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How Realistic Is This?
Old 10-24-2014, 05:28 PM   #1
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How Realistic Is This?

I just got my annual compensation statement from my employer today, which includes projections for my retirement account. I'm not sure I have any confidence in the figures they are presenting as they conflict dramatically with my own conservative (read: realistic) estimates.

I'm sure their math is sound, so the actual numbers of what I currently have in my 401k and what they are projecting aren't relevant. However, I wanted to give you their assumptions and get the collective wisdom of whether or not they are, as they say, "blowing smoke".

Megacorp's Assumptions:
1. The plan and matching contributions remain unchanged.
2. My eligible earnings increase 3% annually.
3. My contribution rate remains unchanged.
4. The IRS limits increase 2.5% annually (note: I do not max out my 401k and will likely not be able to until far later in my career)
5. The account grows at 6.5% annually.

Based on these assumptions, my account will grow from about $30k presently to $2mil by age 65.

My Assumptions:
1. The plan and matching contributions remain unchanged
2. My eligible earnings increase 3% annually only for the next 10 years before I hit a realistic salary ceiling at my company.
3. My contribution rate remains unchanged.
4. The IRS limits keep pace with my ability to contribute to the account.
5. The account grows at 5% annually.

Based on my assumptions, my account will only grow from $30k to $780k by age 65. I plan on retiring before then with the help of my Roth IRA, but that's another matter.

These are two drastically different estimates and goes to show what a few percentages can do over time.

What do you all think are more realistic assumptions. Am I being too conservative? Is Megacorp being too optimistic? Do you think reality will be somewhere in between?

Assume account performance mirrors the DOW/S&P and my earnings will stay on par with the national average salary over time, maybe a little higher.

P.S. They also tell me I'll be able to draw on Social Security at age 62.
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Old 10-24-2014, 05:44 PM   #2
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Megacorp's assumptions do not seem outlandish to me.

The 3% annual earnings increase probably assumes both merit and promotional increases. Even if you hit the top of the range for your job, the ranges typically increase as a result of inflation and you might be promoted. While it depends on what you do, 3% annual average increase does not seem outlandish to me. If they have a DB plan, I suspect they use the same salary increase assumptions in calculating their projected benefit obligation.

6.5% annual investment return also does not seem outlandish. The long term historical return on equities is 10% and on a 60/40 AA is 8.9% IIRC so 6.5% is a reasonable haircut.

FWIW, I use 3% inflation and a 5.5% investment return in my retirement planning, but I concede that the 5.5% is very conservative given the historical return for my AA is 8.9%.

I'm somewhat surprised in the difference in the result. If you take your projection model and substitute their assumptions for yours, do you get close to their $2m?
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Old 10-24-2014, 06:08 PM   #3
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Quote:
Originally Posted by pb4uski View Post
Megacorp's assumptions do not seem outlandish to me.

The 3% annual earnings increase probably assumes both merit and promotional increases. Even if you hit the top of the range for your job, the ranges typically increase as a result of inflation and you might be promoted. While it depends on what you do, 3% annual average increase does not seem outlandish to me. If they have a DB plan, I suspect they use the same salary increase assumptions in calculating their projected benefit obligation.

6.5% annual investment return also does not seem outlandish. The long term historical return on equities is 10% and on a 60/40 AA is 8.9% IIRC so 6.5% is a reasonable haircut.

FWIW, I use 3% inflation and a 5.5% investment return in my retirement planning, but I concede that the 5.5% is very conservative given the historical return for my AA is 8.9%.

I'm somewhat surprised in the difference in the result. I you take your projection model and substitute their assumptions for yours, do you get close to their $2m?
Yes, their numbers all work out when I substitute. I don't disagree with the math.

I guess another way of asking the question is this:

If you plot out the growth of these two areas: salary and 401k fund, they look like nice neat, exponential curves. What I'm really wondering, perhaps from the older folks, is how many people actually experience careers and returns that fit these curves? Is it better to factor in periods of slower growth or does it all even out in the end?

Or another question along the same lines:

Who here has at least a decade or more of retirement planning under their belt with what they believed were realistic estimates, and has reality surprised or disappointed you?
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Old 10-24-2014, 06:11 PM   #4
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Seems realistic. I am just a regular analyst at a typical company and have averaged (over 25 years working) a 7.25% yearly raise.

My 401k would be over $2,000,000 in 18 years (I'm 47 now) with a modest 5.5% return going forward.




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Old 10-24-2014, 07:09 PM   #5
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Megacorps assumptions seem reasonable, even conservative, but they are for generic worker x. If you know something whereby you won't get pay raises as assumed, then don't count on them. I think the 6% factors in slow and great returns. Last year market returned like 30% but depending on your index, we are flat to 3% this year.

For personal experience, I found that once the kids college expenses were done, and my mortgage was 10 years old, I had more extra cash than ever. I still live below means and save max Roth 401k plus other taxable accounts. I think if you keep the same lifestyle, those 50s can be a time to really beef up savings or investments.
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Old 10-26-2014, 01:31 PM   #6
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Is Megacorp assuming you will work there and contribute to their retirement account until you're ready to retire? If so, that does not seem realistic, based on what I know about younger workers from my workplace, and have read about them in news media. Between megacorpses not having "loyalty" to their workers and the workers jumping about, it seems hardly anyone will stay in one place for a career.

Although, I guess you can take your 401K with you to other jobs, so that might keep the assumptions in the realm of reality.

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Old 10-26-2014, 02:05 PM   #7
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The lack of any specified inflation rate makes for a bit of guesswork. Are these figures (the growth %ages and the final account balances) "real" or nominal? It looks like they are nominal, and the company is counting on about 2.5% inflation (since the IRS allowable increase in 401K contributions pretty much tracks inflation, IIRC). If that's right, then they are counting on your earnings going up by 0.5% in real terms every year (seems low), and they are counting on the account balance to go up by about 4% per year in real terms on average. That is about right in historical terms: the S&P 500 real return from 1929 to present (with dividends re-invested) is about 6%. Now, typically a retirement fund would own a significant portion of more conservative assets (bonds, fixed income, etc), so 4% is probably about right or maybe a >bit< high for their particular assets mix.

But, I don't count on seeing results as good as that over the next 40 years. I'd be more comfortable with a real growth rate projection for equities of about 4% or so, so maybe 2.5% to 3% for a typical pension portfolio containing bonds, fixed income, etc.

Now, if they've mixed the nominal and real growth rates, then there's no telling what the heck they are projecting.
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Old 10-26-2014, 02:08 PM   #8
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Quote:
Originally Posted by StickInTheMud View Post
I guess another way of asking the question is this:

If you plot out the growth of these two areas: salary and 401k fund, they look like nice neat, exponential curves. What I'm really wondering, perhaps from the older folks, is how many people actually experience careers and returns that fit these curves? Is it better to factor in periods of slower growth or does it all even out in the end?

Or another question along the same lines:

Who here has at least a decade or more of retirement planning under their belt with what they believed were realistic estimates, and has reality surprised or disappointed you?
Salary growth and savings growth are influenced in two totally separate ways. My company seems to pay homage to a steady 3%/yr salary adjustment for decent work in good times. My retirement savings have experienced a 7% rate of return over the past 30 years, but you wouldn't see that looking at any two years. Still, you mitigate risk (uncertain adversity) for both in the same sorts of ways: diversify your opportunity space (be flexible with job opportunities when young, use market index mutual funds for savings), take the long view (take jobs that have long term growth potential, save and hold instead of trying to trade the immediate market behavior)

Reality has surprised me in my mostly serendipitous success, in that I did some of the diversification and long view by being too lazy to aggressively manage things, both career and savings. I did consciously work the two fundamentals of career and savings, doing the best work I knew to do in the job at hand, and regular saving out of my paycheck (my dad used to say, you can't worry about rates of return until you have some money in the first place).

One more aspect of risk mitigation I've fallen into and worth pointing out is the acquisition of multiple sources of retirement income. I'll have four, and each has its own strengths and potential calamities. But, we could meet mandatory expenses with any one of them. This was also serendipitously acquired, I just woke up one day and realized my meandering around the work world had set me up this way.

So, I guess my experience would advise you to work hard, take new career opportunities when the come along, save money and forget about it until you turn 55, when you're too old to spend it on mid-life crises...
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Old 10-28-2014, 02:45 PM   #9
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I started keeping track of my portfolio growth/returns in 2006, so 8 years. I assumed 5% growth. I am actually very close to that projected number for 2014 so far (of course, the market fluctuations mean that the path to get there was very bumpy).

I also assume a lower salary increase (I work for the fed gov't, and we had 3 years of freezes followed by a 1% COLA adjustment last year. But, you sound like you are very young. When I was younger I got promotions/raises etc. that were much larger. I am at a level I am happy at now, so don't count on any more big raises.
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