Related topics: retirement, financial planning, Social Security, savings, Liz Weston

Roger Ibbotson has a problem with most retirement calculators. They're either too simple or too complex, and sometimes they're both at the same time.

That's a serious issue, says Ibbotson, a finance professor at the Yale School of Management, because people increasingly are in charge of investing for their own retirements. Yet they're getting conflicting and sometimes misleading answers to the biggest question of all: How much should I save?

Here are some of the thing that Ibbotson, who founded a leading financial research firm, Ibbotson Associates, says are wrong with many retirement calculators available today:

They use static return assumptions. Assuming your investments will return 8%, 9% or any other static figure is old school. Financial planners today typically use Monte Carlo simulations, a statistical technique that factors in long-term performance to calculate thousands of possible results for a given portfolio. With these simulations, you can learn your probability of success -- the chances that your portfolio and your financial plan will provide enough money for retirement.

They require too much knowledge -- or guessing -- from consumers. In addition to asking you to guess your investment results, you're usually asked to answer other tough questions: When will you retire? How long will you live after that? How much will you get from Social Security? What will your home be worth? How much, if anything, will you inherit?

They overestimate retirement spending. The default assumption is that you'll need 70% to 80% of your current gross income to retire. Although some financial planners argue that replacement rate is too low, others have more recently contended that such percentages may be too high because they don't reflect the fact that many people's spending drops as they age.

A better mousetrap

Ibbotson thought there was a better way to determine the ideal savings rate, a method that employed the financial-planning world's sophisticated techniques but was simple enough that any consumer could use it.

So with the help of two Ph.D. researchers at Ibbotson Associates and two financial planners from Kreitler Associates in New Haven, Conn., Ibbotson built what he thinks is a better mousetrap. The result, which Ibbotson dubbed, the "National Savings Rate Guidelines for Individuals" (.pdf file), debuted in 2007 in the Journal of Financial Planning.

With the charts the researchers created, individuals can quickly look up their ideal savings rates based on their ages, incomes and accumulated savings for retirement -- in other words, how much they've already saved.

The magic number it produces represents the percentage of your gross income you need to save today to replace 80% of your net income starting at age 65, ensuring, at least theoretically, a comfortable retirement. Ibbotson defines net income as your gross income minus what you're saving for retirement.

A warning here: If you're much over 35 and you haven't already saved a substantial sum for retirement, the suggested savings percentage is going to be scary -- either a little scary or a lot scary, depending on how old you are and how much you've put aside.

(Also, Ibbotson ran a limited number of income scenarios, topping out at $120,000; frankly, if you make a lot more than that, you need to talk to a certified financial planner.)

Please don't panic. Things might not be as dreary as they seem. You may be able to craft a workable retirement plan by:

• Working past age 65, either full time or part time.
• Living on less in retirement.
• Factoring in other assets, such as an inheritance or the sale of your home.

What Ibbotson's percentages reflect is the importance of an early start if you want to be assured of a comfortable retirement that starts at age 65.

"If you haven't started by age 35 or 40, it's really hard" to save enough to accumulate an adequate nest egg, Ibbotson said. "The longer you wait, the more you have to save" to make up for the delay.

In fact, the percentage of your income you must save if you start at age 45 is typically more than twice what it would have been had you begun at age 25, according to Ibbotson's charts. If you wait until age 55, the percentage is often triple what it would have been had you started 30 years earlier. Someone in their mid-50s who earned $80,000 a year, for example, would have to save more than one-third of their income -- 36.6% -- to accumulate enough to retire at 65.

Fine-tune your magic number

To understand how to use this research in your retirement planning, you should understand the assumptions Ibbotson and his cohorts made, and how you might want to fine-tune the number you get.

Ibbotson's tool includes these points:

It uses a replacement rate of 80% of net income. Net income, as I mentioned earlier, is defined by Ibbotson as your gross income minus what you're saving for retirement. Some financial planners believe this level is far too low and want their clients to shoot for replacing 80% or more of their gross income to ensure an adequate retirement. (Some insist 100% of gross makes more sense for clients who expect to travel extensively or indulge in expensive hobbies.)

Other planners, though, say that's way too much because retiree expenses tend to drop precipitously in later years. These planners contend the financial-services industry is encouraging people to over-save and unnecessarily delay retirement.

My take: 80% of net income is probably enough to ensure a comfortable but not luxurious retirement. If you want to travel a lot or spend more lavishly, you should treat Ibbotson's indicated percentage as the minimum you should save. If, on the other hand, you think you can get by with less, you might use MSN Money's Retirement Planner instead, adjusting the "How much you'll need annually" input to reflect your future budget.

It doesn't include post-retirement medical care. This is a significant omission because various studies show out-of-pocket costs are soaring despite Medicare coverage, which kicks in when you're 65. Figures vary, but Fidelity Investments estimates that a couple who retired in 2009 without retiree health-care benefits needs $240,000 for medical costs over the remainder of their lives.

This is another reason to kick up your savings a percentage point or two. One easy way to figure out how much: Use the MSN Money Retirement Planner and add $10,000 to the amount you expect to need annually in retirement.

It uses immediate annuities as a proxy for the sum you'll need. I think this is a pretty brilliant solution to the issue of life expectancy. Rather than guess how long people might live, or ask them to guess, Ibbotson turned to the experts. Insurance companies that sell immediate annuities, which give people a lifelong stream of income in exchange for a lump-sum payment, are experts at managing the life-expectancy risk of large groups of people.

To figure out how much you'd need at age 65, the researchers looked at the cost of an inflation-indexed immediate annuity with a lifetime payout that would replace 80% of your net income. The main problem with this approach is that the size of the checks you get depends on prevailing interest rates when you buy your immediate annuity, and interest rates have been dismally low lately. If rates rise substantially, you'd get more bang for your investment buck and may not need to save as much.

There's no way to know in advance what interest rates may be like when you retire; just know that your nest egg may not need to be as big as Ibbotson indicates.

It assumes Social Security won't change. I think this is a fair assumption if you're in the lower-earning brackets, say $40,000 and below, since Congress is unlikely to trim benefits for the lowest-income workers who rely on Social Security the most. But the more you earn and the younger you are, the less you should expect from Social Security.

Ibbotson's approach doesn't allow you to adjust this input, so you might want to use MSN Money's Retirement Planner [[link=Retirement Planner http://moneycentral.msn.com/retire/planner.aspx]] if you want to reduce or eliminate your expected Social Security benefits from your calculations.

It assumes you'll get market returns. The charts used Monte Carlo simulations to come up with savings rates and nest eggs that have a 90% probability of success, meaning you'd have enough to live on without significant risk of running out of cash. But this approach assumes you'll at least match the market benchmarks, and most individuals don't.

Even if your portfolio is entirely made up of index funds, you're still paying at least some fees, however minimal, that ensure you'll underperform the market. If you trade frequently or use investments with sales loads or high annual fees, you're likely to fall even further behind. This is yet another reason to save at least 1% more than the indicated percentage (and to keep your investment expenses as low as possible).

It assumes you won't inherit money, sell your house or use a reverse mortgage. If you think you may rely on any of these sources of income, you might want add those amounts to your nest egg in the Magic Number Calculator, check out a more complex retirement planner, such as the one included in Microsoft Money personal-finance software, or consult with a fee-only financial planner. (Microsoft is the publisher of MSN Money.)

In short, Ibbotson's guidelines are not the be-all and end-all of retirement calculations. But they're an excellent tool for people who are confused about how much to save and who don't want to spend hours fiddling with more-complicated retirement planners. Ibbotson has done most of the heavy lifting for you, so now there's really no excuse not to get started.

Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.