Retirement Saving Guide
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- 1. THE T. ROWE PRICERetirementSavings GuidePlan, save, and enjoyyour retirement.This guide is designed to help you thinkcarefully about your own retirementgoals and explore strategies and solutionsthat can help you achieve them.
2. T.RowePriceRetirementSavingsGuide. 3. Plan, Save, and Enjoy Your Retirement.>> This guide is designed to help you think carefully about your own retirement goals and explore strategies and solutions that can help you achieve them. Whether youre stillsaving for your retirement, preparing to leave your full-time career, or currently retired andmanaging your income, this guide offers you the collective expertise of experienced T. Rowe Pricefinancial planners and investment specialists.AdditionAl RetiRementPlAnning ResouRcesWhat Youll Find in this guide:Our Web site provides Saving for Retirement.nGuidelines on Saving for Retirement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3extensive online guidanceon comprehensive retirement nBalancing College and Retirement Savings . . . . . . . . . . . . . . . . . . . . . . . . 7planning, including helpful nStrategic Tips for Young Investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9calculators and tools. Youcan also contact a T. RoweApproaching Retirement.nStrategies for Optimizing Retirement Income . . . . . . . . . . . . . . . . . . . . . 12Price retirement specialistat 1-800-638-5660 for moreLiving in Retirement.information on how tonPlan for a Successful Retirement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18put our investment andnDetermining a Realistic Withdrawal Amount and Asset Allocation . . . 19planning solutions to worknStrategies for Coping After Retiring Into a Bear Market . . . . . . . . . . . . 22for your retirement.Tools and Resources.nYour Financial Road Map to Successful Retirement . . . . . . . . . . . . . . . . 26nGetting a Reality Check on Your Retirement Income Plan . . . . . . . . . . 28 troweprice.com/retirementplanning | 1-800-638-56601 4. SavingforRetirement. 5. guidelines on saving for Retirement>>Are you saving enough for retirement? This may be the most important financialchallenge you face as the responsibility of funding retirement continues to shift fromemployers to individuals. And yet several recent studies have revealed that people are not savingenough for a financially secure retirement, especially as life expectancies continue to rise. Withpeople living longer and retiring without a guaranteed pension income, retirement planningis more important today than even a decade ago. Here are some guidelines on how much youneed to save.One of the biggest risks for peopledelay saving until late in their careers,As indicated in the tables on page 4,planning for retirement is that they mayhowever, may need to save as much asthe burden on the investor can increasenot save enough to live comfortably in25% or more of their salary, and even substantially by delaying saving. Fortheir retirement years, says Christine then they may not accumulate enough example, those who are 20 years fromFahlund, CFP, T. Rowe Prices senior assets to reach their goal. Ms. Fahlund retirement and have saved only onefinancial planner. If you dont save notes that most retirees will also receive times their current salary may be able toenough today, you may be faced with Social Security and possibly income replace only 29% of their preretirementthe harsh reality later in life of having tofrom part-time work, so that their totalsalaryeven if they save 15% of theircut your expenses and standard of livingamount of income in retirement may be pretax salary each year between nowdramatically. Thats why its so impor- closer to 70% of their salary than 50%, and retirement. On the other hand, iftant to start saving as early as possible including these other sources. they had already saved three times theirand develop a disciplined approach. The results of the T. Rowe Price study current salary, a 15% savings rate mightare reflected in the tables on page 4. They enable them to replace almost half (47%)How Much Is Enough? show the percentage of salary that mightof their income at retirement.Determining a reasonable savings rate be replaced in retirement depending on:Keep in mind, however, that thesefor your retirement will depend on(1) the number of years until retirement; projections do not take into account thevarious factors, including your expected(2) what percentage of pretax current possibility of receiving salary increaseslifestyle in retirement, health concerns, salary is being saved annually (assumingin excess of 3% on average due tohow much risk you are willing to take the current salary increases by 3% each promotions, job or career changes, orin your portfolio, the amount you haveyear); and (3) the amount already saved performance bonuses. Of course, thesaved so far, and how much time you for retirement, expressed as a multiple ofmore an individuals income rises, thehave until retirement.current salary. more difficult it may be to replace the In an effort to help investors gain These projections are based on the targeted percentage of it in retirementperspective on their retirement savings assumption that the investor using this unless the individual increases his orneeds, T. Rowe Price has used a sophis- accumulation strategy will have a 70% her savings rate over time.ticated computer analysis (known as simulation success rate (the odds of suc-Monte Carlo simulation) to develop pro- cess) and that he or she maintains an Starting Earlyjections based on thousands of possible asset allocation of 60% stocks and 40%Theres no doubt that starting retire-future market scenarios.bonds prior to retirement and then shifts ment planning early in life reduces the Using this methodology, we can to a more conservative approach40% mental stress and pain later on,compare the effects that a wide variety stocks and 60% bondsafter retirement.Ms. Fahlund says. Most companiesof savings rates and investment strate- For example, an individual who is offer some sort of match in theirgies are likely to have on the amount 40 years from retirement (i.e., approxi-401(k) plan, and, if you qualify, youof salary an investor may be able tomately 30 years old) and has no savings can include that as part of your 15%replace in retirement without running but expects to save 15% of pretax salarytotal contribution. For example, ifout of money. each year in combination with his or heryou save 6% of your salary and theemployer may be able to replace 61% company matches 50 cents on the dol-The 15% Solutionof preretirement salary in retirement lar for that portion, you are alreadyThe analysis suggests that individualsfrom savings. If that person had alreadysaving at 9% of salary. So employeesgenerally should strive to save at leastsaved one times his or her current salary,should at least take full advantage of15% of their pretax salary (including which means if someone earning $40,000employer matches.employer contributions) in order forhas saved $40,000, then a 15% annual The most important issue to focustheir investments to replace 50% or savings rate might enable him or her to on is what percentage of your annualmore of their current salary in retire- replace 79% of current salary, adjusted income you need to replace in yourment, adjusted for inflation. Those who for inflation.retirement, she adds. Usually, people troweprice.com/retirementplanning | 1-800-638-56603 6. need at least 75% of their preretire-ment income in retirement even if theyhave taken care of most of their majorHow Much of Your Salary Can You Replace in Retirement?expenses such as college education fortheir kids, saving for retirement, and20 Years to Retirementpaying off their mortgage. Of course,Current Savings as Multiple of Current Pretax Salarysome of this may come from other Annual Savings0x 1x 3x 5xsources such as Social Security, a pen-(% of Currentsion, and part-time employment.Pretax Salary)Retirement Income as % of Salary Ultimately, at least part of each5% 7% 16%34% 51%investors future financial success will10 1423 4058depend on how much he or she has15 2029 4765already saved. Obviously, if someone20 2736 5472has not saved for retirement, that situ-25 3443 6179ation cannot be changed retroactively.However, he or she may still be ableto generate some savings before retire- 30 Years to Retirementment by not spending any employmentCurrent Savings as Multiple of Current Pretax Salarybonuses or any inheritance, or by down- Annual Savings0x 1x 3x 5xsizing or changing a residence upon (% of Currentretirement and investing the difference.Pretax Salary) Whatever savings plan for retirement Retirement Income as % of Salaryyou pursue, you should review your 5%12% 25% 50%75%results periodically to see if you are on 10 253763 88track. In addition, you may want to 15 375075100consult the retirement planning informa-20 496288113tion and calculators on our Web site, 25 6275 100125troweprice.com/retirementplanning.A Better Alternative to the 40 Years to RetirementAverage Rate of Return Current Savings as Multiple of Current Pretax SalaryMany retirement planning analyses stillAnnual Savings0x 1x 3x 5xbase their investment projections on (% of Current Pretax Salary)fixed average annual rates of return. Retirement Income as % of SalaryIn effect, these analyses assume that5%20%38%74% 109%the identical investment return will be 10 40 59 94130achieved each and every year. 15 61 79115151 In fact, the results of projections using20 81 99135171the average rate of return method are 25101120156192usually not the same as the results ofprojections of multiple simulations of The projections or other information generated regarding the likelihood of various investmentthe markets potential ups and downs.outcomes are hypothetical in nature, do not reflect actual investment results, and are notGenerally, average rate of return calcu- guarantees of future results.lations paint a picture that may be tooThe tables show what percentage of preretirement income you may be able to replace fromoptimistic and not realistic enough. For savings, based on years to retirement, current savings expressed as a multiple of currentexample, they may result in a recom- salary, and what percentage of pretax salary is being saved on a tax-deferred basis each year between now and retirement. So if you are 30 years from retirement and have saved threemendation to save less for retirement times your current salary and are saving 15% of your salary each year, you may be able tothan will actually be required based onreplace 75% of your preretirement salary in retirement.the unpredictable nature of the markets. The analysis assumes annual salary increases of 3% and that the amount of income in retire- Monte Carlo simulation is an analyti- ment increases by 3% each year to keep pace with inflation. It also assumes that your portfoliocal tool for modeling future uncertainty.consists of 60% stocks and 40% bonds prior to retirement and 40% stocks and 60% bonds afterIn contrast to deterministic tools (e.g.,retirement. The analysis is based on 100,000 potential (not historical) market scenarios with a 70% chance of maintaining this income stream throughout a 30-year retirement period. Theexpected-value calculations) that model analysis assumes annualized expected returns of 10.0% for stocks, 6.5% for bonds, and 4.75%the average-case outcome, Monte Carlofor short-term bonds and annual expenses of 1.211% for stocks, 0.726% for bonds, and 0.648%simulation generates ranges of outcomesfor short-term bonds.based on our underlying probabilitySource: T. Rowe Price Associates, Inc.model. Thus, outcomes generated via4troweprice.com/retirementplanning | 1-800-638-5660 7. Monte Carlo simulation incorporate These monthly returns are then used to Market crises that can cause assetfuture uncertainty and give you a likeli-generate thousands of simulated market classes to perform similarly overhood of a certain goal being achieved, scenarios. These scenarios represent a time, reducing the accuracy of thewhile deterministic methods do not.spectrum of possible performance for projected portfolio volatility and the asset classes being modeled. The returns. The model is based on theAddressing Uncertainty success rates are calculated based onlong-term behavior of the assetThe analysis results in a range of pos-these scenarios. classes and therefore is less reliablesible future outcomes of a retirement We do not take any taxes or required for short-term periods.planning investment strategy under minimum distributions (RMDs) into A model assumption that there is nothousands of different market scenarios, consideration, and we assume no earlycorrelation between asset class returnsallowing us to determine the likelihoodwithdrawal penalties.from month to month. This meansthat each strategy will still have assets that the model does not reflect theremaining at the end of retirement. This nvestmentexpensesintheformofanIexpense ratio are subtracted from the average periods of bull and bearprobability measure is called a strategysmarkets, which can be longer thansimulation success rate and reflects theexpected annual return of each assetclass. These expenses are intended to those modeled.number of times in the simulations aparticular strategy succeeds (i.e., has represent the average expenses for a Inflation that is assumed to be con-at least $1 remaining in the portfolio at typical actively managed fund within thestant; variations in inflation levels arethe end of the retirement period).peer group for each asset class modeled.not reflected in our calculations. The chart below is a hypothetical exam- An analysis that does not take into Material Limitationsple illustrating 11 simulations.consideration all asset classes; other Material limitations of the investment asset classes not considered may have We started with a current balance model include: characteristics similar or superior toand tracked changes to the balanceover a specific time period. Each line Extreme market movements that maythose being analyzed.in the graph represents this strategyoccur more frequently than repre-IMPORTANT: The projections oras it responded in our simulations tosented in our model. other information generated by theone hypothetical sequence of monthly Some asset classes that have relativelyT. Rowe Price Investment Analysisinvestment returns.limited histories. While future resultsTool regarding the likelihood of various The orange line represents the hypo-for all asset classes in the model may investment outcomes are hypotheticalthetical sequence of monthly investmentmaterially differ from those assumed in nature, do not reflect actual invest-returns that resulted after 30 years in thein our calculations, the future resultsment results, and are not guaranteesmedian ending balance, where 50% of thefor asset classes with limited histories of future results. The simulations areoutcomes are above the median ending may diverge to a greater extent than based on a number of assumptions.balance and 50% are below it.the future results of asset classes with There can be no assurance that the longer track records.Material AssumptionsThe investment results shown in the AccountValuevarious charts in this booklet were devel-oped with Monte Carlo modeling using$5,000,000the following material assumptions: 4,000,000 The underlying long-term expectedannual return assumptions for the asset 3,000,000classes indicated in the charts Aboveare not historical returns, but are2,000,000based on our best estimates for futurelong-term periods. Our annual return 1,000,000 50%assumptions take into consideration Belowthe impact of reinvested dividends and0capital gains.051015 202530 We use these expected returns, alongYearsinRetirementwith assumptions regarding the vola- Median ending balance after 30 years in retirement is illustrated attility for each asset class, as well asthe end of the orange line, reflecting one of the 11 simulations ofthe intra-asset class correlations, to potential market scenarios: 50% of the outcomes result in ending balances above the median balance and 50% below.generate a set of simulated, randommonthly returns for each asset classThis is a hypothetical illustration. There are 11 simulations in this example.over the specified period.The projections or other information generated regarding various investment strategies are hypo-thetical in nature, do not reflect actual investment results, and are not guarantees of future results.troweprice.com/retirementplanning | 1-800-638-56605 8. projected or simulated results will be simulating 100,000 possible marketsimulation scenarios used (in this caseachieved or sustained. scenarios and various asset allocation100,000) to obtain the simulation success The charts present only a range ofstrategies. The underlying long-termrate. These results are not predictions,possible outcomes. Actual results will expected annual return assumptionsbut they should be viewed as reason-vary with each use and over time, and(gross of fees) are 10% for stocks; 6.5%able estimates.such results may be better or worsefor intermediate-term, investment-grade Source: T. Rowe Price Associates, Inc.than the simulated scenarios. Clientsbonds; and 4.75% for short-term bonds.should be aware that the potential The following expense ratios are thenfor loss (or gain) may be greater than applied to arrive at net-of-fee expecteddemonstrated in the simulations. returns: 1.211% for stocks; 0.726% for The initial contribution or withdrawalintermediate-term, investment-gradeamount is the percentage of the initialbonds; and 0.648% for short-term bonds.value of your salary or investments For each combination of initialcontributed or withdrawn in thecontribution or withdrawal amountfirst year where the entire amount isand investment strategy, we count thecontributed or withdrawn on the firstnumber of simulation scenarios that areday of the year; in each subsequentsuccessful (i.e., in which there is atyear, the amount is adjusted to reflectleast $1 remaining in your account ata 3% annual rate of inflation. The the end of your retirement). We dividesimulation success rates are based onthis number by the total number of6 troweprice.com/retirementplanning | 1-800-638-5660 9. Balancing college and Retirement savings>> If youre a parent, you may find yourself asking which financial goal should take priorityfunding your childs college education or saving for your retirement. Whilefinancial planners generally suggest that retirement take precedence, many parents are firmlycommitted to providing their children with enough money for college. Here is some expertguidance on how to successfully balance college and retirement savings.While financial priorities are a matter ofpersonal choice, parents need to keep Juggling Competing Goals: Saving for Retirement andthings in perspective, cautions T. Rowe Your Childrens College EducationPrice Senior Financial Planner Christine36-Year Investment Period (including 18 years precollege)Fahlund, CFP. She points out that if Final Balanceyou dont have sufficient assets or a pen-(thousands)$3,000sion, there are limited options other than OptionAOptionBOptionCOptionDSocial Security and continued employ-2,500 $2,541ment for funding your retirement. $2,042 On the other hand, there are various2,000$1,694 $1,650funding sources for college, ranging$1,361from loans and scholarships to sum-1,500$1,100mer jobs and, in many cases, gifts from 1,000grandparents. $759 $506 Another important consideration is 500 $253whether you want to be financially self- $80$126sufficient in retirement or whether you0All savings forSavings forSplit savings untilSavings for collegewant your childrenwho may be try-retirement retirement onlycollege begins,only for first 18ing to raise their own familiesto helpfor 18 years, then then save foryears, then for used for 10-year retirement onlyretirement onlysupport you as well, Ms. Fahlund says.college loan, then over final 18 yearsover final 18 yearsThe best strategy for your family over- for retirement again over finalall is for you to stay financially healthy,eight yearsso your first priority probably should be Available atAvailable at Available atinvesting for your own futureunless college age retirement age retirement ageyou live very modestly and know that after tax pretax (with 50% pretax (with no 401(k) match) 401(k) match)you can rely on a substantial pension tocover your needs in retirement.The chart compares the impact of different savings strategies on the amount of money Nevertheless, we recognize thatpotentially available for retirement and college. All scenarios assume that a couple with a combined income of $100,000 invests 6% of their income each year over the next 36 years (18saving only for retirement is not very years prior to their child starting college and 18 years from the start of college until the coupleappealing to most parents. They want toretires). The examples also assume the couples income grows 3% annually; investments earnsave for college as well. an average annual 8% pretax rate of return; and retirement savings are invested in a 401(k) plan and college savings in a 529 plan. Any earnings grow tax-deferred in both types of plans3000Comparing Strategies but can be withdrawn federal tax-free from the 529 plan (if used for qualified educationalAvailabT. Rowe Price analyzed various sav-expenses), while the entire savings in the 401(k) is subject to taxation upon withdrawal. The2500 Availab assumed 401(k) match is 50%. In the scenario where the investor takes out a loan for collegeings strategies to compare the possible (Option B), the amount borrowed is based on a 5% bank loan that could be paid back over a2000 Availabimplications of different approaches 10-year period, with the amount allocated to college savings.to investing for retirement and college1500simultaneously. The results, shown in the chart at1000right, are for comparative purposes onlymove up 300 pts500and do not indicate how much someonemay actually need to save to meet his or 0Savings for retirement onlySavingsyears, then used for until college begins, then saveretirement again over final 8 yearsAll for 18 for RetirementSplit savings 10-year Savings loan, then for for retirement only overfor retirement only over final 18 ycollege for college only for first 18 years, then final 18 yearsher individual college and retirementsavings goals.troweprice.com/retirementplanning | 1-800-638-5660 7 10. The examples make these assumptions:be subject to taxation upon withdrawalThis strategy produces the lowestthe parents have a combined income ofin retirement.) amount available for college, although$100,000, which increases 3% annually;If the couple decided to focus onthe amount available at retirement isthey invest 6% of their salary each year college first, investing the same amountonly 20% less than if the investor hadover a 36-year period (18 years prior to each year in a 529 plan for the first 18saved exclusively for retirement for thethe child starting college and 18 yearsyears, they could accumulate $253,000 full 36 years. Even though the couplefrom the start of college until the parentsby the time the child starts school temporarily ceased funding retirementretire); savings earn an average annual(Option D in the chart). In this case,for a decade, they were still able to8% pretax return; and retirement savings they would defer saving for retire- benefit significantly from the long-termare invested in a 401(k) plan and collegement until the child starts college. This compounding of the investments madesavings in a 529 plan where earnings are strategy provides the most for collegeduring the first 18 years.also tax-deferred and, unlike the 401(k),but potentially reduces their retire-could be withdrawn tax-free. ment savings by 70% compared with A Balancing Act There is, of course, no single strategy[ ] the all-retirement strategy. Unless an investor has numerous other ways that will work best for every family. As . . . dont fall into the trap to pay for retirement, this strategyyou evaluate your investing options, its of becoming so obsessed should probably not be considered, important to keep in mind the effects of with . . . paying for college Ms. Fahlund suggests. the trade-offs you make, Ms. FahlundWhat if this family decided on a dualadvises. Its all a balancing act. While that you neglect your its admirable to want whats best for approach, splitting their annual invest- own retirement.ment between college and retirement your children, dont fall into the trap of until college started, and then investing becoming so obsessed with the goal of If the couple invests only for theironly for retirement after that (Option C)?paying for college that you neglect yourown retirement over the full 36-year They would accumulate more than twice own retirement.period (Option A in the chart on as much for retirement compared with Earnings on a 529 plan distributionpage 7), their retirement nest egg would the putting-college-first plan, althoughnot used for qualified expenses may bebe worth nearly $1.7 million, assuming the amounts dedicated to college wouldsubject to income taxes and a 10% federaltheir 401(k) plans offered no matching be worth about 50% less.penalty. Please note that the availability ofcontributions. If their plans providedThe final scenario (Option B) involves tax or other benefits may be conditioneda 50% match, the amount accumulatedsaving only for retirement until collegeon meeting certain requirements, such aswould be more than $2.5 million. begins, then using the full annual savingsresidency, purpose for or timing of distri- Given the potential boost provided amount for the next 10 years to repay a butions, or other factors, as applicable.by a company match, investors should college loan at 5% interest. After that,certainly factor this in when choosing the couple reverts to saving exclusivelya savings strategy, Ms. Fahlund says. for retirement over the final eight years.(Note: All money in the 401(k) would8 troweprice.com/retirementplanning | 1-800-638-5660 11. strategic tips for Young investors>>If youre a young investor, long-term financial goals like saving for retirement mayseem very distant. But even if youre at the onset of your career, its important tobegin saving for your financial goals as soon as possible. Here are some strategic tips fromT. Rowe Price financial planners to help you get started.Pay yourself first: Those who say theyllA T. Rowe Price analysis suggests that With a nondeductible Traditionalsave or invest after taking care of other saving at least 15% of your salary each IRA, only the earnings in the accountexpenses often find that theres noth-year for retirement as soon as you startare taxed when withdrawn. With aing left over. To make it easier to pay working, and then maintaining at leastdeductible Traditional IRA, youryourself first, enroll in your companysthat percentage throughout your career, contributions are tax-deductible in the401(k) plan or sign up for an automaticcan put you on a path toward a finan- year you make them, but then taxesasset builder program in which money cially secure retirement. must be paid on the assets at with-from your paycheck or bank account Consider IRA investments: For singledrawal. If you dont need tax benefitsoften as little as $50 per monthcan be tax filers with earned income of less thannow, the potential for future tax-freeautomatically invested for you. $120,000 for 2010, investing in a Rothwithdrawals may make the Roth IRAIRA can help you start building a retire- the better choice.Start early: Due to the effects of com-pounding, starting early can have signifi-ment nest egg. The Roth IRA tends toInvest in equities for long-term growthcant long-term benefits. As seen in the be a better choice for younger investorspotential: For your retirement portfolio,chart below, for example, someone who than Traditional IRAs (whether deduct-invest up to 90% in equities, assumingsaves $100 per month for 10 years inible or nondeductible) because of how you can tolerate market downturns.a tax-deferred account and then stops the tax benefit works.Historically, investments in stockscontributing would accumulate more byWith a Roth IRA, you receive nohave provided more long-term growthage 65 than someone who waits 10 yearstax deduction on your contributions,opportunities than bonds and short-termbefore starting, and then invests $100but you pay no taxes (assuming certaininvestments. Since younger investorsper month for the subsequent 33 years.conditions are met) on the much largerhave a longer period of time to overcomeOf course, someone who saved $100 amount you are likely to have accumu- market setbacks, it is usually prudent forper month for the entire 43 years would lated when you begin withdrawing from them to invest a significant portion ofdo best, ending up with more than your Roth IRA decades from now. Since their portfolio in stocks. This percentage$450,000. you could be in a higher tax bracket at can be decreased as you get older.retirement than you are early in yourLook for free money: When evaluatingcareer, the tax-free withdrawals becomejob opportunities, check out the avail-that much more valuable.ability of a 401(k) plan, when you wouldbe eligible to participate, and whetherthe company will match some of your The Advantage of Starting Earlycontributions. The free money from aSaving $100 per MonthAccount Valuecompany match can make a significant Years of Savingat Age 65contribution to your retirement nest egg.Balance long- and short-term goals:43 years$450,478Although thinking about a retirementthats 30 to 40 years away can be dif-10 years no contributions $255,824ficult when other needs seem morepressing, its important to make saving no contributions 33 years $194,654for retirement an equalif not moreimportantpriority. Strive to save at Age: 223265least 10% to 15% of your income forStarting early is key to accumulating retirement savings. A 22 year old who invests $100 perretirement, with any additional savingsmonth for 10 years and then stops investing could accumulate more than someone whoearmarked for short-term goals such as adelays saving for 10 years and then contributes until age 65, even though the investor whocar, vacation, or house.delayed contributed more than three times as much ($39,600) as the investor who started early Saving for both long- and short-term and then stopped ($12,000). Of course, the investor who contributes for the full 43 years endsup with a significantly higher account value at retirement.goals means youll have money formajor expenditures, while also helpingThese amounts assume $100 invested each month in a tax-deferred account and an 8% annualrate of return.to ensure your financial future. troweprice.com/retirementplanning | 1-800-638-56609 12. Budget for unexpected expenses: To Get the insurance you need: One way toPay off your credit cards: The ideal waymake sure you dont spend more thanprotect yourself against very large unex- to use credit cards is to pay them off, inyou earn, in addition to budgeting for pected expenses is to purchase insurance. full, every month. Credit cards are usu-fixed expenses (housing, utilities) andWhile most people wouldnt think of ally the most expensive source of bor-flexible expenses (restaurants, recre- going without car insurance, other typesrowed money. The interest you pay onation), you also need to plan for unex-of insurance also provide a safety netyour credit card purchases can add sig-pected expenses such as car repairs or and dont necessarily cost a lot. Rentersnificantly to the cost of an itemmoneyhealth care costs. Often, those in finan-insurance provides liability coverage asthat could be directed toward yourcial trouble find that although they werewell as protection for your possessions.retirement or other savings goals instead.not living beyond their means, they were Health insurance is also important, evenPaying your credit card and other billsunprepared for unexpected expenses.if its only a catastrophic policy to tideon time can eliminate penalty fees andSuddenly they are overspending and you over until you are eligible for analso enhance your credit profile.must start borrowing.employers group plan.10troweprice.com/retirementplanning | 1-800-638-5660 13. ApproachingRetirement. 14. strategies for optimizing Retirement income>>With more than 70 million baby boomers likely to enter retirement over the next20 years, the hard truth is that only a small minority are accumulating enoughsavings to provide for their income needs during decades in retirement.This uncomfortable reality is particularly Working Longersalary to 25%, for exampleis cer-true given the overall rise in life expec- Generally, Ms. Fahlund says that notainly positive but relatively marginaltancy, sharply rising medical costs, the single decision will improve preretirees in terms of increasing annual retire-trend toward more active and costly retire-potential retirement security as much asment income from investments in justment lifestyles, and, not least, the relentlesscontinuing to work even a few more yearsa few years.toll of inflation. beyond the anticipated retirement date. ikewise, those who invest more L For the financially fortunate with suf-Appealing or not, this is usually the best aggressively as they approachficient personal savings, Social Securityoption for those who come up short on retirementmoving, say, from 60%benefits, and corporate pensions to meet retirement savings. of their portfolio assets in equities toall their retirement income needs, the main Unless preretirees enjoy a windfall or 70% or morealso are not likely tofinancial challenges of retirement are how a sharp rise in their incomes late in their make up for lost time. And becauseto invest and spend wisely and perhaps careers, those just a few years from retiring of potentially greater investmentprovide for their heirs as well. who have not saved enough will probably volatility, this step could actually However, more than 75% of workers not be able to make up their shortfalls cause their portfolio balances to dropage 55 and older report having less than solely with increased savings levels or bysignificantly just before or after their$250,000 in investments apart from their investing more aggressively. They simplydesired retirement date.homes and pensions, according to a March will not have enough time for their assets2010 survey by the Employee Benefit n the other hand, continuing to work O to compound.Research Institute (EBRI). At a recom- full time could increase preretireesT. Rowe Price studies show:mended initial withdrawal amount of 4%,expected annual retirement income he long-term impact of a greater T from their investments, in todays dol-that provides an income from their invest- rate of savings at this late stageeven lars, by about 7% for each additionalments of just $10,000 in the first year of boosting saving from 15% of ones year of work and contributions.retirement. Nevertheless, those approaching retire-ment can improve their income and finan-Exhibit 1. The Impact on Retirement Income of Working and Saving Longercial security in retirement depending onCumulative Percentage Gain in Retirement Income From Investments at Different Savings Ratestheir flexibility and their approach to (Current Dollars)four big decisions that are usually under 100% 2their control: 25% Savings RateRetirement Income80 1 hen they stop working. W 15% Savings Rate % Increase in 060 0% Savings Rate hen they start taking Social Security. W40 ow they manage withdrawals from H their savings. 20 ow they allocate their assets. H 0 6263 64 65 66 67 6869 70 The first two can have a significant impactAge Start Taking Withdrawalson the amount of income in retirement, This chart shows the cumulative percentage increase in retirement income from anwhile the second two affect the sustainability investment portfolio for each year the individual continues to work beyond age 62,of that income over a 30-year retirement.depending on whether 25%, 15%, or 0% of wages is invested each year. All figures are in Taken together, controlling thesecurrent dollars. The study assumes an annual salary of $100,000; $500,000 in tax-deferred savings at age 62; an annual inflation rate of 3%; an asset allocation of 40% stocks, 40%decisions will go a long way towardbonds, and 20% short-term bonds and cash; and a 90% probability that income will bedetermining retirees overall security insustained until at least age 95. Portfolio performance is based on a probability analysisretirement, says Christine Fahlund, CFP, described in the Guidelines on Saving for Retirement article on page 3.a senior financial planner at T. Rowe Price. So, for example, if this individual worked until 65, his or her annual retirement income fromCareful planning helps preretirees do a investments would be 28% greater than if he or she had retired at 62, assuming he or she saved 25% of his of her salary each year. Even if none of the annual earnings were saved, thebetter job of optimizing their resources soindividuals income would be 12% greater at 65 because he or she did not have to tap into histhat they can live with fewer worries andor her retirement savings while continuing to work.greater opportunities.12troweprice.com/retirementplanning | 1-800-638-5660 15. Working an additional three yearssay4% per year, or about 12% after three $15,000 annually from Social Security butfrom ages 62 to 65and continuing to years, because the retiree would not have you continue working with annual wagessave 15% of salary could raise annualto tap into existing savings. of $30,000, your annual benefit would beincome from investments by 22%, orWhile many retirees may not want orreduced by $7,920. This leaves only $7,080,by 39% after working an additional be able to continue working in their same pretax, to spend instead of $15,000. If yourfive years. (See chart on page 12 forjobs full time, they could still improve theirtotal wages were approximately $44,200 orunderlying assumptions.) potential income in retirement by working more, this strategy for taking Social Security part time in the same or another job. will not apply since the $1 for $2 reduction nd if this individual worked anAAlthough wages are likely to bewould exceed the expected benefit and youextra five years and boosted his or her reduced with part-time work, the same would not have any benefits to spend.savings to 25% of annual earnings, his potential financial dynamics apply:Once you reach full retirement age,or her annual retirement income from Every dollar earned is one that doesnt however, you can work and earn as muchsavings would be 50% higher than if have to be withdrawn from retirementas you like without any reductions inhe or she had retired at age 62. savings. Indeed, $20,000 in annual income Social Security benefits. Moreover, your The logic behind this is simple: Thosefrom a part-time job is the equivalent of Social Security benefit at full retirementwho continue working can contribute to withdrawing 4% a year from an additionalage would be recalculated to reflect anytheir savings for a few more years, delay$500,000 in savings.months you did not receive a benefit checktapping into their nest eggs, and reduce theAs you near retirement, you may wantdue to excess earned income.number of years that their assets will haveto consider phasing it in rather than sim- Therefore, if you are still working whento generate income in retirementa ply stopping work altogether, or possibly you reach full retirement age and wouldpowerful combination.switching to another, more enjoyable, typelike to start taking your Social Security Moreover, as discussed next, this strat-of work, Ms. Fahlund suggests. This benefits then invest or spend them, you canegy may enable them to delay when they approach may allow you to spend moredo so without any reduction in benefits nostart taking Social Security benefits, which time on new pursuits while growing thematter how much you earn.can significantly increase those payments. assets you will need to draw on later. Also, those who continue working mayTaxing Social Securityreceive health and life insurance and pre- Taking Social Security With Taxes can also affect your Social Securityscription drug benefits from their employ- Earned Income benefits. If you continue to have substantialersall expenses that more and moreIf you are at least 62, you can receive Socialearned income or income from otherretirees have to cover themselves. (Retirees Security benefits and continue to work full sources such as investments in retirement,are not eligible for Medicare until age 65.) or part time, but there is a trade-off. Until you may have to pay income tax on a Delaying retirement does not neces-you reach full retirement age (see pages 14 portion of your Social Security benefits.sarily mean delaying gratification, Ms. and 15), your Social Security benefits are For instance, married couples filing aFahlund says. One novel strategy that canreduced by $1 for every $2 earned above joint return with between $32,000 andboth boost retirement income and makea certain amount each year. (This amount$44,000 in provisional income may haveworking longer more palatable involves is $14,160 in 2010.) In the year of yourto pay income tax on up to 50% of theirspending more, while still working, on full retirement age, benefits are reduced Social Security benefits, even if they earnhobbies, travel, education, or other retire- by $1 for every $3 earned over $37,680 in no wages during this period. Couples withment dreams rather than investing the2010 until you actually reach the month more than $44,000 in provisional incomeadditional earnings from work. of full retirement age. Therefore, if you may have to pay tax on up to 85% of This strategy could still increaseturn 62 this year and expect to receive their benefits.retirement income from investments byExhibit 2. The Impact of Delaying Social Security BenefitsSocial Security payments calculated using the Quick Calculator onAnnual Annual AgeSocialSecurity %Increase SocialSecurity%Increasethe ssa.gov Web site. This assumes an individual who is age 62 in BenefitsPaymentin OverBenefit Paymentin OverBenefit 2010 (with a full retirement age of 66) who is continuing to workBegin CurrentDollars atAge62 InflatedDollarsatAge62 and earning $100,000 each year until benefits begin. Actual benefitscould be higher or lower than those obtained from the calculator.62 $17,760 $17,7606319,164 8%20,268 14% Each year this individual continues working, his or her annual retire-6420,94018 22,728 28ment income in todays dollars from Social Security would increaseby about 8% and annual retirement income in inflated dollars from6522,75228 25,404 43Social Security would increase by about 14% per year, regardless of6624,61239 28,308 59how much of his or her additional wages he or she saves annually.6726,80851 31,752 79Delaying taking Social Security benefits from age 62 until age 706829,02863 35,436 100 would result in an increase of more than $15,600 in todays dollars6931,27276 39,372 122 per year and almost $25,600 in inflated dollars per year.7033,38488 43,356 144 Sources: T. Rowe Price Associates and Social Security Administration.troweprice.com/retirementplanning | 1-800-638-5660 13 16. Total Social Security Benefits Received*Benefits in this hypothetical example are not adjusted for inflation.Exhibit 3: Total Social Security Benefits Received, In Pretax Current Dollars,Depending on Age They Begin(Assuming $17,760 Annual Benefit at age 62; $24,612 at Full Retirement Age of 66; and $33,384 at Age 70) For single filers, up to half the benefit "7is taxable with provisional income of Exhibit 3. Total Social Security Benefits Received, in Pretax Current Dollars,Depending on Age They Begin"8$25,000 to $34,000 and up to 85% is tax-able for income over $34,000. (Provisional(Assuming $17,760 Annual Benefit at Age 62; $24,612 at Full Retirement Age of 66; and $33,384"9at Age 70)income is your adjusted gross income,including wages, plus any tax-exempt$159,840 Take Benefits at Age 6270$123,060interest income from your investments, $33,384 Take Benefits at Age 66 Take Benefits at Age 70Retirees Ageplus half of your Social Security benefit.) $337,44080 $369,180Delaying Social Security $367,224Delaying taking Social Security ben-$515,04090$615,300efits can significantly increase a retirees $701,064income. For example, those benefits 0$200,000 $400,000 $600,000 $800,000(in todays dollars) increase approximatelyTotal Social Security Benefits Received8% per year based on Social SecurityAdministration formulas.T. Rowe Price financial planners citeremainder of your life, except in certain Thus, delaying three years (from 62results of recent actuarial studies that urgecircumstances, she says.to 65) results in a 28% increase in the married investors who are 65, for exam-purchasing power of a retirees Socialple, to plan for at least one spouse livingThree Steps CombinedSecurity benefits, and delaying until age in retirement to 95. Taking all three steps to increase potential70 almost doubles the purchasing power If our hypothetical Social Security recip-retirement incomecontinuing to workof these benefits (about 88%). (See chart ient lives to 90 or longer, he or she wouldand save at a 15% rate and delaying Socialon page 13.) The potential gain in actual ultimately receive more total benefits ifSecuritycould increase the purchasingbenefits could be even higher (abouthe or she began taking them at 70 than ifpower of total retirement income from144%) because Social Security benefits arehe or she started at 66 or 62, even though retirees combined investments and Socialadjusted annually for inflation.benefits were paid over a shorter period.Security benefits by about 8% for each Exhibit 3 shows total Social Security Extreme care must be taken whenyear after 62, or 25% in three years (asbenefits in current pretax dollars, depend- deciding at what age to begin taking yourreflected in Exhibit 4, which also providesing on when benefits begin and how long Social Security payments, Ms. Fahlund the underlying assumptions).they are paid, assuming a $24,612 annualcautions. The annual amount, at what-And doing that from ages 62 to 70benefit at full retirement age of 66 com- ever age you pick to begin taking Social would almost double total retirementpared with a $17,760 benefit at 62, or aSecurity, will be locked in [adjusted forincome from investments and Social$33,384 benefit at 70. Analyzing whetherinflation or possible other credits] for the Security in todays dollars.you should take benefits at a reduced ratebefore reaching full retirement age, orExhibit 4. The Combined Impact of Working Longer and Delaying Social Securitywhether you might be better off in the Cumulative Increase in Retirement Income From Investments and Social Security for Each Year After Age 62long run by waiting for your scheduledbenefit at full retirement age or later,100%really depends on whether you can afford80 0% Savings RateRetirement Income 15% Savings Rateto delay receiving benefits and how long % Increase in60 25% Savings Rateyou expect to live. For example, a personwho receives a pretax benefit of $17,76040starting at age 62 will have received the 20same total benefits by 77 (16 years) as if 0he or she had started receiving a $24,612 63 6465 66 67 68 6970 Age Start Taking Withdrawals and Social Securitybenefit at 66. From 78 on, the cumula-This chart shows the cumulative percentage increase in total retirement income fromtive benefit is greater if this individualboth working and saving longer and delaying Social Security for each year beyond age 62,had waited to begin benefits until full depending on whether 25%, 15%, or 0% of wages is invested each year. The assumptions areretirement age (assumed to be 66 in thisthe same as for the charts on pages 13 and 14 that show gains from just working longer orfrom delaying Social Security benefits.example).So, for example, if this preretiree worked until age 65, his or her annual combined Likewise, if this individual delayed retirement income from investments and from Social Security would be 30% greater than ifbenefits until age 70, thus qualifying for ahe or she had retired at 62, assuming he or she saved 25% of his or her salary each year. Evenbenefit of $33,384, his or her cumulative if none of the annual earnings were saved, the preretirees income would be 21% greater at65 because he or she did not have to tap into his or her retirement savings while continuingbenefits would be greater from ageto work, and he or she delayed taking Social Security benefits, which increase in value for81 on compared with starting benefits ateach year they are postponed until age 70. If this individual worked until 67 and saved 25%62. Although 81 may seem a long way off,of salary, his or her combined retirement income would be 52% greater than at 62.14 troweprice.com/retirementplanning | 1-800-638-5660 17. To boil this down, here is another wayIts often easy to underestimate longev- T. Rowe Price simulation studiesof looking at the overall benefit of workingity, particularly because married couples show that:longer and delaying Social Security ben-may neglect to take into account their joint or a 30-year retirement, an initialFefits. If a 62 year old wants about a 30% life expectancy when it comes to Social withdrawal amount of 4% from aincrease in the purchasing power of his orSecurity. balanced portfolio of assets (with 3%her retirement income from investments Many financial planners used to recom-annual increases in the withdrawaland Social Security, then he or she could:mend taking your Social Security benefits amount for inflation) would provide asas soon as you become eligible, Ms.high as an 89% chance of having assets etire in three years at 65 by savingRFahlund says. But today, with greater lon- remaining at the end of this period. A25% of his or her salary annually.gevity, delaying Social Security for as long5% initial withdrawal amount with etire in three and a half years at 65R as possible may be the best strategy if youby saving 15% of his or her salaryinflation adjustments, on the othercan afford it. hand, reduces these odds to a range ofannually.40% to 65%, depending on the asset etire in four years at 66 by spend-R Taking Withdrawalsallocation strategy.ing rather than saving his or her The third and fourth major decisions facedadditional earnings.by preretireestheir withdrawal amounts f retirees suffer poor portfolio returnsIand their portfolios asset allocation in in the first few years of retirement,(These illustrations assume that the retireeretirementboil down to figuring outthey should consider lowering theirdoes not begin taking Social Security until how to maximize the amounts they canwithdrawal amounts temporarily or athe or she stops working.) withdraw initially from their retirementleast holding their annual withdrawals Keep in mind that, for those who con-savings without running out of moneyflat for a while instead of increasingtinue working and begin Social Security during their lifetimes. them for inflation. Extensive analysisbenefits prior to attaining full retirementWhile working longer, saving more, by T. Rowe Price has demonstratedage (66 for most boomers), some benefitsand delaying Social Security benefits can that this approach is much morecould be temporarily withheld depending increase total retirement income, decid-advantageous than, for example,on the amount of wages earned.ing on an appropriate initial withdrawalattempting to counteract a market In general, analyzing whether preretireesamount from portfolio assets and adjustingdownturn by dramatically reducingshould decide to take benefits early, at agethat amount as necessary can go a longthe level of equitiesand hence the62, or whether they would be better off inway toward lowering the risk that retireeslong-term growth potentialin retir-the long run by waiting for increased bene- outlive their resources.ees portfolios.fits until as late as age 70 really depends on In most cases, your ability to avoidwhether they can afford to delay receiving No analysis can cover every contin-running out of money is driven more bygency, Ms. Fahlund says. But, in general,benefits, whether they are married, and, to your initial and subsequent withdrawalsome extent, how long they expect to live.an initial 4% withdrawal amount givesamounts than by your asset allocation preretirees a high probability of not hav-strategy, which for many investors is ing to worry about depleting their assetscounterintuitive, Ms. Fahlund says.too quickly, unless they retire into a severebear market. (For additional information on MonteCarlo analysis, refer to Guidelines onSaving for Retirement on page 3.)Exhibit 5. How Much Can You Withdraw in Retirement?The estimated probability of maintaining several initial withdrawal amounts throughout a 30-yearAsset Allocationretirement without running out of money, depending on the investors asset allocation. This analysisIn general, making minor adjustments toassumes pretax withdrawals from tax-deferred assets and can be applied to any size retirementportfolio. In this study, the initial withdrawal amounts are increased by 3% for inflation. a balanced portfolio in retirement has lessimpact on financial security than the other30-YearRetirementPeriodthree decisions.First-YearStock/BondMix However, preretirees often make the WithdrawalAmount 80/20 60/40 40/60 20/80serious mistake of assuming that the safestpath in retirement is minimizing equitySimulation Success Rate*exposure to lower their market risk.7%28%19%7% 1%Instead, moderate exposure to equities is6 45 38 24 7recommended for diversification, growth5 65 63 57 40 potential, sustaining real income, and pro-viding a cushion to cover unexpected4 84 87 89 89expenses during a 30-year retirement.*The probability of having at least $1 in the portfolio at the end of 30 years. The probability analysis Also, to increase the potential wealth thatused for determining this is explained in Guidelines on Saving for Retirement on page 3.retirees could draw on in emergenciesor troweprice.com/retirementplanning | 1-800-638-5660 15 18. to possibly leave more money to heirsretirees could opt for somewhat higherallocations to equities, though that doescarry greater risk in market downturns. Ms. Fahlund advises retirees to main-tain at least a 40% allocation to equities,even into their 80s, and to keep no morethan 30% of their assets in cash or short-term bonds. The bottom line, she says, is thatif you have too much set aside for emer-gencies in cash, which usually has a verymodest annual return, you run the risk ofnot keeping up with inflation and possi-bly running out of resources from whichto take withdrawals. And if you have toomuch invested in stocks, you lessen yourability to cope with market uncertaintiesand run the risk of having to sell equitiesduring a market setback to provide forincome or unexpected contingencies. The answer is to maintain a balanced,diversified portfoliowith moderategrowth potential and a moderate riskprofile. With all of these critical decisionswhen to stop working, when to starttaking Social Security, how much to with-draw from your portfolio in retirement,and determining the right asset allocationstrategythe overarching concepts areto maintain flexibility in your plans forretirement and make thoughtful decisionsregarding financial matters that are underyour control, she adds. Such preretirement planning can helpoptimize your financial prospects foryears to come.16troweprice.com/retirementplanning | 1-800-638-5660 19. LivinginRetirement. 20. Plan for a successful Retirement>>While you were accumulating your retirement savings, chances are you evaluatedyour investment strategy regularly to ensure that you were still on track with yourlong-term objectives. But what you may not realize is that consistently evaluating your invest-ment strategy is just as important once youre retired and drawing on your retirement assets.Here are some proven ways to help make your retirement a success.A good technique is to closely moni- for your next car and earn a 5% after-expenses later in life, now is probablytor your income and spending as you tax annual rate of return, in five yearsthe best time to buy itwhile you areprogress through retirement so youof investing you will have accumulatedinsurable and your premiums are stillcan continue to evaluate whether your almost $17,000, which could go a long reasonable. Since most people want tooriginal projections are on target, says way toward purchasing that car.continue living at home, you may wantChristine Fahlund, CFP, senior finan- And remember that if most of yourto think of this as stay-in-my-own-cial planner with T. Rowe Price. It isretirement savings are in tax-deferredhome insurance, says Ms. Fahlund.important to recognize that it is the investment accounts, you will most Rethink your plans if your retirementsequence of returns, not just their average likely owe income taxes on your pretaxhousing choices are costing you more thanthat can make a difference in how longcontributions and any earnings when you thought they would. You may want toyour retirement assets may last. A fewyou withdraw the assets. So you may consider moving to a residence that is lesspoor-performing years in the very early have less to spend than your actual with- costly and/or easier to maintain. Dontpart of your retirementcombined with drawal amount.buy anything that might involve taking onan overzealous withdrawal strategy new mortgage debt, says Ms. Fahlund.could deplete your retirement savings Fine-Tune YourInstead, buy something less expensiveprematurely. Therefore, by reviewingInvestment Strategy than your current dwelling so you can uti-your strategy at least once a year you canKnowledgeable investment choices canlize the profits from the sale to add to yourdecide whether you will need to reduceenhance the potential of your long-term reserves. Also, you may want to compareyour planned withdrawal amounts inretirement assets. The growth potentialwhat your cost of living might be if youthe coming year to better preserve your of stock exposure may reduce the risk moved to another part of the countryassets. In fact, if you experience very that inflation will significantly decreasesay, to be closer to your children or grand-positive market returns for several years the purchasing power of your portfoliochildren.in retirement, you may actually be able during retirement, says Ms. Fahlund.Building in financial safeguards willto adjust your withdrawals to boost yourRetirees who think they should beenable you to enjoy this new phase ofincome further. holding 20% of their retirement sav-your lifewhatever you choose to do.ings in equities need to reconsider thisFor some retirees, it may mean embark-Adapt Your Budget approach. Ms. Fahlund notes that ining on a new career or extensive travel. IfTodays retirees could spend up toorder to keep pace with inflation, thoseyou find you need additional retirementone-third of their lives in retirement. investors in and approaching retirement savings, working part time is one way toWith increased life expectancies, retire- should consider an allocation to equities help close any gap between retirementment portfolios need to provide incomeof 60% to 40%, gradually decreasing spending and income.for longer periods than previouslyyour equity exposure to 30% and 20% in Retirement planning isnt limitedanticipated. In order to sustain your your 80s and 90s. to something you do only before youretirement income, its important toretire; its an ongoing process of review-reexamine your budget periodically to Take Controling and fine-tuning. Given todaysdetermine whether youre spending Successfully managing your retirement longer life spans, you and your spousewithin your means.also involves anticipating life occurrences may live 30 years or more in retirement.In addition, its helpful to separate non-that might affect your finances. ForReexamining your financial plans afterdiscretionary expenses from discretionary example, if you havent already, make your first years in retirement and assess-ones, creating a list of what you needa decision about long-term care (LTC) ing them on a regular basis can helpversus what you may want. It shouldinsurance. This insurance can help coverensure that you have the assets you needbe a red flag if youre not paying your nursing home costs or assistance in yourto last your lifetime.credit card bills in full every month, own home, should it become necessary.says Ms. Fahlund. Try to avoid acquir- The older you are, the more LTC insur-ing new debt by budgeting for big-ticketance is likely to cost. If you think youreplacements, such as large appliances. may want LTC insurance to protect youFor example, if you save $250 per month and your spouse from potentially costly18 troweprice.com/retirementplanning | 1-800-638-5660 21. determining a Realistic Withdrawal Amount and Asset Allocation>>Many people look forward to retirement, but it can be one of the most complicatedstages of life from a financial planning point of view. In addition to charting a suit-able investment strategy, retirees need to consider estate planning issues, health insuranceneeds, andone of the thorniest decisionshow much they can afford to spend each monthwithout jeopardizing their future financial security.Retirees must consider the risk of out-of retirement, assuming this amount isof maintaining an initial 4% to 5% with-living their assets. How should they increased by 3% annually to keep pace drawal amount.reconcile that possibility with a desire with inflation throughout retirement.What if this investor decided to retireto maximize annual income so thatNo analysis can predict the future,earlier? Although the same strategy at agetheir retirement years are as fulfilling but a 4% initial withdrawal gives you a 60 (assuming a 25-year retirement period)as they expect?high probability that you wont run out may offer only a 50/50 chance of sustain- For many investors, the most impor-of money, using a reasonably diversifieding a 6% initial withdrawal amount, 5%tant issue to focus on when they retire is investment strategy, Mr. Cleary says.would be more reasonable. If the invest-choosing a sustainable monthly incomeOnce you go much over that percent-ment horizon were extended to 30 years,amount, says Todd Cleary, head of age, you have to start worrying about the investor would have to consider a 4%financial planning for T. Rowe Price.the possibility of depleting your assetsinitial withdrawal to achieve a high prob-The effective resolution of the other too quickly. ability of not running out of money.planning issues, including your investmentTheres a big leap between a 20- andstrategy, is driven by this key decision. Determining the Odds30-year retirement horizon, Mr. Cleary Also, with more people retiring with- Instead of relying on an average annual says. If you are planning for more thanout guaranteed pension income due to rate of return projection, T. Rowe Prices20 years, you have to consider lowerthe prevalence of defined contribution program models thousands of possibleinitial withdrawal amounts and having atretirement plans, longer life expectancy,market scenarios to determine the prob- least a 40% to 60% equity exposure.and potential changes in Social Security,ability of success for a broad variety ofit has become more important than ever retirement withdrawal strategies. Effect of Portfolio Strategyto develop a realistic income plan that can The tables on the next page show We have found that your ability to avoidmaintain purchasing power over a longthe estimated probability (simulation running out of money in retirement isperiod of time, perhaps 20 to 30 years.success rate) of maintaining variousdriven more by your initial withdrawal Determining a reasonable initial with-spending rates throughout retirement, amount than your asset allocation strategy,drawal amount from your retirement depending on the investors initial so investors should focus on that first,assets will be influenced by various fac-withdrawal amount, time horizon, andsays Christine Fahlund, CFP, a seniortors, including your expectations forasset allocation. The analysis reflects a financial planner at T. Rowe Price. Thoseinvestment returns and inflation, your broad range of investment and spend-who begin retirement with a conservativelifestyle, health concerns, how long ing strategies tested over 100,000 pos- withdrawal amount, such as 4% of theiryou expect to live, how much money sible scenarios of market performance.starting balance, and are planning on ayou may want to leave your heirs, andThe guidelines can be applied for any 20- to 25-year time horizon do not neces-how much volatility you are willing to amount of retirement assets.sarily need to assume much volatility inassume in your investment portfolio.Many retirees may have to make trade-their investment approach. As indicated in Based on our experience with clientsoffs between how much they can spend, the chart on the next page, a strategy withand sophisticated computer analysis, the likelihood that they will be able only 20% invested in equities, a 4% initialthe firms planners suggest that peopleto sustain assets in retirement, and thewithdrawal amount, and a 25-year timeshould probably spend more conserva- investment risk they are willing to take. horizon has a 98% simulation success rate.tively than they expected if they want toFor example, the model indicates thatHowever, if you want to spend morebe reasonably sure of not depleting theiran investor retiring at 65 with a 20-year or plan on the possibility of living lon-assets prematurely.investment horizon using a balanced ger or would like to create a cushion Taking into account inflation, the vari-portfolio (60% stocks, 30% bonds, and for emergencies or for your heirs, theability of market returns, and average life10% short-term bonds) has a 75% chanceasset allocation decision becomes moreexpectancy, they conclude that a relativelyof maintaining a 6% initial withdrawalimportant. Under these circumstances,safe initial withdrawal amount is aboutamount (with 3% annual increases) and Our analysis shows that retirees with4% to 5% of portfolio assets the first yearan extremely high probability (over 90%)long time horizons [about 30 years]troweprice.com/retirementplanning | 1-800-638-5660 19 22. * The following asset allocations include How Much Can You Withdraw in Retirement?short-term bonds: 60/40 includes 60% The table shows the estimated probability of maintaining several initial withdrawal stocks, 30% bonds, and 10% short-term bonds; 40/60 includes 40% stocks, 40% amounts throughout retirement, depending on the investors asset allocation and bonds, and 20% short-term bonds; and time horizon. The analysis assumes pretax withdrawals from tax-deferred assets20/80 is composed of 20% stocks, 50% bonds, and 30% short-term bonds. and can be applied to any size retirement portfolio. ** T. Rowe Price has analyzed a variety ofretirement spending strategies using20-YearRetirementPeriod computer simulations to determine theInitialStock/Bond Mix* likelihood of success (having at least $1 Withdrawal Amount 80/2060/4040/60 20/80remaining in the portfolio at the end ofSimulationSuccessRate** the retirement period) for each strategy,7%56% 52%44%26%shown as a percentage in each grid. The 6 7475 75 71 analysis for each retirement strategy is 5 8992 95 97 based on running 100,000 hypothetical 4 9799 99 99 future market scenarios that account fora wide variety of return possibilities. The25-YearRetirementPeriod initial withdrawal amount is the percent-Initial Stock/Bond Mix* age of assets withdrawn at the beginningWithdrawal Amount80/2060/4040/60 20/80of the first year of retirement as a lump SimulationSuccessRate** sum made at the beginning of each year 7% 39% 30%17% 4%and is inflation adjusted (3%) annu-65753 44 25 ally. Investment scenarios are based57778 78 73 on hypothetical (not historical) annual49194 97 98 rates of return for the three asset classesrepresented in the portfolio mixes. The30-YearRetirementPeriod return assumptions of 10.00% for stocks,6.50% for bonds, and 4.75% for short-termInitialStock/Bond Mix*bonds are based on our best estimates Withdrawal Amount 80/2060/4040/60 20/80for future long-term periods. The assumedSimulationSuccessRate** expense ratios for these asset classes are7%28% 19% 7% 1%1.211% for stocks, 0.726% for bonds, and 6 4538 247 0.648% for short-term bonds. 5 6563 57 40 4 8487 89 89These examples present only a range of possible outcomes. Actual results will vary35-YearRetirementPeriodwith each use and over time, and such results may be better or worse than the InitialStock/Bond Mix* simulated scenarios. Withdrawal Amount 80/2060/4040/60 20/80SimulationSuccessRate**Source: T. Rowe Price Associates, Inc.6%37% 28%14% 2% 5 5752 41 19 The second row, based on the same 4 7879 77 71simulation analysis, shows the median 3 9396 98 99 percentage of each portfolios originalFor additional information on Monte Carlo analysis, refer to Guidelines on Savings forpurchasing power remaining after 30Retirement on page 3. years, expressed in todays dollars. Inshould generally have no more than 20% cushion) the investor has to fall back on half of the simulated scenarios, eachto 30% of their assets in cash and thatduring retirement or to leave behind. The portfolio strategy had a balance equalthey should keep at least 30% to 40% table on the next page reflects a coupleto at least this percentage of its startingin equities, according to Jerome Clark, of measures of retirement security. value, adjusted for inflation.Asset Allocation portfolio manager.The top row shows the probabilityFor example, if the investor retired If they have a much bigger cash posi-(simulation success rate) that the investor with $500,000, of which 60% was intion than that and consequently trim will not run out of assets in retirementequities, 30% in bonds, and 10% intheir equity exposure, they increase the and sustain this income stream, based short-term bonds, it is likely that, afterlikelihood of failing to maintain income on various portfolio strategies testeda 30-year retirement period, the portfo-throughout their retirement years.over 100,000 potential market scenarios lio would still have a median balance of and assuming a 4% initial withdrawal$395,000 in current dollars (79% of itsCreating a Cushion amount. With this conservativeoriginal value). With a 20% equity posi-Pursuing a moderately growth-orientedwithdrawal, each of the investmenttion, on the other hand, the T. Roweinvestment strategy in retirement maystrategies provides more than an 80%Price analysis suggests that the medianalso increase the amount of wealth (or chance of not running out of money. balance would be only $180,000, or 36%20troweprice.com/retirementplanning | 1-800-638-5660 23. of the original value. (The median port-at least a 70% simulation success rateTo further cope with market uncer-folio ending balance for a single strategyor chance of not running out of money. tainty and reduce the chances of havingis the one in which half of the projected They also advise planning on a 30-year to sell investment assets during a marketending balances are greater than this retirement horizon if the retiree is in hissetback to meet unexpected contingen-amount and half are less.)or her early to mid-60s. While that maycies, retirees are also advised to maintain If the initial withdrawal amount wereseem like a long time for maintaininga reserve or emergency savings account5% instead of 4%, not only do the simu- retirement income, the IRS life expec- of extremely liquid, short-term invest-lation success rates drop sharply, but so tancy tables estimate that a 60-year-ments that is not used to generatedo the projected median portfolio bal-old individual should live, on average,monthly income in retirement.ances after 30 years. In this case, in half another 25 years. But that means half ofFinally, retirees are urged to withdrawthe projections the retirement income those age 60 today are expected to liveassets from their accounts in a tax-strategy invested in a 60/30/10 portfolio longer than that.efficient manner (generally preservingcould still provide purchasing power Those who want the assurance that tax-deferred assets as long as possible),of 26% of its original value, while the at least a portion of their retirement to take minimum distributions from20/50/30 portfolio, with the same 5%income is guaranteed for life might also their IRA and other retirement accountsinitial withdrawal amount, might have consider a fixed or variable annuity for as required, and to carefully reviewrun out of money by that time.part of their assets, especially if they dotheir beneficiary designations for these Generally speaking, maintaining ornot have guaranteed pension income.accounts periodically.conserving your purchasing power mayDepending on their particular situa-Once an income strategy in retire-benefit you and your family in severaltion, a deferred or an immediate annuity ment is determined, the plan should beimportant ways, Ms. Fahlund says.might be more appropriate. reviewed annually, especially if your port-You are likely to have more assets in With the shift toward defined con-folio suffers a decline in value, you haveyour investment portfolio throughouttribution plans (such as 401(k) plans),to withdraw more than you had planned,retirement to cover special events as wellmany retirees must now assume theor your personal circumstances change.as medical expenses or other emergen- risk of providing themselves an incomeBy carefully developing your retire-cies, to have more investable assets to through all market environments over ment financial plan now and under-generate income if you outlive your pro-a potentially long time. For that reason,standing the possible effects of time,jected life expectancy, and to have moreshifting some of that risk to an insurance spending rate, and investment approachassets to leave your heirs, as well. company for a fee may be appealing.on its potential success, you can reduceMany decisions related to the purchase the financial stress often associated withCoping With Uncertainty and annuitization of the particular insur- retirement and avoid having to makeIf you expect to rely on your investmentance products, however, are irrevocable, undesirable adjustments along the way.assets as the primary source for your so it is very important to understand theretirement income, T. Rowe Price plan-consequences of each choice before tak-ners suggest choosing a strategy that has ing action. Impact of Portfolio Strategy on Retirement Security 4% Initial Withdrawal Amount With 30-Year Retirement PeriodPortfolioStrategyPercentage invested in stocks, bonds, and short-term bonds80/20/060/30/1040/40/2020/50/30 Simulation success rate for sustaining retirement income184% 87%89%89% Percentage of original portfolios purchasing power after 30 years (median wealth)299% 79%59%36% Median wealth after 30 years based on $500,000 portfolio at retirement (in current dollars)2 $495,000$395,000$295,000$180,000 The simulation success rate reflects the probability of sustaining retirement income over 30 years for each portfolio strategy based on 100,000 1 potential market scenarios, assuming 4% of portfolio assets is withdrawn the first year of retirement and that amount increases by 3% each year for inflation. Return assumptions, net of estimated expenses, include 8.79% for stocks, 5.78% for bonds, and 4.10% for short-term bonds. This reflects the median percentage of the portfolios original purchasing power remaining after 30 years based on a 4% initial withdrawal amount 2 with 3% inflation adjustments to the withdrawal amount annually. So in half the simulated scenarios for each strategy, the portfolio had an ending balance of this amount or more. For example, if the investor retired with $500,000 in assets, after all withdrawals the portfolio with 80% invested in stocks retained 99% of its purchasing power after 30 years, or $495,000 in current dollars. The portfolio with 40% in stocks would have a pur- chasing power of 59% or more in half the cases. So pursuing a more aggressive strategy in retirement may increase the chance of having a bigger cushion for emergencies or having more money to leave to heirs.troweprice.com/retirementplanning | 1-800-638-5660 21 24. StrategiesforCopingAfterRetiringIntoaBearMarket>>Retirees should have a plan for sustaining their income over a 30-year retirement.But the best-laid plans can be upset if they find theyve retired into a bear market.In general, if retirees limit their initial retirement has a higher cost becauseThe T. Rowe Price analysis assumeswithdrawals to 4% of their invest-its money that wont be invested to that an investor retires with a $500,000ment portfoliosand then increase thatearn returns in succeeding years whenportfolio invested 55% in equities andamount by 3% a year for inflationtheythe markets recover, says James 45% in bonds, takes 4% of his or her port-should stand an almost 90% chance Tzitzouris, Jr., investment analyst on folio ($20,000) the first year, and increasesof being able to sustain that incomeT. Rowe Prices asset allocation team, that amount by 3% each year to keep upstream over 30 years without runningwho conducted the simulation study.with inflation ($20,600 in the second year,out of money, according to a T. RoweAnd the less they have invested after $21,218 in the third year, etc.).Price Investment Analysis Tool usinga bear market, the less potential they Based on a sophisticated methodol-thousands of potential market simula- have to benefit from the compounding ogy involving 10,000 simulated portfoliotions. But what if they happen to retireof any earnings in subsequent years.outcomes, this investor stands an 89%near the start of a bear market? The Cutting back on withdrawals may chance of having enough left in the port-short answer is that bear markets can be be necessary: If retirees find that theyfolio to sustain this rate of withdrawalsdevastating for new retirees who do nothave retired into a bear market, theover a 30-year time span. (See article ontake action to compensate. While their most effective tactic to sustain a high page 3 for a detailed description of thisinstinct may be to flee the risk of equity chance of not outliving their assets is probability analysis.)markets, a more effective strategy, as a to cut back significantly on the amount The analysis showed that if the inves-new T. Rowe Price analysis shows, is toof money they withdraw from their tors portfolio had an average annualizedtemporarily reduce annual withdrawalsportfolios. Or, if that approach is too return that ranged from less than 0%from their nest eggs.drastic, they can choose to keep theirto less than 5% in the first five years of Our research shows that withdraw-annual withdrawal amounts constantretirement and continued the originaling too much in retirementparticularlyrather than increasing them each yearearly in retirementis the most likely for inflation as originally planned.cause of running out of money, saysChristine Fahlund, CFP, a seniorfinancial planner with the firm. Thatswhat you need to adjust, and the sooner For Retirement Success, the First Five Years Are Criticalthe better.Odds of Success Plummet if Withdrawal Amount Exceeds Portfolio Returns Bear marketssometimes defined as100%Projected Probability of Success*89%a drop in the S&P 500 Index of at least9020%are not infrequent. Over the last8074% 69%80 years, one has occurred about every 7064% 60 57%three years, with an average duration 51% 50 43%of about one year and an average 40decline of 35%, according to Ned Davis 30Research. Recent retirees may be review- 20ing their investment and spending plans100as a result of the sharp decline in the At 4% to3% to2% to 1% to 0% to Lessequity markets.Retirement1