Retirement Saving Guide

THE T. ROWE PRICE

Retirement
Savings Guide
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.

T. Rowe Price
Retirement Savings Guide.

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 you’re still
saving for your retirement, preparing to leave your full-time career, or currently retired and
managing your income, this guide offers you the collective expertise of experienced T. Rowe Price
financial planners and investment specialists.

AdditionAl RetiRement
PlAnning ResouRces What You’ll Find in this guide:
Our Web site provides Saving for Retirement.
n Guidelines on Saving for Retirement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
extensive online guidance
on comprehensive retirement n Balancing College and Retirement Savings . . . . . . . . . . . . . . . . . . . . . . . . 7

planning, including helpful n Strategic Tips for Young Investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
calculators and tools. You
can also contact a T. Rowe Approaching Retirement.
n Strategies for Optimizing Retirement Income . . . . . . . . . . . . . . . . . . . . . 12
Price retirement specialist
at 1-800-638-5660 for more
Living in Retirement.
information on how to
n Plan for a Successful Retirement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
put our investment and
n Determining a Realistic Withdrawal Amount and Asset Allocation . . . 19
planning solutions to work
n Strategies for Coping After Retiring Into a Bear Market . . . . . . . . . . . . 22
for your retirement.

Tools and Resources.
n Your Financial Road Map to Successful Retirement . . . . . . . . . . . . . . . . 26

n Getting a Reality Check on Your Retirement Income Plan . . . . . . . . . . 28

troweprice.com/retirementplanning | 1-800-638-5660 1

guidelines on saving for Retirement

>> Are you saving enough for retirement? This may be the most important financial
challenge you face as the responsibility of funding retirement continues to shift from
employers to individuals. And yet several recent studies have revealed that people are not saving
enough for a financially secure retirement, especially as life expectancies continue to rise. With
people living longer and retiring without a guaranteed pension income, retirement planning
is more important today than even a decade ago. Here are some guidelines on how much you
need to save.
“One of the biggest risks for people delay saving until late in their careers, As indicated in the tables on page 4,
planning for retirement is that they may however, may need to save as much as the burden on the investor can increase
not save enough to live comfortably in 25% or more of their salary, and even substantially by delaying saving. For
their retirement years,” says Christine then they may not accumulate enough example, those who are 20 years from
Fahlund, CFP®, T. Rowe Price’s senior assets to reach their goal. Ms. Fahlund retirement and have saved only one
financial planner. “If you don’t save notes that “most retirees will also receive times their current salary may be able to
enough today, you may be faced with Social Security and possibly income replace only 29% of their preretirement
the harsh reality later in life of having to from part-time work, so that their total salary—even if they save 15% of their
cut your expenses and standard of living amount of income in retirement may be pretax salary each year between now
dramatically. That’s why it’s so impor- closer to 70% of their salary than 50%, and retirement. On the other hand, if
tant to start saving as early as possible including these other sources.” they had already saved three times their
and develop a disciplined approach.” The results of the T. Rowe Price study current salary, a 15% savings rate might
are 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 might of their income at retirement.
Determining a reasonable savings rate be replaced in retirement depending on: Keep in mind, however, that these
for your retirement will depend on (1) the number of years until retirement; projections do not take into account the
various factors, including your expected (2) what percentage of pretax current possibility of receiving salary increases
lifestyle in retirement, health concerns, salary is being saved annually (assuming in excess of 3% on average due to
how much risk you are willing to take the current salary increases by 3% each promotions, job or career changes, or
in your portfolio, the amount you have year); and (3) the amount already saved performance bonuses. Of course, the
saved so far, and how much time you for retirement, expressed as a multiple of more an individual’s income rises, the
have 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 retirement
perspective on their retirement savings assumption that the investor using this unless the individual increases his or
needs, 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 process) and that he or she maintains an Starting Early
jections based on thousands of possible asset allocation of 60% stocks and 40% “There’s 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 approach—40% mental stress and pain later on,”
compare the effects that a wide variety stocks and 60% bonds—after retirement. Ms. Fahlund says. “Most companies
of savings rates and investment strate- For example, an individual who is offer some sort of match in their
gies are likely to have on the amount 40 years from retirement (i.e., approxi- 401(k) plan, and, if you qualify, you
of salary an investor may be able to mately 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 salary total contribution. For example, if
out of money. each year in combination with his or her you save 6% of your salary and the
employer may be able to replace 61% company matches 50 cents on the dol-
The 15% Solution of preretirement salary in retirement lar for that portion, you are already
The analysis suggests that individuals from savings. If that person had already saving at 9% of salary. So employees
generally should strive to save at least saved one times his or her current salary, should at least take full advantage of
15% of their pretax salary (including which means if someone earning $40,000 employer matches.”
employer contributions) in order for has saved $40,000, then a 15% annual “The most important issue to focus
their investments to replace 50% or savings rate might enable him or her to on is what percentage of your annual
more of their current salary in retire- replace 79% of current salary, adjusted income you need to replace in your
ment, adjusted for inflation. Those who for inflation. retirement,” she adds. “Usually, people


need at least 75% of their preretire-
ment income in retirement even if they
have taken care of most of their major
How Much of Your Salary Can You Replace in Retirement?
expenses such as college education for
their kids, saving for retirement, and 20 Years to Retirement
paying off their mortgage. Of course, Current Savings as Multiple of Current Pretax Salary
some of this may come from other Annual Savings 0x 1x 3x 5x
sources such as Social Security, a pen- (% of Current
sion, and part-time employment. Pretax Salary)
Retirement Income as % of Salary
“Ultimately, at least part of each 5% 7% 16% 34% 51%
investor’s future financial success will 10 14 23 40 58
depend on how much he or she has 15 20 29 47 65
already saved. Obviously, if someone 20 27 36 54 72
has not saved for retirement, that situ- 25 34 43 61 79
ation cannot be changed retroactively.
However, he or she may still be able
to generate some savings before retire- 30 Years to Retirement
ment by not spending any employment Current Savings as Multiple of Current Pretax Salary
bonuses or any inheritance, or by down-
Annual Savings 0x 1x 3x 5x
sizing or changing a residence upon
(% of Current
retirement and investing the difference.” Pretax Salary)
Whatever savings plan for retirement Retirement Income as % of Salary
you pursue, you should review your 5% 12% 25% 50% 75%
results periodically to see if you are on 10 25 37 63 88
track. In addition, you may want to 15 37 50 75 100
consult the retirement planning informa- 20 49 62 88 113
tion and calculators on our Web site, 25 62 75 100 125
troweprice.com/retirementplanning.

A Better Alternative to the 40 Years to Retirement
“Average” Rate of Return Current Savings as Multiple of Current Pretax Salary
Many retirement planning analyses still Annual Savings 0x 1x 3x 5x
base their investment projections on (% of Current
Pretax Salary)
fixed average annual rates of return. Retirement Income as % of Salary
In effect, these analyses assume that 5% 20% 38% 74% 109%
the identical investment return will be 10 40 59 94 130
achieved each and every year. 15 61 79 115 151
In fact, the results of projections using 20 81 99 135 171
the “average” rate of return method are 25 101 120 156 192
usually not the same as the results of
projections of multiple simulations of The projections or other information generated regarding the likelihood of various investment
the market’s potential ups and downs. outcomes are hypothetical in nature, do not reflect actual investment results, and are not
Generally, average rate of return calcu- guarantees of future results.
lations paint a picture that may be too The tables show what percentage of preretirement income you may be able to replace from
optimistic and not realistic enough. For savings, based on years to retirement, current savings expressed as a multiple of current
example, 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 three
mendation to save less for retirement
times your current salary and are saving 15% of your salary each year, you may be able to
than will actually be required based on replace 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 portfolio
cal tool for modeling future uncertainty. consists of 60% stocks and 40% bonds prior to retirement and 40% stocks and 60% bonds after
In 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. The
expected-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 Carlo for short-term bonds and annual expenses of 1.211% for stocks, 0.726% for bonds, and 0.648%
simulation generates ranges of outcomes for short-term bonds.
based on our underlying probability Source: T. Rowe Price Associates, Inc.
model. Thus, outcomes generated via

4 troweprice.com/retirementplanning | 1-800-638-5660

Monte Carlo simulation incorporate • These monthly returns are then used to • Market crises that can cause asset
future uncertainty and give you a likeli- generate thousands of simulated market classes to perform similarly over
hood of a certain goal being achieved, scenarios. These scenarios represent a time, reducing the accuracy of the
while 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 the
Addressing Uncertainty success rates are calculated based on long-term behavior of the asset
The analysis results in a range of pos- these scenarios. classes and therefore is less reliable
sible 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 no
thousands of different market scenarios, consideration, and we assume no early correlation between asset class returns
allowing us to determine the likelihood withdrawal penalties. from month to month. This means
that each strategy will still have assets that the model does not reflect the
remaining at the end of retirement. This • nvestment expenses in the form of an
I
expense ratio are subtracted from the average periods of “bull” and “bear”
probability measure is called a strategy’s markets, which can be longer than
simulation success rate and reflects the expected annual return of each asset
class. These expenses are intended to those modeled.
number of times in the simulations a
particular 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 the stant; variations in inflation levels are
the 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 Limitations
ple 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 to
and tracked changes to the balance
over a specific time period. Each line • Extreme market movements that may those being analyzed.
in the graph represents this strategy occur more frequently than repre- IMPORTANT: The projections or
as it responded in our simulations to sented in our model. other information generated by the
one hypothetical sequence of monthly • Some asset classes that have relatively T. Rowe Price Investment Analysis
investment returns. limited histories. While future results Tool regarding the likelihood of various
The orange line represents the hypo- for all asset classes in the model may investment outcomes are hypothetical
thetical sequence of monthly investment materially differ from those assumed in nature, do not reflect actual invest-
returns that resulted after 30 years in the in our calculations, the future results ment results, and are not guarantees
median ending balance, where 50% of the for asset classes with limited histories of future results. The simulations are
outcomes 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 Assumptions
The investment results shown in the Account Value
various charts in this booklet were devel-
oped with Monte Carlo modeling using $5,000,000

the following material assumptions:
4,000,000
• The underlying long-term expected
annual return assumptions for the asset
3,000,000
classes indicated in the charts
Above

are not historical returns, but are 2,000,000
based on our best estimates for future
long-term periods. Our annual return 1,000,000
50%
assumptions take into consideration
Below

the impact of reinvested dividends and 0
capital gains. 0 5 10 15 20 25 30
• We use these expected returns, along Years in Retirement

with assumptions regarding the vola- • Median ending balance after 30 years in retirement is illustrated at
tility for each asset class, as well as the end of the orange line, reflecting one of the 11 simulations of
the 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, random
monthly returns for each asset class This 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.


projected or simulated results will be simulating 100,000 possible market simulation scenarios used (in this case
achieved or sustained. scenarios and various asset allocation 100,000) to obtain the simulation success
The charts present only a range of strategies. The underlying long-term rate. These results are not predictions,
possible outcomes. Actual results will expected annual return assumptions but 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 worse for intermediate-term, investment-grade
Source: T. Rowe Price Associates, Inc.
than the simulated scenarios. Clients bonds; and 4.75% for short-term bonds.
should be aware that the potential The following expense ratios are then
for loss (or gain) may be greater than applied to arrive at net-of-fee expected
demonstrated in the simulations. returns: 1.211% for stocks; 0.726% for
The initial contribution or withdrawal intermediate-term, investment-grade
amount is the percentage of the initial bonds; and 0.648% for short-term bonds.
value of your salary or investments For each combination of initial
contributed or withdrawn in the contribution or withdrawal amount
first year where the entire amount is and investment strategy, we count the
contributed or withdrawn on the first number of simulation scenarios that are
day of the year; in each subsequent “successful” (i.e., in which there is at
year, the amount is adjusted to reflect least $1 remaining in your account at
a 3% annual rate of inflation. The the end of your retirement). We divide
simulation success rates are based on this number by the total number of


Balancing college and Retirement savings

>> If you’re a parent, you may find yourself asking which financial goal should take
priority—funding your child’s college education or saving for your retirement. While
financial planners generally suggest that retirement take precedence, many parents are firmly
committed to providing their children with enough money for college. Here is some expert
guidance on how to successfully balance college and retirement savings.

While financial priorities are a matter of
personal choice, parents need to keep Juggling Competing Goals: Saving for Retirement and
things in perspective, cautions T. Rowe Your Children’s College Education
Price Senior Financial Planner Christine 36-Year Investment Period (including 18 years precollege)
Fahlund, CFP®. She points out that if Final Balance
you don’t have sufficient assets or a pen- (thousands)
$3,000
sion, there are limited options other than Option A Option B Option C Option D
Social Security and continued employ- 2,500
$2,541
ment for funding your retirement.
$2,042
On the other hand, there are various 2,000
$1,694 $1,650
funding sources for college, ranging $1,361
from loans and scholarships to sum- 1,500
$1,100
mer jobs and, in many cases, gifts from
1,000
grandparents. $759
$506
“Another important consideration is 500
$253
whether you want to be financially self- $80 $126

sufficient in retirement or whether you 0
All savings for Savings for Split savings until Savings for college
want your children—who may be try- retirement retirement only college begins, only for first 18
ing to raise their own families—to help for 18 years, then then save for years, then for
used for 10-year retirement only retirement only
support you as well,” Ms. Fahlund says. college loan, then over final 18 years over final 18 years
“The best strategy for your family overfor retirement
again over final
all is for you to stay financially healthy, eight years
so your first priority probably should be
Available at Available at Available at
investing for your own future—unless college age retirement age retirement age
you 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 to
cover your needs in retirement. The chart compares the impact of different savings strategies on the amount of money
“Nevertheless, we recognize that potentially 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 (18
saving only for retirement is not very
years prior to their child starting college and 18 years from the start of college until the couple
appealing to most parents. They want to retires). The examples also assume the couple’s income grows 3% annually; investments earn
save 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 plans
3000
Comparing Strategies but can be withdrawn federal tax-free from the 529 plan (if used for qualified educational
Availab

T. Rowe Price analyzed various sav- expenses), while the entire savings in the 401(k) is subject to taxation upon withdrawal. The
2500
Availab
assumed 401(k) match is 50%. In the scenario where the investor takes out a loan for college
ings strategies to compare the possible
(Option B), the amount borrowed is based on a 5% bank loan that could be paid back over a
2000 Availab
implications of different approaches 10-year period, with the amount allocated to college savings.
to investing for retirement and college 1500
simultaneously.
The results, shown in the chart at 1000

right, are for comparative purposes only
move up 300 pts
500
and do not indicate how much someone
may actually need to save to meet his or 0
Savings for retirement onlySavingsyears, then used for until college begins, then saveretirement again over final 8 years
All for 18 for Retirement
Split savings 10-year Savings loan, then for for retirement only overfor retirement only over final 18 y
college for college only for first 18 years, then final 18 years
her individual college and retirement
savings goals.


The examples make these assumptions: be subject to taxation upon withdrawal This strategy produces the lowest
the parents have a combined income of in retirement.) amount available for college, although
$100,000, which increases 3% annually; If the couple decided to focus on the amount available at retirement is
they invest 6% of their salary each year college first, investing the same amount only 20% less than if the investor had
over a 36-year period (18 years prior to each year in a 529 plan for the first 18 saved exclusively for retirement for the
the child starting college and 18 years years, they could accumulate $253,000 full 36 years. Even though the couple
from the start of college until the parents by the time the child starts school temporarily ceased funding retirement
retire); savings earn an average annual (Option D in the chart). In this case, for a decade, they were still able to
8% pretax return; and retirement savings they would defer saving for retire- benefit significantly from the long-term
are invested in a 401(k) plan and college ment until the child starts college. This compounding of the investments made
savings in a 529 plan where earnings are strategy provides the most for college during 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
“. . . don’t fall into the trap to pay for retirement, this strategy you evaluate your investing options, it’s
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. Fahlund
What if this family decided on a dual advises. “It’s all a balancing act. While
that you neglect your it’s admirable to want what’s best for
approach, splitting their annual invest-
own retirement.” ment between college and retirement your children, don’t fall into the trap of
until college started, and then investing becoming so obsessed with the goal of
If the couple invests only for their only for retirement after that (Option C)? paying for college that you neglect your
own 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 distribution
page 7), their retirement nest egg would the putting-college-first plan, although not used for qualified expenses may be
be worth nearly $1.7 million, assuming the amounts dedicated to college would subject to income taxes and a 10% federal
their 401(k) plans offered no matching be worth about 50% less. penalty. Please note that the availability of
contributions. If their plans provided The final scenario (Option B) involves tax or other benefits may be conditioned
a 50% match, the amount accumulated saving only for retirement until college on meeting certain requirements, such as
would be more than $2.5 million. begins, then using the full annual savings residency, 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 exclusively
a savings strategy,” Ms. Fahlund says. for retirement over the final eight years.
(Note: All money in the 401(k) would


strategic tips for Young investors

>> If you’re a young investor, long-term financial goals like saving for retirement may
seem very distant. But even if you’re at the onset of your career, it’s important to
begin saving for your financial goals as soon as possible. Here are some strategic tips from
T. Rowe Price financial planners to help you get started.
Pay yourself first: Those who say they’ll A T. Rowe Price analysis suggests that With a nondeductible Traditional
save or invest after taking care of other saving at least 15% of your salary each IRA, only the earnings in the account
expenses often find that there’s noth- year for retirement as soon as you start are taxed when withdrawn. With a
ing left over. To make it easier to pay working, and then maintaining at least deductible Traditional IRA, your
yourself first, enroll in your company’s that percentage throughout your career, contributions are tax-deductible in the
401(k) plan or sign up for an “automatic can put you on a path toward a finan- year you make them, but then taxes
asset 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 single drawal. If you don’t need tax benefits
often as little as $50 per month—can be tax filers with earned income of less than now, the potential for future tax-free
automatically invested for you. $120,000 for 2010, investing in a Roth withdrawals may make the Roth IRA
IRA 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 to Invest in equities for long-term growth
cant long-term benefits. As seen in the be a better choice for younger investors potential: For your retirement portfolio,
chart below, for example, someone who than Traditional IRAs (whether deduct- invest up to 90% in equities, assuming
saves $100 per month for 10 years in ible or nondeductible) because of how you can tolerate market downturns.
a tax-deferred account and then stops the tax benefit works. Historically, investments in stocks
contributing would accumulate more by With a Roth IRA, you receive no have provided more long-term growth
age 65 than someone who waits 10 years tax deduction on your contributions, opportunities than bonds and short-term
before starting, and then invests $100 but you pay no taxes (assuming certain investments. Since younger investors
per month for the subsequent 33 years. conditions are met) on the much larger have a longer period of time to overcome
Of course, someone who saved $100 amount you are likely to have accumu- market setbacks, it is usually prudent for
per month for the entire 43 years would lated when you begin withdrawing from them to invest a significant portion of
do 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 your
Look for free money: When evaluating
career, the tax-free withdrawals become
job opportunities, check out the avail-
that much more valuable.
ability of a 401(k) plan, when you would
be eligible to participate, and whether
the company will match some of your The Advantage of Starting Early
contributions. The “free money” from a Saving $100 per Month
Account Value
company match can make a significant
Years of Saving at Age 65
contribution to your retirement nest egg.
Balance long- and short-term goals:
43 years $450,478
Although thinking about a retirement
that’s 30 to 40 years away can be dif- 10 years no contributions $255,824
ficult when other needs seem more
pressing, it’s important to make saving no contributions 33 years $194,654
for retirement an equal—if not more
important—priority. Strive to save at Age: 22 32 65
least 10% to 15% of your income for
Starting early is key to accumulating retirement savings. A 22 year old who invests $100 per
retirement, with any additional savings
month for 10 years and then stops investing could accumulate more than someone who
earmarked for short-term goals such as a delays saving for 10 years and then contributes until age 65, even though the investor who
car, 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 ends
up with a significantly higher account value at retirement.
goals means you’ll have money for
major expenditures, while also helping These amounts assume $100 invested each month in a tax-deferred account and an 8% annual
rate of return.
to ensure your financial future.


Budget for unexpected expenses: To Get the insurance you need: One way to Pay off your credit cards: The ideal way
make sure you don’t spend more than protect yourself against very large unex- to use credit cards is to pay them off, in
you earn, in addition to budgeting for pected expenses is to purchase insurance. full, every month. Credit cards are usu-
fixed expenses (housing, utilities) and While most people wouldn’t think of ally the most expensive source of bor-
flexible expenses (restaurants, recre- going without car insurance, other types rowed money. The interest you pay on
ation), you also need to plan for unex- of insurance also provide a safety net your credit card purchases can add sig-
pected expenses such as car repairs or and don’t necessarily cost a lot. Renter’s nificantly to the cost of an item—money
health care costs. Often, those in finan- insurance provides liability coverage as that could be directed toward your
cial trouble find that although they were well as protection for your possessions. retirement or other savings goals instead.
not living beyond their means, they were Health insurance is also important, even Paying your credit card and other bills
unprepared for unexpected expenses. if it’s only a catastrophic policy to tide on time can eliminate penalty fees and
Suddenly they are overspending and you over until you are eligible for an also enhance your credit profile.
must start borrowing. employer’s group plan.


strategies for optimizing Retirement income

>> With more than 70 million baby boomers likely to enter retirement over the next
20 years, the hard truth is that only a small minority are accumulating enough
savings to provide for their income needs during decades in retirement.

This uncomfortable reality is particularly Working Longer salary to 25%, for example—is cer-
true given the overall rise in life expec- Generally, Ms. Fahlund says that “no tainly positive but relatively marginal
tancy, 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 as ment income from investments in just
ment lifestyles, and, not least, the relentless continuing to work even a few more years a 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 approach
ficient personal savings, Social Security option for those who come up short on retirement—moving, say, from 60%
benefits, and corporate pensions to meet retirement savings. of their portfolio assets in equities to
all their retirement income needs, the main Unless preretirees enjoy a windfall or 70% or more—also are not likely to
financial challenges of retirement are how a sharp rise in their incomes late in their make up for lost time. And because
to invest and spend wisely and perhaps careers, those just a few years from retiring of potentially greater investment
provide 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 drop
age 55 and older report having less than solely with increased savings levels or by significantly just before or after their
$250,000 in investments apart from their investing more aggressively. They simply desired retirement date.
homes and pensions, according to a March will not have enough time for their assets
2010 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 preretirees’
T. 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 today’s dol-
that provides an income from their invest-
rate of savings at this late stage—even lars, by about 7% for each additional
ments of just $10,000 in the first year of
boosting saving from 15% of one’s 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 Longer
cial security in retirement depending on Cumulative Percentage Gain in Retirement Income From Investments at Different Savings Rates
their flexibility and their approach to (Current Dollars)
four big decisions that are usually under 100%
2
their control:
— 25% Savings Rate
Retirement Income

80 1
• hen they stop working.
W — 15% Savings Rate
% Increase in

0
60 — 0% Savings Rate
• hen they start taking Social Security.
W
40
• ow they manage withdrawals from
H
their savings. 20

• ow they allocate their assets.
H 0
62 63 64 65 66 67 68 69 70
The first two can have a significant impact Age Start Taking Withdrawals
on the amount of income in retirement,
This chart shows the cumulative percentage increase in retirement income from an
while 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 these current 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 toward bonds, and 20% short-term bonds and cash; and a 90% probability that income will be
determining retirees’ overall security in sustained until at least age 95. Portfolio performance is based on a probability analysis
retirement,” 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 from
“Careful 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, the
better job of optimizing their resources so individual’s income would be 12% greater at 65 because he or she did not have to tap into his
that they can live with fewer worries and or her retirement savings while continuing to work.
greater opportunities.”


Working an additional three years—say 4% per year, or about 12% after three $15,000 annually from Social Security but
from ages 62 to 65—and continuing to years, because the retiree would not have you continue working with annual wages
save 15% of salary could raise annual to tap into existing savings. of $30,000, your annual benefit would be
income from investments by 22%, or While many retirees may not want or reduced 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 your
five years. (See chart on page 12 for jobs full time, they could still improve their total wages were approximately $44,200 or
underlying 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 an
A
Although wages are likely to be would exceed the expected benefit and you
extra 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 doesn’t however, you can work and earn as much
savings would be 50% higher than if
have to be withdrawn from retirement as you like without any reductions in
he 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: Those from a part-time job is the equivalent of Social Security benefit at full retirement
who continue working can contribute to withdrawing 4% a year from an additional age would be recalculated to reflect any
their savings for a few more years, delay $500,000 in savings. months you did not receive a benefit check
tapping into their nest eggs, and reduce the “As you near retirement, you may want due to excess earned income.
number of years that their assets will have to consider phasing it in rather than sim- Therefore, if you are still working when
to generate income in retirement—a ply stopping work altogether, or possibly you reach full retirement age and would
powerful combination. switching to another, more enjoyable, type like 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 can
egy may enable them to delay when they approach may allow you to spend more do so without any reduction in benefits no
start taking Social Security benefits, which time on new pursuits while growing the matter how much you earn.
can significantly increase those payments. assets you will need to draw on later.”
Also, those who continue working may Taxing Social Security
receive health and life insurance and pre- Taking Social Security With Taxes can also affect your Social Security
scription drug benefits from their employ- Earned Income benefits. If you continue to have substantial
ers—all expenses that more and more If you are at least 62, you can receive Social earned income or income from other
retirees 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 a
Fahlund says. One novel strategy that can reduced by $1 for every $2 earned above joint return with between $32,000 and
both boost retirement income and make a certain amount each year. (This amount $44,000 in “provisional income” may have
working longer more palatable involves is $14,160 in 2010.) In the year of your to pay income tax on up to 50% of their
spending more, while still working, on full retirement age, benefits are reduced Social Security benefits, even if they earn
hobbies, travel, education, or other retire- by $1 for every $3 earned over $37,680 in no wages during this period. Couples with
ment dreams rather than investing the 2010 until you actually reach the month more than $44,000 in provisional income
additional earnings from work. of full retirement age. Therefore, if you may have to pay tax on up to 85% of
This strategy could still increase turn 62 this year and expect to receive their benefits.
retirement income from investments by

Exhibit 2. The Impact of Delaying Social Security Benefits
Social Security payments calculated using the Quick Calculator on
Annual Annual
Age Social Security % Increase Social Security % Increase the ssa.gov Web site. This assumes an individual who is age 62 in
Benefits Payment in Over Benefit Payment in Over Benefit 2010 (with a full retirement age of 66) who is continuing to work
Begin Current Dollars at Age 62 Inflated Dollars at Age 62 and earning $100,000 each year until benefits begin. Actual benefits
could be higher or lower than those obtained from the calculator.
62 $17,760 – $17,760 –
63 19,164 8% 20,268 14% Each year this individual continues working, his or her annual retire-
64 20,940 18 22,728 28 ment income in today’s dollars from Social Security would increase
by about 8% and annual retirement income in inflated dollars from
65 22,752 28 25,404 43
Social Security would increase by about 14% per year, regardless of
66 24,612 39 28,308 59 how much of his or her additional wages he or she saves annually.
67 26,808 51 31,752 79
Delaying taking Social Security benefits from age 62 until age 70
68 29,028 63 35,436 100 would result in an increase of more than $15,600 in today’s dollars
69 31,272 76 39,372 122 per year and almost $25,600 in inflated dollars per year.
70 33,384 88 43,356 144 Sources: T. Rowe Price Associates and Social Security Administration.


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 "7
is 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 "9
at Age 70)
income is your adjusted gross income,
including wages, plus any tax-exempt $159,840 Take Benefits at Age 62
70 $123,060
interest income from your investments, $33,384
Take Benefits at Age 66
Take Benefits at Age 70

Retiree’s Age
plus half of your Social Security benefit.) $337,440
80 $369,180
Delaying Social Security $367,224

Delaying taking Social Security ben- $515,040
90 $615,300
efits can significantly increase a retiree’s $701,064
income. For example, those benefits 0 $200,000 $400,000 $600,000 $800,000
(in today’s dollars) increase approximately Total Social Security Benefits Received
8% per year based on Social Security
Administration formulas. T. Rowe Price financial planners cite remainder of your life, except in certain
Thus, delaying three years (from 62 results of recent actuarial studies that urge circumstances,” she says.
to 65) results in a 28% increase in the married investors who are 65, for exam-
purchasing power of a retiree’s Social ple, to plan for at least one spouse living Three Steps Combined
Security benefits, and delaying until age in retirement to 95. Taking all three steps to increase potential
70 almost doubles the purchasing power If our hypothetical Social Security recip- retirement income—continuing to work
of these benefits (about 88%). (See chart ient lives to 90 or longer, he or she would and save at a 15% rate and delaying Social
on page 13.) The potential gain in actual ultimately receive more total benefits if Security—could increase the purchasing
benefits could be even higher (about he or she began taking them at 70 than if power of total retirement income from
144%) because Social Security benefits are he or she started at 66 or 62, even though retirees’ combined investments and Social
adjusted 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 when year after 62, or 25% in three years (as
benefits in current pretax dollars, depend- deciding at what age to begin taking your reflected in Exhibit 4, which also provides
ing on when benefits begin and how long Social Security payments,” Ms. Fahlund the underlying assumptions).
they are paid, assuming a $24,612 annual cautions. “The annual amount, at what- And doing that from ages 62 to 70
benefit at full retirement age of 66 com- ever age you pick to begin taking Social would almost double total retirement
pared with a $17,760 benefit at 62, or a Security, will be locked in [adjusted for income from investments and Social
$33,384 benefit at 70. Analyzing whether inflation or possible other credits] for the Security in today’s dollars.
you should take benefits at a reduced rate
before reaching full retirement age, or Exhibit 4. The Combined Impact of Working Longer and Delaying Social Security
whether you might be better off in the Cumulative Increase in Retirement Income From Investments and Social Security for Each Year
After Age 62
long run by waiting for your scheduled
benefit at full retirement age or later, 100%
really depends on whether you can afford 80 � 0% Savings Rate
Retirement Income

� 15% Savings Rate
to delay receiving benefits and how long
% Increase in

60 � 25% Savings Rate
you expect to live. For example, a person
who receives a pretax benefit of $17,760 40
starting at age 62 will have received the 20
same total benefits by 77 (16 years) as if
0
he or she had started receiving a $24,612 63 64 65 66 67 68 69 70
Age Start Taking Withdrawals and Social Security
benefit at 66. From 78 on, the cumula-
This chart shows the cumulative percentage increase in total retirement income from
tive benefit is greater if this individual both 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 are
retirement age (assumed to be 66 in this the same as for the charts on pages 13 and 14 that show gains from just working longer or
from 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 if
benefits until age 70, thus qualifying for a he or she had retired at 62, assuming he or she saved 25% of his or her salary each year. Even
benefit of $33,384, his or her cumulative if none of the annual earnings were saved, the preretiree’s income would be 21% greater at
65 because he or she did not have to tap into his or her retirement savings while continuing
benefits would be greater from age to work, and he or she delayed taking Social Security benefits, which increase in value for
81 on compared with starting benefits at each 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.


To boil this down, here is another way It’s often easy to underestimate longev- T. Rowe Price simulation studies
of looking at the overall benefit of working ity, 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 initial
F
efits. If a 62 year old wants about a 30% life expectancy when it comes to Social withdrawal amount of 4% from a
increase in the purchasing power of his or Security. balanced portfolio of assets (with 3%
her retirement income from investments “Many financial planners used to recom- annual increases in the withdrawal
and Social Security, then he or she could: mend taking your Social Security benefits amount for inflation) would provide as
as soon as you become eligible,” Ms. high as an 89% chance of having assets
• etire in three years at 65 by saving
R
Fahlund says. “But today, with greater lon- remaining at the end of this period. A
25% of his or her salary annually.
gevity, delaying Social Security for as long 5% initial withdrawal amount with
• etire in three and a half years at 65½
R as possible may be the best strategy if you
by saving 15% of his or her salary inflation adjustments, on the other
can afford it.” hand, reduces these odds to a range of
annually.
40% to 65%, depending on the asset
• etire in four years at 66 by spend-
R Taking Withdrawals
allocation strategy.
ing rather than saving his or her The third and fourth major decisions faced
additional earnings. by preretirees—their withdrawal amounts • f retirees suffer poor portfolio returns
I
and their portfolio’s asset allocation in in the first few years of retirement,
(These illustrations assume that the retiree retirement—boil down to figuring out they should consider lowering their
does not begin taking Social Security until how to maximize the amounts they can withdrawal amounts temporarily or at
he or she stops working.) withdraw initially from their retirement least holding their annual withdrawals
Keep in mind that, for those who con- savings without running out of money flat for a while instead of increasing
tinue working and begin Social Security during their lifetimes. them for inflation. Extensive analysis
benefits prior to attaining full retirement While working longer, saving more, by T. Rowe Price has demonstrated
age (66 for most boomers), some benefits and delaying Social Security benefits can that this approach is much more
could be temporarily withheld depending increase total retirement income, decid- advantageous than, for example,
on the amount of wages earned. ing on an appropriate initial withdrawal attempting to counteract a market
In general, analyzing whether preretirees amount from portfolio assets and adjusting downturn by dramatically reducing
should decide to take benefits early, at age that amount as necessary can go a long the level of equities—and hence the
62, or whether they would be better off in way toward lowering the risk that retirees long-term growth potential—in 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 avoid
whether they can afford to delay receiving “No analysis can cover every contin-
running out of money is driven more by gency,” Ms. Fahlund says. “But, in general,
benefits, whether they are married, and, to your initial and subsequent withdrawal
some extent, how long they expect to live. an initial 4% withdrawal amount gives
amounts than by your asset allocation preretirees a high probability of not hav-
strategy, which for many investors is ing to worry about depleting their assets
counterintuitive,” Ms. Fahlund says. too quickly, unless they retire into a severe
bear market.”
(For additional information on Monte
Carlo analysis, refer to “Guidelines on
Saving 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-year Asset Allocation
retirement without running out of money, depending on the investor’s asset allocation. This analysis In general, making minor adjustments to
assumes pretax withdrawals from tax-deferred assets and can be applied to any size retirement
portfolio. In this study, the initial withdrawal amounts are increased by 3% for inflation. a balanced portfolio in retirement has less
impact on financial security than the other
30-Year Retirement Period
three decisions.
First-Year
Stock/Bond Mix However, preretirees often make the
Withdrawal Amount 80/20 60/40 40/60 20/80 serious mistake of assuming that the safest
path in retirement is minimizing equity
Simulation Success Rate*
exposure to lower their market risk.
7% 28% 19% 7% 1%
Instead, moderate exposure to equities is
6 45 38 24 7 recommended for diversification, growth
5 65 63 57 40 potential, sustaining real income, and pro-
viding a “cushion” to cover unexpected
4 84 87 89 89
expenses 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 that
used for determining this is explained in “Guidelines on Saving for Retirement” on page 3.
retirees could draw on in emergencies—or


to possibly leave more money to heirs—
retirees could opt for somewhat higher
allocations to equities, though that does
carry 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 more
than 30% of their assets in cash or short-
term bonds.
“The bottom line,” she says, “is that
if you have too much set aside for emer-
gencies in cash, which usually has a very
modest annual return, you run the risk of
not keeping up with inflation and possi-
bly running out of resources from which
to take withdrawals. And if you have too
much invested in stocks, you lessen your
ability to cope with market uncertainties
and run the risk of having to sell equities
during a market setback to provide for
income or unexpected contingencies.
“The answer is to maintain a balanced,
diversified portfolio—with moderate
growth potential and a moderate risk
profile.
“With all of these critical decisions—
when to stop working, when to start
taking Social Security, how much to with-
draw from your portfolio in retirement,
and determining the right asset allocation
strategy—the overarching concepts are
to maintain flexibility in your plans for
retirement and make thoughtful decisions
regarding financial matters that are under
your control,” she adds.
“Such preretirement planning can help
optimize your financial prospects for
years to come.”


Plan for a successful Retirement

>> While you were accumulating your retirement savings, chances are you evaluated
your investment strategy regularly to ensure that you were still on track with your
long-term objectives. But what you may not realize is that consistently evaluating your invest-
ment strategy is just as important once you’re 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 probably
tor your income and spending as you tax annual rate of return, in five years the best time to buy it—while you are
progress through retirement so you of investing you will have accumulated insurable and your premiums are still
can continue to evaluate whether your almost $17,000, which could go a long reasonable. “Since most people want to
original projections are on target,” says way toward purchasing that car.” continue living at home, you may want
Christine Fahlund, CFP®, senior finan- And remember that if most of your to think of this as ‘stay-in-my-own-
cial planner with T. Rowe Price. It is retirement savings are in tax-deferred home’ insurance,” says Ms. Fahlund.
important to recognize that it is the investment accounts, you will most Rethink your plans if your retirement
sequence of returns, not just their average likely owe income taxes on your pretax housing choices are costing you more than
that can make a difference in how long contributions and any earnings when you thought they would. You may want to
your retirement assets may last. A few you withdraw the assets. So you may consider moving to a residence that is less
poor-performing years in the very early have less to spend than your actual with- costly and/or easier to maintain. “Don’t
part of your retirement—combined with drawal amount. buy anything that might involve taking on
an overzealous withdrawal strategy— new mortgage debt,” says Ms. Fahlund.
could deplete your retirement savings Fine-Tune Your “Instead, buy something less expensive
prematurely. Therefore, by reviewing Investment Strategy than your current dwelling so you can uti-
your strategy at least once a year you can Knowledgeable investment choices can lize the profits from the sale to add to your
decide whether you will need to reduce enhance the potential of your long-term reserves.” Also, you may want to compare
your planned withdrawal amounts in retirement assets. “The growth potential what your cost of living might be if you
the coming year to better preserve your of stock exposure may reduce the risk moved to another part of the country—
assets. In fact, if you experience very that inflation will significantly decrease say, to be closer to your children or grand-
positive market returns for several years the purchasing power of your portfolio children.
in retirement, you may actually be able during retirement,” says Ms. Fahlund. Building in financial safeguards will
to adjust your withdrawals to boost your “Retirees who think they should be enable you to enjoy this new phase of
income further. holding 20% of their retirement sav- your life—whatever you choose to do.
ings in equities need to reconsider this For some retirees, it may mean embark-
Adapt Your Budget approach.” Ms. Fahlund notes that in ing on a new career or extensive travel. If
Today’s retirees could spend up to order to keep pace with inflation, those you find you need additional retirement
one-third of their lives in retirement. investors in and approaching retirement savings, working part time is one way to
With increased life expectancies, retire- should consider an allocation to equities help close any gap between retirement
ment portfolios need to provide income of 60% to 40%, gradually decreasing spending and income.
for longer periods than previously your equity exposure to 30% and 20% in Retirement planning isn’t limited
anticipated. In order to sustain your your 80s and 90s. to something you do only before you
retirement income, it’s important to retire; it’s an ongoing process of review-
reexamine your budget periodically to Take Control ing and fine-tuning. Given today’s
determine whether you’re spending Successfully managing your retirement longer life spans, you and your spouse
within your means. also involves anticipating life occurrences may live 30 years or more in retirement.
In addition, it’s helpful to separate non- that might affect your finances. For Reexamining your financial plans after
discretionary expenses from discretionary example, if you haven’t already, make your first years in retirement and assess-
ones, creating a list of what you need a decision about long-term care (LTC) ing them on a regular basis can help
versus what you may want. “It should insurance. This insurance can help cover ensure that you have the assets you need
be a red flag if you’re not paying your nursing home costs or assistance in your to 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-ticket ance is likely to cost. If you think you
replacements, such as large appliances. may want LTC insurance to protect you
For example, if you save $250 per month and your spouse from potentially costly


determining a Realistic Withdrawal Amount and Asset Allocation

>> Many people look forward to retirement, but it can be one of the most complicated
stages 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 insurance
needs, and—one of the thorniest decisions—how much they can afford to spend each month
without jeopardizing their future financial security.

Retirees must consider the risk of out- of retirement, assuming this amount is of 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 retire
to maximize annual income so that “No analysis can predict the future, earlier? Although the same strategy at age
their 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 won’t run out may offer only a 50/50 chance of sustain-
“For many investors, the most impor- of money, using a reasonably diversified ing 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 income “Once 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 assets initial 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 investment “There’s a big leap between a 20- and
strategy, is driven by this key decision.” Determining the Odds 30-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 than
out guaranteed pension income due to rate of return projection, T. Rowe Price’s 20 years, you have to consider lower
the prevalence of defined contribution program models thousands of possible initial withdrawal amounts and having at
retirement 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 of
it has become more important than ever retirement withdrawal strategies. Effect of Portfolio Strategy
to develop a realistic income plan that can The tables on the next page show “We have found that your ability to avoid
maintain purchasing power over a long the estimated probability (simulation running out of money in retirement is
period of time, perhaps 20 to 30 years. success rate) of maintaining various driven 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 investor’s initial so investors should focus on that first,”
assets will be influenced by various fac- withdrawal amount, time horizon, and says Christine Fahlund, CFP®, a senior
tors, including your expectations for asset allocation. The analysis reflects a financial planner at T. Rowe Price. Those
investment returns and inflation, your broad range of investment and spend- who begin retirement with a conservative
lifestyle, health concerns, how long ing strategies tested over 100,000 pos- withdrawal amount, such as 4% of their
you expect to live, how much money sible scenarios of market performance. starting balance, and are planning on a
you may want to leave your heirs, and The 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 in
assume in your investment portfolio. Many retirees may have to make trade- their investment approach. As indicated in
Based on our experience with clients offs between how much they can spend, the chart on the next page, a strategy with
and sophisticated computer analysis, the likelihood that they will be able only 20% invested in equities, a 4% initial
the firm’s planners suggest that people to sustain assets in retirement, and the withdrawal amount, and a 25-year time
should 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 to For example, the model indicates that However, if you want to spend more
be reasonably sure of not depleting their an 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, the
ability of market returns, and average life 10% short-term bonds) has a 75% chance asset allocation decision becomes more
expectancy, they conclude that a relatively of maintaining a 6% initial withdrawal important. Under these circumstances,
“safe” initial withdrawal amount is about amount (with 3% annual increases) and “Our analysis shows that retirees with
4% to 5% of portfolio assets the first year an extremely high probability (over 90%) long time horizons [about 30 years]


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