Stress Test Your Retirement Plan

Many people have opened their 401(k) and/or other retirement savings account statements and found that they have lost a significant percentage of their retirement nest egg. I've experienced the same thing and friends who are still working often ask me, usually with a tinge of schadenfreude in their voice, "so (smarty pants), when are you going back to work?" Not yet, I tell them. Here's why.

In the course of every retirement, there are going to be economic downturns. True, the current downturn is the worst since the great depression. But it's just another economic downturn. During a 30 to 40 year retirement, you're bound to experience a few of them. Perhaps the silver lining that can be found in this doozy of a downturn is that if your retirement plan can survive it (without you going back to work or living out of your car and eating only beans and rice cooked over Sterno®), it can probably survive anything. In that way, like what the Federal Reserve Bank is doing for the nations top banks, this downturn is sort of a "stress test" for your retirement plan.

But, without risking the chance that you'll completely running out of money in a few years, how can you really determine where your retirement plan stands? One approach might to do an actual stress test of your plan again using a realistic retirement calculator.

One calculator I like is called ESPlannerBasic. ESPlannerBasic a comprehensive retirement planning software program developed by Laurence Kotlikoff, a professor of economics at Boston University. One great thing about the software is that it's available on the Internet for free. A more robust version of the software is also available for a fee.

The software "calculates how much you should spend, save, and insure each year to achieve a stable living standard." Those who are already retired can use the software to test their current levels of spending to see if their retirement plan is still viable. If your plan doesn't pass the test, you'll know exactly how much you'll need to cut. Those on the verge of retirement can use the software to see whether or not now is the time to take the plunge.

I've stress tested my retirement plan using Kotlikoff's ESPlannerBasic and have learned a few things about my retirement plan. First, I've learned that, despite the setbacks caused by the recent financial crisis, my retirement plan is still viable, as long as I keep my spending under strict control. Whew! Second, the stress test results provided by ESPlannerBasic reinforced what I already know and that is that controlling the expenditure side of the retirement plan ledger is the key to a successful retirement.

ESPlannerBasic has a few flaws, for example it assumes that you will live to 100 years old (you have a less that 1% chance) and doesn't allow you to tap the equity in your home for your support. However, the software is a good basic tool for making stress test estimates.