The Methodology, Assumptions, and Limitations of the Merrill Edge® Personal Retirement Calculator
The information generated by the Merrill Edge® Personal Retirement Calculator was developed by Merrill Lynch Wealth Management ("MLWM") to estimate how current savings or investments and estimated future contributions may help to meet estimated financial needs in retirement.
The calculator does not take into account a number of important factors that materially impact both what you should save or invest for retirement and which investments may be best for you, including your tax bracket and expected tax payments, other investments or insurance coverage you currently hold, or large expenses you and your family may have both now and in the future, such as educational expenses, alimony, long-term care and health care costs.
Simple questions about your circumstances are used to get personalized information in order to generate a hypothetical scenario and analyze how it could potentially perform over time. The output of the calculator is highly dependent on the accuracy and completeness of your input. The figures entered on the input page of the calculator are for hypothetical purposes only. You should enter figures that reflect your individual situation. The results provided by the calculator are also intended for illustrative purposes only and accuracy is not guaranteed. The calculator's assumptions are based on numerous factors that make the calculations uncertain, such as the use of assumptions about hypothetical returns and inflation as well as data you have provided. Neither Bank of America Corporation nor the Personal Retirement Calculator can predict or guarantee future results.
The calculator's results are generated through the use of Monte Carlo simulation to determine the likelihood of levels of returns that a portfolio might experience under different market conditions. The Monte Carlo Analysis is a mathematical technique, based on the statistics of probability, that is used to estimate the likelihood that your assets may realize your target growth goal within the time frame indicated using assumptions of hypothetical risk and return as well as inflation. See more information below.
These results are hypothetical estimates only. This is not and should not be considered a fee-based comprehensive financial plan. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy.
This analysis is not a guarantee as your actual results may vary materially.
You are encouraged to consult with qualified professionals to discuss your particular situation, such as your tax bracket, expense obligations and current investments before implementing any financial or regulatory changes.
Methodology – How the Calculator Works
The calculator assumes two stages of wealth management: accumulation and distribution. It starts by gathering specific information directly from you: your current age, desired retirement age, current retirement savings or investments, annual income, monthly retirement contributions, and your investment style for the accumulation stage, which helps the calculator select an appropriate asset allocation and risk profile.
Using Monte Carlo simulation, the calculator simulates 1000 market performance trials based on the results generated by your answers. The returns in each of the years for each of the trials are generated randomly by algorithmic analysis based on average returns and risks associated with the investment style during the accumulation phase. Every trial uses the same accumulation period. In each trial, each year, the portfolio return is generated randomly by algorithmic analysis based on a statistical analysis that assumes a "normal distribution" whose mean is the average annual return of the portfolio and whose standard deviation is the annual risk of the portfolio. In each trial, the initial investment amount and contributions are grown during the accumulation period using the generated portfolio returns.
The calculator is designed to generate an estimated personal retirement number and two scenarios: "average market performance" and "poor market performance." Your personal retirement number is defined as a simple estimate (excluding tax considerations, personal expense obligations and other factors) of the minimum assets you will need to have at your selected retirement age to replace 85% (or the percentage you selected) of your pre-retirement income before taxes.
"Average market performance" represents a 50% probability that the balance of funds at your selected retirement year will be at least the 50th percentile balance generated by the market performance trials. "Poor market performance" represents a 90% probability that the balance at retirement will be at least the 90th percentile balance. Since market uncertainty is reflected in the variability of the returns in these trials, the 50th percentile balance corresponds to the trials that were closer to the middle of the distribution and the 90th percentile balance corresponds to the trials that were farther from the middle.
The annual contributions in future years are assumed to grow at the rate of inflation (based on the default amount of 2.5%) or at the income growth rate specified by you. Normal distribution is a statistical term that means the results are based on a theoretical data distribution which is evenly distributed, centered on the average return of the simulations. The most probable results of the simulations tend to fall closer to the average return, with less probable returns either progressively higher or progressively lower than the average return. Standard deviation is a useful measure of the variability of return earned by an investment portfolio. In performance measurement, it is generally assumed that a larger degree of variability implies that greater risk was taken to achieve the return.
Before beginning the distribution stage, the calculator computes distribution values such as the amount estimated to fund your retirement based on 85% (or your selected percentage) of your pre-retirement income before taxes (personal retirement number). The personal retirement number uses the cost of a hypothetical annuity from a highly-rated, credit-worthy issuer with a discount rate (return) of 4.7%. The hypothetical annuity is an inflation-adjusted annual payment for the duration of the retirement. The assumed average rate of inflation is 2.5% (or your selected percentage) in any single year. This hypothetical instrument and value is highly correlated with interest rates and may become more or less costly as interest rates vary.
During the distribution stage, the calculator computes an estimate of the percentage of your pre-retirement income that you will be able to withdraw every year, beginning at your selected retirement year, to the age of 93 years old (or your selected age). This withdrawal amount is inflation-adjusted assuming a default rate of 2.5% (or your selected percentage). The withdrawal amount will be significantly higher if the assumptions are changed, in the case, for example, of a higher inflation rate.
Assumptions and Limitations of the Merrill Edge® Personal Retirement Calculator
- All amounts are pre-tax
- Compounding is on an annual basis
- The monthly investment is accumulated and invested at one time at the end of the year
- The annual investment is grown at the salary growth rate in subsequent years
- The accumulation period is computed from the current age until retirement age for simulation purposes (assuming no distributions or withdrawals and that all earnings are reinvested)
- The standard deviation for the generation of portfolio returns is used as the annual risk of the portfolio
- The model assumes you will live to 93 years old unless you input a different number (Range 70-100 years old)
- Average Inflation defaults to 2.5% (Range 0-10%)
- Salary growth rate defaults to 2.5% annually (same as inflation rate, range 0-10%)
- The personal retirement number assumes replacement of 85% (or your selected percentage) of your pre-retirement income before taxes (The range is 50% - 130%)
- Does not assume pension or other retirement income
- Includes Social Security benefits, unless you elect not to include them
- Does not include the value of real estate or real estate income
- Income is assumed to be withdrawn once a year at the beginning of the year starting at retirement
- Does not include expenses, such as long-term care, health care costs, disability, education, alimony or other expenses post-retirement
- The determination for being "on track" is when the total projected asset amount at the desired retirement age and during average market performance is greater than or equal to the personal retirement number.
Asset Class Assumptions
Our estimates for forward-looking returns for the major asset classes are shown in the table below.
|Summary of Asset Class Assumptions
||Average Arithmetic Return
In setting the asset class assumptions, MLWM adopted a forward-looking view that MLWM believes is realistic and does not merely assume that historic returns will continue to be realized in the future. It reflects MLWM's belief that it is more responsible to illustrate the effects of lower returns than to rely solely on best case scenarios. MLWM follows a rigorous review process and consider a number of factors and analyses, including a close examination of asset class performance over several economic cycles. Special events or circumstances are also considered, but with the appreciation that future performance may not necessarily follow patterns established in the past.
Index proxies are used as a data input in constructing the forward-looking assumptions. The index proxies represented for equity, fixed income and cash are described below:
Standard & Poor's 500® Total Return Index (Standard and Poor's 500). This is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
60% Ibbotson Long Term Government Total Return Index. This index is based on, to the greatest extent possible, a one-bond portfolio with a term of approximately 20 years and a reasonably current coupon, whose returns did not reflect potential tax benefits, impaired negotiability, or special redemption or call privileges.
40% Ibbotson US Long Term Corporate Total Return Index. This index includes nearly all AAA- and AA-rated bonds with at least 10 years to maturity.
Ibbotson 30-Day U.S. Treasury Bill Total Return. This index is based on a one-bill portfolio containing the shortest-term bill having not less than one month to maturity.
Note: Indices are used for illustrative purposes only, are unmanaged, include the reinvestment of dividends, and do not reflect the impact of management or performance fees. Indices do not represent actual individual accounts. One cannot invest directly in an index.
Model Portfolio Hypothetical Risk/Return
The model assumes that annual discrete returns are normally distributed. The discrete return is the appreciation/depreciation of the portfolio in any given year.
The hypothetical annual expected returns and standard deviations (hypothetical annual risk) are derived using MLWM's capital market assumptions and strategic asset allocations and given in the table below (Exhibit 1) for each model portfolio.
The probabilistic analyses contained in this tool uses forward-looking rates of return developed by MLWM and are presented for informational purposes only.
Exhibit 1: Hypothetical Annual Arithmetic Expected Returns and Standard Deviations
|Hypothetical Annual Expected Return
|Hypothetical Annual Risk
These are the hypothetical statistics used by the Monte-Carlo simulation engine to generate normally distributed returns in a given year under a given scenario. That is, the portfolio returns are normally distributed with the mean and standard deviations given in Exhibit 1.
The projections or other information shown in this report regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. You should carefully review the explanation of the methodology used, including key assumptions, which is provided in this report.
Hypothetical performance results have inherent limitations. There are frequently sharp differences between hypothetical and actual performance results subsequently achieved by any particular trading strategy. Hypothetical performance results do not represent actual trading and are generally designed with the benefit of hindsight.
Probabilistic (Monte Carlo) modeling is a statistical modeling technique in which a set of future outcomes are forecast based on the variability or randomness associated with historical occurrences. In this report, a probabilistic approach issued to determine the likelihood that you may be able to achieve your stated goals and to identify a range of potential wealth outcomes that could be realized. It involves generating thousands of scenarios, each simulating the growth of assets over a specified period of time, taking into account a variety of factors, such as economic conditions, the allocation of assets, portfolio value, cash flow and market volatility. The analysis presented is not a guarantee, prediction or projection of any particular result and actual results may vary materially. Rather, this analysis is directional in nature and can be used to help you evaluate how certain decisions or strategies may impact your ability to achieve your goals.
The five model portfolios are constructed based on investment objectives and risk tolerances. The simulated portfolio risk and return figures in Exhibit 1 represent assumptions and hence should not be viewed as predictions or guarantees of future performance.
Personal Retirement Number
The personal retirement number is defined as an estimate on your input, of the assets needed at retirement to replace 85% (or selected percentage) of your pre-retirement income that keeps pace with inflation before taxes for the duration of your planning horizon which is assumed to be age 93 for all users unless a different age is specified.
The personal retirement number, or retirement goal, is based on purchasing a hypothetical annuity with a discount rate (return) of 4.7% which will last through retirement. The need for retirement income is assumed to last through the user's projected planning horizon which is assumed to be age 93 unless a different age is specified.
The user's current annual income is assumed to grow until retirement age at the salary rate (current default is 2.5% annually) and the inflation rate (current default is 2.5%), both of which can be adjusted. 85% (or your selected percentage) of the pre-retirement annual income, adjusted for inflation, is then used as the amount needed during retirement.
A full retirement age of 67 is assumed for Social Security benefits even if a different retirement age is specified.
Current income is projected into the future using an inflation rate of 2.5% (or your selected percentage).
Past income is computed using the Social Security Administration's (SSA) recommended wage growth factor of 6.6%.
Social Security benefits are only computed for the first year of retirement. Since this amount reduces the annual retirement income needed while computing the retirement goal, it is assumed that benefits grow at the same rate as inflation.
Length of Savings
"Savings may last until age: x-y." This projects the age range at which you will run out of retirement funds based on your projected withdrawal schedule given your current progress under average market performance and poor market performance. The default withdrawal schedule is set to replace 85% (or your selected percentage) of your estimated pre-retirement income before taxes.
Action Plan - Increase In Monthly Contributions
Increase in monthly contribution is calculated by taking the gap between your current progress towards your personal retirement number under poor market performance and average market performance and calculating how much you would need to save additionally every month to bridge that gap by your desired retirement age. This is calculated using the Monte Carlo simulation method (see paragraphs 2 through 4) used to calculate your current projected balances.
The resulting increase in retirement balances is calculated by subtracting your current progress under average market performance and poor market performance from your personal retirement number.
No Guarantee of Results
Because the results of the tool's assumptions are based on numerous factors that make the calculations uncertain and because the tool does not take into consideration a number of important factors, whether you are deemed to have a shortfall or to be on track to reach your personal retirement number, neither Bank of America Corporation nor this tool can guarantee that you will have sufficient income or assets to meet your financial needs throughout your retirement.