evenly spaced intervals throughout the year and that you will begin earning interest immediately on such contributions.

Retirement Portfolio and Rate of Return: We assume that you will invest in a diversified portfolio allocated to various asset classes as set forth below:

We project rates of return for these asset classes based on Capital Market Assumptions (CMAs) that we have derived. The manner in which we derived those CMAs is described in detail below. We assume that your account is rebalanced annually to the asset allocation describe above and assume that you do not incur fees or costs in connection with such rebalancing. In the Monte Carlo simulations that we run, the simulated returns are divided by inflation (which also is simulated), to convert the returns to real returns. As a result, all dollar amounts generated by the tool are in today’s dollars.

Taxes on Income in Retirement: We assume you will pay state and federal income taxes on your income during retirement, and we make an estimate of those taxes based on information we have available, including your state of residence. We calculate estimated federal income taxes assuming you use the standard deduction and do not itemize. We calculate federal capital gains taxes according to current federal capital gains tax rates. For state income taxes we will use each state’s tax brackets and applicable standard deduction and exemption amounts to estimate state income taxes. We calculate state capital gains taxes using state tax rates applicable to ordinary income in your state.

Inflation: We simulate inflation in the Monte Carlo Simulation that we run but we assume that it will average 2.18%.

Income Growth: We assume that your income will grow at the rate of inflation through the date of your retirement.

Capital Markets Assumptions (CMAs):

The rates of return and standard deviations that we use to calculate your numerical results are based on CMAs, which are some educated assumptions we make about how asset classes will perform in the future. The Northwestern Mutual Investment Risk Management Division prepared the CMAs. In the following section, there is a more detailed explanation of how we calculated the CMAs.

The CMAs are based on forecasts of asset class returns over the next 30 years. This tool uses the expected arithmetic means and standard deviations corresponding to the various asset classes used in the portfolio described above. Although not relevant to this tool, the table below also includes geometric means and component returns:

Correlations: The following asset class correlation coefficients were used (rounded to nearest hundredth):

How We Derive the Capital Markets Assumptions:

In order to derive the Capital Markets Assumptions shown above, the Northwestern Mutual Investment Risk Management team built a simulation tool to generate random asset class returns and inflation rates. The CMAs shown above are based on the averages derived from 2000 trials over a thirty-year time period.

In our simulation model, factors in the economy such as inflation, unemployment, and gross domestic product (“economic risk factors”) drive asset class returns. We studied the historical correlation between the economic risk factors and the prices and performance of asset classes. We assume that asset prices and asset returns have different components (such as growth versus dividends or income) and determine each of those components independently, based on the risk factors. The model that we use for simulating asset class returns and inflation assumes that economic risk factors are the drivers of asset class returns. We studied the historical correlation between these risk factors and the prices and performance of asset classes and constructed a statistical model that could explain the prices of asset classes over time based on the risk factors. We also consider current valuation levels of asset classes.

In each of the 2000 trials, we randomized the economic risk factors to create a possible future path of the economy, and each year calculated the asset prices and returns based on the randomized risk factors. For example, if the risk factors show the economy in a recession, negative GDP would negatively impact the price of stocks. We randomize the risk factors using a time series model with mean reversion, meaning that the values in one year are the starting point for determining the values in the next year, and that over time risk factors revert to historical averages. We assume that asset prices and asset returns have different components (such as growth versus dividends or income) and determine each of those components independently, based on the risk factors.

The models we use to randomize risk factors consider present asset prices and current economic conditions as the starting point for simulations. The mean reversion within the model means that each year the average risk factors change, and the returns of asset classes are different, and shift over time.

The simulation considers present asset values and interest rates as its starting point. Compared to historical averages, at the time these simulations were done, equity asset classes were assumed to be richly valued. Thus, in the short term, equity asset classes have lower average returns as valuation levels return to historical averages. In the longer-term equity asset classes average returns increase as the importance of current valuation levels diminishes. The model also considers current interest rates, which are low by historical standards. The simulations assume that over time real interest rates will increase as they revert to historical averages. Cash and Fixed Income have lower short-term rates of return, due to current interest rates, but average returns increase with the assumption that real interest rates will increase as well.

The terms that we used above in describing the CMAs have the meanings ascribed to them below:

Asset Classes: An asset class is a group of investments that have similar features and risk/return characteristics. Market capitalization refers to the number of outstanding shares of stock multiplied by the current price of one share. United States equities are often categorized by their market capitalization, which is an indicator of a company’s size. A brief description of each category and asset class follows, with the abbreviations that will be used to refer to those asset classes in other places when abbreviation is appropriate:

US Equity - Large Cap (LC): Investments in the largest companies in the US with average market capitalization of more than $200 billion.

US Equity - Mid Cap (MC): Investments in companies in the US with average market capitalization of $4 billion.

US Equity - Small Cap (SC): Investments in companies in the US with average capitalization of $1.5 billion.

Although stocks have historically outperformed bonds, they also have historically been more volatile. You should carefully consider your ability to take risk with equities. Investing in companies with small and mid-size capitalizations or with shorter operating histories may present more financial and other risks than investing in companies of larger capitalizations and more seasoned companies. Their securities may also trade less frequently and in lower volumes making their market prices more volatile.

International Developed Markets (DEV): Investments outsides the US in countries with more developed economies.

International Emerging Markets (EMR): Investments outside the US in countries whose economies are less developed or are emerging.

Investing internationally, globally or in emerging markets may involve higher expenses and additional risks not present when investing solely in the U.S. markets, including political, currency and financial reporting risks. International emerging and developing markets may be less liquid and more volatile because they tend to reflect economic structures that are generally less diverse and mature and political systems that may be less stable than those in more developed countries.

Real Estate Securities (RE): Investments in vehicles such as investment trusts that own or invest in real estate properties (e.g., REITs).

Investing in special sectors, such as real estate, can be subject to different and greater risks than more diversified investing and may present more financial and other risks than investing in companies of larger capitalizations and more seasoned companies. Investing in real estate companies entails some of the risks associated with investing in real estate directly, including sensitivity to general and local economic and market conditions, demographic patterns, changes in interest rates and governmental actions.

Commodities (COM): Investments in physical commodities such as oil, copper or coffee through funds that invest in futures contracts.

Commodity prices fluctuate more than other asset prices with the potential for large losses and may be affected by market events, weather, regulatory or political developments, worldwide competition, and economic conditions.

Fixed Income (FI): Bonds and debt securities, and represent loans made by an investor to a government, government agency or corporation, including treasuries, corporate bonds, municipals bonds and mortgage-backed securities. With fixed-income securities and bonds, when interest rates rise, the price of the assets you own declines, which could negatively affect overall performance. Bond prices correlate inversely with interest rates and this effect is usually more pronounced for longer-term bonds making their prices more volatile. At maturity, the issuer of the bond is obligated to return the principal (original investment) to the investor. Bond funds (mutual funds and ETFs) continuously replace the bonds they hold as they mature and thus do not usually have maturity dates and are not obligated to return principal. High yield bonds present greater credit risk than bonds of higher quality. Bond investors should carefully consider risks such as interest rate risk, credit risk, liquidity risk, securities lending risk, repurchase and reverse repurchase transaction risk. A significant rise in interest rates in a short period of time would cause losses in the market value of any bonds or bond funds that you own.

Cash/Cash Equivalents (CSH): Securities that can quickly be converted into cash such as U.S. government Treasury bills, bank certificates of deposit, and other money market instruments.

Other (OTH): Comprised of investments that cannot be classified in any of the other main asset classes. We assume that Other assets have the same risk and return assumptions as US Equity--Large Cap.

Unclassified: Comprised of investments that can’t be classified either due to the investments’ complexity or lack of information about the investments. We assume that Unclassified assets have the same risk and return assumptions as US Equity--Large Cap.

Expected Return: The appreciation/depreciation of a hypothetical portfolio expressed as a percentage per year. Expected returns may be expressed as either an assumed arithmetic means or geometric mean. An arithmetic mean is simply the sum of all returns divided by the number of periods over which the return is calculated. This is also called the average return. A geometric mean is the compounded average return of the asset class over time. If there is any volatility in the returns of a portfolio, the geometric mean will be lower than the arithmetic mean. Expected return estimates are not meant to forecast the performance of a fund or security and do not guarantee future results. Expected return estimates assume reinvestment of all income (dividends and capital gains) and do not account for the impact of taxes, investment costs (such as transaction costs, fees, or other charges associated with the investment), or inflation.

Risk (Investments): The possibility of getting a lower return on an investment than expected or losing your principal.

Standard deviation: Standard deviations shown above are determined from simulations of the asset class returns over time, based on volatility in a 30-year period. Standard deviation is the most common measure of risk and is a statistical measure of the degree to which an individual value in a probability distribution tends to vary from the mean of the distribution. Higher standard deviation numbers indicate higher volatility and greater risk of loss. The standard deviation of a portfolio is calculated using the standard deviations and weightings of each asset class as well as the correlations between the asset classes represented in the portfolio. Standard deviation assumes a log-normal bell-curve-shaped distribution of outcomes. Experience has shown that not all returns fall within the pattern predicted by a normal distribution. Standard deviation does not capture the risk of large short-term declines in value such as market losses that occurred in 2008-2009.

Correlation: Correlation coefficients shown are also based on simulated asset class returns over a 30-year time period. Correlation is the nature of the relationship between two performance variables. If the variables simultaneously increase or decrease in value a positive correlation exists. If one increases as the other decreases, a negative correlation exists. The correlation coefficient is a measure of the degree of correlation between the two performance variables, such as the rates of returns on stock and on bonds, and is an input used in Modern Portfolio Theory to construct an asset allocation. The range of values for the correlation coefficient is from -1 to +1 inclusive. A correlation coefficient of zero indicates that no correlation exists; a correlation coefficient of 1 mean that the variables move perfectly in lockstep; a correlation coefficient of -1 means that they move inversely in lockstep. Asset classes tend to correlate more closely during periods of high market volatility, so the benefits of diversification may not be as apparent during such periods.

Volatility: The degree to which an investment’s return has fluctuated; the variability of an investment’s returns. Volatility is the visible, quantifiable manifestation of risk, including the risk of losing your principal. Standard deviation is a measure of volatility.

About the Monte Carlo Simulations that We Run and Numbers That We Provide to You

When you use this tool to assess your progress toward financial security in retirement, it produces numerical results, including (1) a dollar amount that “you may have” to spend during retirement on a monthly basis, (2) a dollar-amount that “you may need” on a monthly basis to achieve the level of spending that you indicated you would like to meet, and (3) to the extent there is a shortfall between the “you may have” and “you may need” numbers, a dollar-amount that you should consider saving on a monthly basis (your “estimated savings change”) to close the gap between the “you may have” and “you may need” retirement numbers. The manner in which we calculate these numbers is described below.

What you may have

We use Monte Carlo simulations to predict a dollar amount for “what you may have” to spend during your retirement based on your current assets and expected retirement savings rate. Monte Carlo is a method used to simulate the random occurrence of uncertain variables to obtain a range of possible outcomes. The outcomes within the range are then used to make predictions regarding the likelihood that a particular outcome (or set of outcomes) will occur. The Monte Carlo used to generate your numerical results simulates two thousand hypothetical scenarios that randomize the returns on your retirement assets (consistent with the asset allocation described above), the occurrence of a disability, and your lifespan. The Monte Carlo simulations that we ran predicted a range of lump sums at retirement age that would be available to you to spend during your retirement (given the amount that you currently had saved for retirement and amounts that you expected to save in the future). Using these lump sums and other data generated by the Monte Carlo simulations (including your expected retirement length and projected return on your assets during retirement), we calculated an amount that you could expect to be able to spend on a monthly basis without running out of assets. This calculation is done at a 75% confidence level, meaning that 75% of the time, you could expect to be able to spend the “you may have” amount (on a monthly basis) without outliving your retirement assets. These simulations account for the impact of market risk on the expected return of your retirement portfolio and simulate mortality risk as well. We assume that a disability event during retirement does not impact your retirement spending and as a result, we disregard the risk of a disability occurring during your retirement.

What you may need

We calculate “what you may need” in retirement based on information you provided to us regarding your expected level of spending during retirement relative to your current level of spending. We use your current income (net of retirement contributions) as a proxy for what you are spending currently. If you tell us that you expect to spend more in retirement, we add 15% to this amount and if you expect to spend less in retirement, we reduce this amount by 15%. If you tell us that you expect to spend about the same amount, we keep it the same. In each case, we divide the amount by 12 to convert it to a monthly income need.

Estimated Savings Change

Finally, if your “you may have” amount is less than your “you may need” amount, we provide an estimate of the amount of additional monthly contributions you should consider making to your retirement savings to close that gap by the date of your retirement. We perform a number of calculations to provide you with this estimate. First, we calculate the consumption rate that equals (at a 75% confidence level) the fraction of your current expected nest egg that you could expect to spend on an annual basis during retirement without running out of assets before you die. We then take the amount you have told us that you would like to be able to spend on an annual basis during retirement and divide that amount by the consumption rate. The quotient from this calculation equals the nest egg that you will need to accumulate in order to produce your desired income in retirement (again, at a 75% confidence level). To determine the additional amount you need to save to accumulate this nest egg (i.e., your estimated savings change), we subtract from it the amount of your current expected nest egg, and using the annuity formula, we solve for the amount that you would have to save on a monthly basis to accumulate assets equal to that difference at your retirement date. In making this calculation, we assume that your assets will be in an asset allocation consistent with the portfolio described above and that you will experience a constant rate of return on those assets consistent with the CMAs described above. Finally, in order to obtain a more accurate estimate of the additional amount you will need to save to achieve the desired level of income in retirement, we adjust the estimated savings change based on a linear regression analysis we performed on the error of the estimated savings change using the given age, income, retirement contributions, initial savings amount, and need. Using the linear regression to identify the predicted error of the estimated savings change, we make a corresponding adjustment to the estimated retirement contribution amount to more accurately estimate the additional amount you may need to save to achieve your desired level of income throughout retirement (at a 75% confidence level +/- approximately 5 percentage points).

Limitations Of This Tool

The asset allocation assumptions and models presented in this plan are based on generally accepted investment theories and methods as explained above. All the material facts and assumptions on which these models are based are disclosed. This tool is not intended to project the results of actual investments or holdings, and outputs from this tool should not be used as the primary basis of any actual investment decisions. The outputs of the tool should be viewed as general guidance on your progress to financial security and how you can increase the likelihood that you will have sufficient assets to generate your desired income in retirement.

The tool is subject to certain limitations. It does not take into account any social security payments which you may receive upon retirement, and does not take into account pension or annuity payments that you may receive. The tool uses an asset allocation appropriate for an aggressive investor, even though that may not be consistent with your risk tolerance or your investment horizon. We assume that you will rebalance your existing retirement assets into a portfolio consistent with the asset allocation being used (which is described above) on an annual basis, but the tool does not take into account costs or fees that may be associated with rebalancing. The tool also assumes that you continue to hold the portfolio described above (which consists of an asset allocation for an aggressive investor) throughout retirement, which may not be an appropriate for someone in retirement.

The tool assumes that all of your assets are held in taxable brokerage accounts, whereas it is likely that at least some of your retirement assets are held in tax-qualified accounts.

Our assumption that you pay 35% of your income in state and federal taxes may not accurately reflect your current actual tax rate or the rate that you may pay in the future.

The tool treats all simulations in which you do not deplete your retirement assets prior to your death as successful. It does not distinguish simulations that are successful because you had sufficient assets to provide an income for many years during retirement from simulations that were successful because you died before you reached retirement age or because you died very early in retirement.

As noted above, we calculate the various numbers we provide to you at a 75% confidence level. In general, this means that you could expect to achieve the indicated result 75% of the time. The calculation we perform to provide your “you may need” amount, however, is an estimate, and as a result is provided at the 75% confidence level plus or minus approximately 5 percentage points. This means that if you were to add to your current retirement savings the extra amount that we estimate you should save to achieve your desired income in retirement, the likelihood that you would have sufficient assets to produce your desired level of income in retirement would be between approximately 70 and 80% (and there would still be a 20%-30%% chance that you would not have a sufficient nest egg to produce your desired level of income throughout the duration of your retirement).

The information provided to you by this tool is for informational purposes only and may not reflect all policies, holdings or transactions, their values, costs, charges, or proceeds in your portfolio, policies or accounts. Your retirement income and savings information was prepared based on information provided by you and by various other sources. You should not rely on this information to determine the value of your assets. Any decisions made by you, based on such information, are made at your risk. Neither the Northwestern Mutual Life Insurance Company nor any of its affiliates (including Northwestern Mutual Investment Services, LLC and Northwestern Mutual Wealth Management Company) make any representations or guarantees as to the accuracy of the information produced by this tool.