In a previous entry, I mentioned that as part of my learning process I developed my own retirement calculator. At a high level, it’s a good way to synthesize and apply the knowledge that I gained. Writing a program is a creative yet rigorous process to precisely put together a step-by-step recipe to solve a problem.
So what problem am I trying to solve? There are already many professional retirement calculators that can do various what-if scenarios. Or specific use case calculators on Roth conversion, Roth Ira contribution, etc. I’m a good but out-of-practice spreadsheet person. Even so, I have invested 80+ hours to refine the spreadsheet, and test different scenarios. Is all this work justified?
Here are the problems that I noticed that led me to create my own calculator.
- Need fine-grain controls. Specifically, % of each account subject to long term capital gain. As far as I can tell, the calculator I have seen doesn’t know the cost basis of the stock. It must make conservative assumptions about % of gain that’s subject to long term capital gain. I want a better estimation of my capital gain tax as it will be an important factor of my expenses.
- Need account by account drawdown plan. Without talking to a fee based advisor, the core calculators only provide a generic amount projected to be drawn across my accounts. But given the variety of my accounts, I want to know how to balance the drawdown between my pre-tax retirement (401k, etc), long term capital gain, and pre-paid tax retirement (Roth). It should balance withdrawing from different sources and estimate the taxes implication. It should tell me how much to draw from each account type to cover my project expenses that year and taxes.
- Need tax bracket awareness over the plan lifetime. I don’t want to assume a generic effective tax amount. For the calculators, it’s a very reasonable assumption that over the life of the plan that some years my tax might be lower or higher, but it will average out to the effective rate over time. However, I want more precision and optimization. I want the calculator to be tax bracket aware, it should use the effective tax rate AND not exceed when withdrawing funds from pre-tax retirement accounts. Bonus if the calculator can optimize early withdrawal to maximum a lower expense year to fund large expenses that following year so both years are within the target tax bracket. Even more bonus if the calculator can optimize early withdrawal to reduce required minimum distribution for pre-tax retirement to stay within the tax bracket.
- Need different optimization targets. The softwares that I tried has 2 fundamental optimizations. First, predict if I would run out of money. Second, make recommendations to reduce the risk of running out money by adjusting the expected volatility of the portfolio. However, I’m comfortable with my aggressive portfolio strategy because of my diversity of passive and guaranteed income sources. I also segment my portfolio into different risk buckets. I want to try different optimization goals such as : minimal lifetime of tax paid, maximum net worth at the end of the plan, maximum tax deferred estate, etc.
- Need a holistic goal driven optimizer. All the I tested calculators allow you to propose 1 what-if scenario and compare it. For example, it can compare 5 years of Roth conversation of $x per year and compare the impact to net worth over time. But that's not very useful since I have hundreds of permutations that I want to try. I want a goal driven optimizer and constraints that allow me to say, I can do Roth conversion from years X to Y, but not to exceed my taxable bracket of Z. Tell me how much to contribute year by year to maximize my net worth or minimize my lifetime taxable income. The answer might for 1 year be 0 and 50K for another year. It should take into account my projected expenses, and income to find the best recommendation.
Ultimately, I want a personal retirement calculator that recommends year by year how much to withdraw from each source, ensure stress-free wealth in my lifetime, reduce the lifetime of taxes paid, and leave a low taxable legacy for the future.
Answering my initial question, using my spreadsheet, given more conservative and more accurate assumptions, I have out-performed my financial advisor’s retirement calculator by 10%. Assuming the plan works (still a VERY big if), this 80 hours spent will be one the best financial return on investment decision in my life. To be real, I’m humble enough as a programmer to know there are probably bad assumptions, bad calculations, bugs, etc. This is a strong signal for me that a fee based advisor with a more advanced pro version of the software that’s proven would be a good investment of time and money. It was a geeky fun way to really learn about an extremely complex topic.
Some day, I’ll think about how to generalize the spreadsheet, make it user friendly, and share it with the community.
What do you use for retirement planning?
Ricky
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