T h e R i g h T

B a l a n c eHelping participants weigh the financial

and emotional aspects of retirement

Participants approaching the transition into retirement sometimes find themselves in a tricky spot.

While eager to begin a new phase of life, they must juggle priorities and make complex decisions that

could ultimately lay the foundation for a future of financial security—or uncertainty. Moreover, retirement

is a state of mind. As participants put their financial houses in order, they also need to prepare emotionally

for the changes ahead. By getting to know themselves—how they feel about retirement and the things

they want to do—participants can improve their chances of achieving a financially secure and emotionally

satisfying retirement. Using insights from T. Rowe Price financial planning experts, we take a broad look

at the many factors at play during the challenging transitional phase of retirement.

r P S .T r o w e P r i C e . C o m / S P o n S o r14 P l a n l i n k : a P r i l 2 010

Cover STory

Taking The plunge wiThouT a plan in place

Assumptions: The investor, age 65, compares the amount of pretax income from his investments if he delays his retirement – thereby increasing the number of years of contributions and reducing the number of years of spending by the same amount. The end of retirement remains fixed at age 95. The salary at age 65 would be $100,000, increasing by 3% each year thereafter (for inflation) at the end of the calendar year. The investor saves 15% of the salary annually, pretax, at end of each year. The starting pretax balance on January 1 of the year the investor turns 65 is $500,000. The assumed pretax return of the portfolio before the retirement date is 8%; on and after the retirement date, 6%. Withdrawals in retirement are taken at the beginning of each calendar year. This chart is for illustrative purposes only and is not intended to represent the performance of any specific security.

0

20

40

60

80

100

120

1 2 3 4 5 6

109%

85%

64%

45%

28%

13%

How waiting increases your income

NUMBER OF YEARS YOU WAITED TO RETIRE

0

20

40

60

80

100

120

1 2 3 4 5 6 8070

64%

85%

109%

45%

28%

13%

How Waiting Increases Your Income

INC

RE

AS

E O

VE

R A

GE

65

IN

CO

ME

NUMBER OF YEARS YOU WAITED TO RETIRE

0

100

200

300

400

500

600

700

800

to withdraw 4% of their balance the first year and increase that dollar amount for

inflation each year thereafter,” said Fahlund. “Although $125,000 may seem like a lot of

money to a participant, a withdrawal amount of only $5,000 in the first year of retirement may not.”

the caSe for delaying retirement

For participants who think they might not have enough money in retirement, perhaps the most important step they can take is to work a few more years. Barring a financial windfall or a late-career pay increase, participants who are close to retirement and who have not saved enough will probably not be able to make up any shortfalls solely by investing more aggressively. According to Fahlund, “There simply aren’t enough years remaining prior to retirement for their assets to compound significantly.” There is good news for these participants, however. According to research conducted by T. Rowe Price, each additional year of employment could increase their retirement income by approximately 7% to 8%. Not only do participants receive a few extra years of income, they also have more time to contribute to their retirement plans. It also means fewer years their investments will have to support them in retirement. Plus, working longer could provide access to employer-sponsored medical insurance benefits that they might otherwise have to pay for themselves if they are under 65 and not yet eligible for Medicare.

The situation: Plant manager Don Jones wanted to focus on his lifelong love of travel. So when he had a chance to retire at age 62, he jumped at it. Don fig-ured he could afford it—even though he didn’t know how much he’d actually need. Two years later, after spending more than expected, Don was concerned about running out of money. While Social Security covered some monthly expenses, his overall nest egg had dropped significantly. Don didn’t anticipate how a market downturn could affect his withdrawal strategy—or that he might need to return to the work force.

A common challenge: For a variety of reasons—a lack of knowledge about, comfort with, or interest in investing— too many participants make poor investment and savings decisions. Some even avoid them altogether, preferring to delegate or postpone the frequently complex choices involved in building a solid financial strategy. “Unfortunately, the head-in-the-sand approach to retirement is one we see all too often,” said Christine Fahlund, a senior financial planner at T. Rowe Price. This inertia can lead to ineffective financial strategies or, in Don’s case, no strategy at all. In either case, participants are frequently unprepared to meet the financial challenges of retirement.

One factor that may contribute to inertia is sifting through and trying to understand the multitude of investment choices in a retirement plan, which can lead to what experts call “decision paralysis.” Studies have shown that although more choice provides greater opportunities for participants to find an option that fits their circumstances, it also increases the time required to make each decision, if they make any at all.

Savings rates while accumulating assets—and spending behavior in retirement—probably have the greatest effect on the accumulation and sustainability of assets in retirement. According to data from the Employee Benefit Research Institute, the average account balance among 401(k) plan participants in their 50s who participated consistently from 2003 to 2008 was $113,000. For those in their 60s, it was $125,000. “Our general rule of thumb for retirees facing 30 years or so in retirement is

r P S .T r o w e P r i C e . C o m / S P o n S o r P l a n l i n k : a P r i l 2 010 15

Cover STory

maximizing Social Security BenefitS

Delaying the receipt of Social Security benefits can have a significant impact. In fact, benefits can more than double if a retiree delays taking them until age 70 versus taking payments at 62. Although many participants will not be willing or able to wait that long, each year they wait will increase the size of their benefit by approximately 8% to 9% according to Social Security Administration (SSA) formulas, and there will be additional increases for inflation.

Furthermore, for participants who work full time beyond age 62, it is almost always better to delay Social Security benefits at least until “full retirement age” (FRA), as defined by the SSA (generally age 66 for baby boomers). For example, if Don Jones begins taking benefits at 62 and then finds he has to go back to work until he reaches his FRA, his benefits will be reduced by an earnings limit formula.* Fortunately, at Don’s FRA, the SSA will recalculate his monthly benefits to include any money he lost as a result of the earned income reductions. After his FRA, he can earn as much money as he chooses each year without any reduction in Social Security benefits.

“Many financial planners used to recommend taking Social Security benefits as soon as you were eligible,” Fahlund says. “But with people living longer, delaying Social Security may be a better strategy for today’s preretirees or retirees.

“But whatever participants do,” she cautions, “they should consider their options carefully and get professional advice if they need to, before making Social Security decisions.” This is because—except in certain circumstances—the annual amounts of payments (adjusted for inflation) for which people are eligible generally are locked in for the rest of their lives—and for the remainder of a surviving spouse’s life.

Cumulative benefits in this hypothetical example have not been increased for inflation. They are in current, pretax dollars.

Access to experts. Periodic Web meetings cover topics that matter most to preretirees, in a convenient, interactive way. Attendees hear it live, straight from the experts—T. Rowe Price portfolio specialists, analysts, and senior financial planners—who conduct 30-minute presentations and take time to person-ally respond to questions. These sessions are gaining momentum across plans, with more than 1,800 participants (representing 300 clients) tuning into last year’s “Retiring in a down economy” program. Topics slated for 2010 include “Additional retirement savings opportunities” and “Preparing to retire.”

Professional guidance. Webinar attendees can sign up for a complimentary one-on-one retirement income consultation. During these online dialogues, a T. Rowe Price retirement

specialist offers an individualized, comprehensive review of a participant’s retirement income projections. Using the Retirement Income Calculator, attendees can set their specific retirement goals and receive direct recommendations to develop a clear plan of action. Participants appear to value this more personalized approach: In a recent survey, more than 98% of attendees reported satisfaction with their consultation experience.

Online solutions. T. Rowe Price tools are simple to use yet powerful in their ability to deliver strategic, customized solutions before and during retirement. During the transitional phase, participants can assess their potential income and expenses needs with tools such as the Retirement Income Calculator and the Retiree Budget Calculator.

Simple, coSt-effective wayS to encourage Smart retirement income deciSionS

While T. Rowe Price offers a wide variety of resources for participants as they transition into retirement, the following may be particularly helpful:

100908070

Total Cumulative Bene�ts Received, in Pretax Current Dollars

BE

NE

FIT

S I

N T

HO

US

AN

DS

AGE TO RECEIVE BENEFITS

IF YOU START SS AT AGE: 62

0

100

200

300

400

500

600

700

8006670

r P S .T r o w e P r i C e . C o m / S P o n S o r16 P l a n l i n k : a P r i l 2 010

Cover STory

getting in the right mindSet

In fact, being emotionally prepared for retirement can be just as important as

financial well-being (as measured by income and wealth), according to a recent study by the

Center for Retirement Research.** Findings showed factors such as good health and retiring at an age individuals are emotionally comfortable with can have a greater impact on overall retirement satisfaction.

With retirement comes change, which can be significant. A retiree’s life can be seriously disrupted, altering once-familiar routines, traditional responsibilities, and friendships. Preretirees should carefully consider their changing circumstances and the lifestyle they want to lead, asking the hard questions they are almost sure to face at some point:

• When do I want—or need—to retire?

• Am I willing and able to keep working? For how long?

• Do I want to start a new career?

• What are the things I’ve always wanted to do?

• Where will I live?

• Who will I be spending time with?

Fahlund recommends coming up with several answers for each question, writing everything down, and talking with a spouse or family members before proceeding. A time-consuming yet worthwhile process, these outcomes will inevitably impact financial decisions as well.

“What people find is they may have to make difficult trade-offs in retirement, and they may have more dreams than money,” said Fahlund. “Retirees know what they’re supposed to do, but they also don’t want to miss opportunities they’ve waited a lifetime to enjoy. Before officially retiring, it’s important for them to determine how their financial resources will enable them to accomplish the things they want to do, without assuming the risk of having to change their lifestyle later. Protecting one’s self from future emotional, as well as financial, stress is a key part of planning.”

The situation: On paper, accountant Steve Roberts looked set for retirement. Thanks to years of diligent saving, he had enough money. The mortgage was paid off, and Steve and his wife were active and healthy. All this provided peace of mind—enough to retire at age 62. A year later, Steve was restless. Despite having a solid finan-cial plan, he overlooked a key personal consideration: He might actually miss work. Steve realized—unexpectedly—that his career provided a large measure of his identity through the years.

The human side of retirement: For many retirement savers, the focus is on developing a financial strategy. An equally impor-tant task—and one that’s frequently overlooked—is determining whether an individual is emotionally ready to retire.

“Around age 50, most people ‘wake up,”’ said Fahlund. “They start to reevaluate savings and investing strategies, number crunch, learn all they can, even consider big lifestyle changes.”

“Emotional drivers —the nonfinancial aspects of retirement planning—can preoccupy workers from here on out. Having a clear sense of needs and wants can provide focus during this critical decision-making time.”

Personalized communication. Targeted messaging can motivate participants to make more appropriate choices for retirement saving and investing—and help them understand how those choices could translate into income during retirement. Specifics of each participant’s account information and the investments and policies of his or her plan are integrated automatically. The tools are sophisticated, but the setup is easy.

Please contact your T. Rowe Price representative for details on these services, as well as other T. Rowe Price offerings.

Financially ready doesn’t always mean retirement ready

r P S .T r o w e P r i C e . C o m / S P o n S o r P l a n l i n k : a P r i l 2 010 17

Cover STory

common sense guidelines For all preretirees

financial ruleS of thumB

Savings rate. Mid-to late-career employees should be saving at least 15% of their salaries annually. Savings may include retirement plan contributions, employer contributions, or personal savings and investments outside a retirement plan. For participants who are significantly behind, the percentage they need to save could be substantially higher.

Income sources. Financial experts recommend that retirees plan on replacing approximately 75% of preretirement salary in order to enjoy a standard of living similar to that experienced before retiring. Of that, Social Security may replace about 20% and another 5% may come from part-time work or pension benefits. This leaves about 50% to be replaced by personal savings—such as those from defined contribution plans, savings accounts, and taxable investments.

Withdrawals. In the first year of retirement, retirees should typically plan on withdrawing 4% of their investment assets—and increase that initial withdrawal amount each year for inflation. Unfortunately, even modest increases in that initial withdrawal amount can drastically increase the odds of running out of money. Research indicates that retirees on average withdraw more than the recommended 4% from their defined contribution plan accounts. Sometimes, they withdraw much more: T. Rowe Price has documented instances of initial with-drawals of 9% to 10%—a rate that will rapidly deplete their retirement plan account portfolios.

Asset allocation. Diversifying a retirement portfolio among stocks, bonds, and short-term investments can help reduce the effects of short-term market volatility, while providing growth potential to keep pace with overall inflation and specific fast-growing expenses, such as health care. That being said, diversification cannot assure a profit or protect against loss in a declining market. The T. Rowe Price general rule of thumb is that an investor approaching retirement or early in the with-drawal process should allocate approximately 40% to 60% of his or her portfolio to stock funds. Over time, retirees need to adjust their equity allocations downward to reflect their chang-ing needs and circumstances.

A solid financial strategy can “frame the dreams,” says Fahlund, helping participants determine how much they will have in retirement and what they will be able to spend. As a retirement date nears, participants should be sure to consider the following challenges and guidelines:

retirement challengeS

Longevity. Simply put, Americans are living longer. And most tend to underestimate the amount of time they are likely to live in retirement. According to the American Society of Actuaries, more than 50% of couples retiring today at age 65 will have one spouse live to age 90, and one in four of these couples will have one spouse reach age 95. Investors who don’t plan for a retirement that could last for 30 years or more face the very real risk that they will run out of money prematurely. And while participants are living longer, inflation may be simultaneously eroding the purchasing power of their retirement assets. Although inflation has averaged just 3% annually over the past 80 years, the pur-chasing power of $100 at this rate would be cut in half in just 23 years. Additionally, the cost of some goods and services that a participant may need most in retirement—medical care, for example—could be rising faster than the 3% historical average.

Volatility. The turbulence that shook the world’s stock and bond markets in 2008 and 2009 provided ample evidence that market valuations can fluctuate substantially and significantly affect the value of retirement investments. For example, the S&P 500 Index lost approximately 57% of its value from its peak in October of 2007 to its low reached in March 2009. Bond markets were also affected, resulting in substantial losses in all but the most conservative investments. Bear markets can be troublesome, in particular, for those participants transitioning into retirement. Just as they start taking withdrawals from their portfolio, those assets drop in value—resulting in a double hit to savings accounts that are intended to last a lifetime. “Unfortunately, most retirees can’t live emotionally with too much volatility in their portfolios, yet their investment portfolio will not be able to support them for 30 years without it. The challenge is to strike the right balance,” according to Fahlund.

r P S .T r o w e P r i C e . C o m / S P o n S o r18 P l a n l i n k : a P r i l 2 010

Cover STory

other conSiderationS

These steps can facilitate planning in other areas during transition to retirement:

Pay down debts. Before retiring, participants should try to pay off any large debts such as mortgage loans, credit cards, or car payments, which may significantly reduce the amounts they need to withdraw from their retirement investments.

Understand distribution options. Upon retirement, participants face choices regarding drawing down the assets in their retirement plan accounts. Taking time to study the pros and cons of each option in advance is important.

Review beneficiaries. By keeping beneficiary information up to date, participants can ensure assets will be distributed as they intend.

Apply for Medicare three months prior to age 65. Unless participants are still receiving health insurance benefits from their employers, they should apply in advance for benefits, since Medicare is likely to charge late filers significant penalties.

Reassess insurance needs. The right insurance and enough of it can protect preretirees and retirees against the financial risk of poor health, liability exposure, or untimely death. Participants should review their insurance coverage options—long-term care, liability, and life—to ensure they are appropriate, and if still employed, also consider disability insurance.

Seek expert advice. With so much at stake, preretirees may choose to work directly with professional advisors who can help with decisions regarding savings and distribution amounts, insurance needs, investment asset allocation, and the ultimate distribution of their estates.

“Participants need to balance many financial and emotional considerations as they transition to retirement—when to stop working, what to do when they stop working, timing Social Security benefits, and possibly returning to work,” said Fahlund.

“At the same time, they need to formulate very flexible plans, since their circumstances are likely to continue to change throughout a long retirement. With the proper planning, participants can feel more secure as they enter the very different world of retirement.”

written by Brian Kane and Ellen Persons

* The current formula is $1 for every $2 dollars of earned income over the limit ($14,160 in 2010) in the years prior to the year of an individual’s FRA. In the months of the calendar year just prior to an individual’s FRA birthday, the wage limit is higher ($37,680 in 2010) and the reductions are less at $1 for every $3 earned over the wage limit.

** “What Makes Retirees Happy?,” Keith A. Bender and Natalia A. Jivan, Center for Retirement Research, February 25, 2005.

r P S .T r o w e P r i C e . C o m / S P o n S o r P l a n l i n k : a P r i l 2 010 19

Cover STory