Estimating The True Cost of Retirement

MARCH 22, 2017 Estimating The True Cost of Retirement TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. 2017 TD Ameritrade

Important Disclosures MARCH 23, 2016 Annuities are long-term investments designed for retirement purposes. Withdrawals of taxable amounts are subject to income tax and, if taken prior to age 59½, a 10% federal tax penalty may apply. Early withdrawals may be subject to withdrawal charges. Optional riders are available at an additional cost. All guarantees are based on the claims paying ability of the insurer. An annuity is a tax-deferred investment. Holding an annuity in an IRA or other qualified account offers no additional tax benefit. Therefore, an annuity should be used to fund an IRA or qualified plan for annuity features other than tax deferral. Product features and availability vary by state. Restrictions and limitations may apply. Investors should carefully consider a variable annuity s risks, charges, limitations, and expenses, as well as the risks, charges, expenses, and investment objectives of the underlying investment options. This and other important information is provided in the product and underlying fund prospectuses. To obtain copies of the prospectuses, contact an annuity specialist at 800-347-7496 or email annuities@tdameritrade.com. Please read them carefully before investing. All guarantees are based on the claims paying ability of the insuring company. Past performance of a security, strategy or index is no guarantee of future results or success. The material, views and opinions expressed in this presentation are solely those of the presenter and may not be reflective of those held by TD Ameritrade, Inc. The webcast is provided for general information purposes only and should not be considered an individualized recommendation or advice. TD Ameritrade makes no representations or warranties with respect to the accuracy or completeness of the information provided. Examples and recommendations presented by Morningstar should not be considered a recommendation or solicitation by TD Ameritrade to purchase or sell any specific security. TD Ameritrade and Morningstar are separate, unaffiliated companies and not responsible for one another s products, services or policies. This presentation includes a feature that allows recording of electronic (including audio) participant-shared content. By continued participation in this session you automatically consent to such recording, and the subsequent rebroadcast of any recording.

Today s Speaker David Blanchett, PhD, CFA, CFP Head of Retirement Research, Morningstar Investment Management, LLC Research in financial planning, tax planning, annuities, and retirement Published in variety of industry and academic journals Frequent speaker at industry conferences and contributor in national media Master s degree in Financial Services from The American College Master s degree in Business Administration from University of Chicago PhD in personal financial planning at Texas Tech University

Agenda Retirement For illustration only. 5

Relative Importance Home Retirement For illustration only. 6

Two Sides of the Equation Liabilities Assets Liabilities For illustration only. 7

8 Assets

The Past as a Guide For illustration only. 9

Stocks, Bonds, Bills, and Inflation 1926 2013 10

10 Year Average Annual Compounded Real Return for the S&P 500 Stocks Return 10% Per Year? 25% 20% 15% 10% 5% 0% (good time to have retired) -5% (bad time to have retired) -10% Dec-35 Aug-49 Apr-63 Dec-76 Sep-90 May-04 10 Year Period Ending Source: Ibbotson 11

Income How Much Do I Have to Save for Retirement: the 4% Rule (=25x Rule) $100,000 $80,000 $60,000 Inflation Adjustments $40,000 Initial Income $20,000 $0 1 4 7 10 13 16 19 22 25 28 Retirement Year For illustration only. Source: Author s Calculations. 12

Initial Sustainable Withdrawal Rate Where the 4% Rule Comes From Historical US Data 14% 12% 10% 8% 6% 4% 2% 0% 1900 1910 1920 1930 1940 1950 1960 1970 1980 Retirement Year 13

An International Perspective on Historical Returns 1.28% 1.84% 2.34% 2.72% 4.06% 5.01% Average annual compounded real return for a 60% stock, 40% bond portfolio: 1900 2015. Source: Dimson, Marsh, and Staunton, Morningstar Direct. 14

Initial Sustainable Withdrawal Rate An International Perspective 14% 12% 10% 8% 6% 4% 2% 0% 1900 1910 1920 1930 1940 1950 1960 1970 1980 Retirement Year 15

Average Annual 10 Year Future Compounded Bond Return Bond Yields and Future 10 Year Bond Returns 15% 12% y = 0.9466x + 0.0084 R² = 0.9203 9% 6% 3% 0% 0% 3% 6% 9% 12% 15% Current Bond Yield Source: Ibbotson 16

Future 10 Year Annualized Return CAPE Ratios and Future 10 Year Stock Market Returns 20% 16% 12% y = -0.0035x + 0.1461 R² = 0.2384 8% 4% 0% 5 10 15 20 25 CAPE Ratio Source: Robert J. Shiller 17

A Build Up Approach to Forecast Asset Class Returns Equities Fixed Income Credit spread Term spread Real Rate Inflation 18

Our Best Guess on Future Returns (2017 Capital Market Assumptions) Before Inflation After Inflation 1-10 11-20 20+ 1-10 11-20 20+ Cash 1.3% 2.0% 3.2% -1.0% -0.3% 0.9% US Bonds 2.7% 3.4% 5.4% 0.4% 1.2% 3.1% US Large Cap Stocks 3.2% 5.6% 8.1% 0.9% 3.3% 5.7% US Small Cap Stocks 3.4% 6.1% 8.8% 1.1% 3.7% 6.4% International Stocks 6.4% 7.0% 7.8% 4.0% 4.7% 5.4% Emerging Market Stocks 8.9% 8.1% 7.3% 6.6% 5.8% 5.0% Doesn t include the impact of fees or taxes, so realized returns will be lower potentially much lower 19

Income Goal Running a Projection Determining Failure $10,000 Income Goal $8,000 $6,000 Income Shortfall $4,000 $2,000 $0 1 2 3 4 5 6 7 8 9 10 For illustration only. 20

Portfolio Balance < $0 â $0 What is Failure? Client Living Status Alive Dead Not Failure Not Failure Failure Not Failure For illustration only. 21

Probability of Success The Safety of The 4% Rule, Past versus Future 100% 80% 90% 93% 93% 93% 93% 92% 91% 90% 88% 79% 57% 56% 61% 64% 65% 65% 64% 60% 49% 37% 40% 21% 20% 8% 3% 0% 0% 20% 40% 60% 80% 100% Portfolio Equity Allocation Historical Returns Model Forecasted Returns Model Source: Low Bond Yields and Efficient Retirement Income Portfolios by David Blanchett, Journal of Retirement 22

Is 4% Safe? 23

Withdrawal Rate A More Colorful Perspective of 4% 12% 10% 8% 6% 4% 5.3% 4.8% 4.0% 6.1% 5.7% 4.9% 7.7% 6.6% 5.7% 10.0% 9.1% 6.5% Male Female Joint 2% 0% 65 70 75 80 Age Source: Low Bond Yields and Efficient Retirement Income Portfolios by David Blanchett, Journal of Retirement 24

The Retirement Liability 25

Common Liability Assumptions 80% Inflation 30 Replacement Rate Need Change years Retirement Period For illustration only. 26

Replacement Rate 27

What Changes Consumption Smoothing Δ Expenses Change At/During Retirement $ $ Income Differences Source: Estimating the True Cost of Retirement by David Blanchett, White Paper 28

Average Lifetime Growth in Real Wage, Age 25 = $1 Earnings Curves $2.20 $2.00 $1.80 $1.60 $1.40 $1.20 $1.00 25 35 45 55 65 Age High School College Advanced 29

Replacement Rates For Various Households Source: Replacement Ratio Study by Aon Consulting 30

Retirement Consumption 31

What Drives Retiree Spending? What They Buy (Consumption Basket) How Much the Spend 32

The Retirement Consumption Puzzle For illustration only. 33

% of Total Expenditures as a Percentage of Total Consumption by Age 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 25 35 45 55 65 75 85 Age Other Transportation Insurance & Pensions Housing Healthcare Food Entertainment Clothes Charity Source: Estimating the True Cost of Retirement by David Blanchett, Morningstar White Paper 34

% of Total Expenditures % of Total Expenditures Medical Spending for Different Income Levels Median Spending Highest 1 in 20 Households 50% 40% 30% 20% 10% 50% 40% 30% 20% 10% 0% 60 65 70 75 80 Age 0% 60 65 70 75 80 Age Low Income Mid Income Low Income Mid Income Source: Estimating the True Cost of Retirement by David Blanchett, Morningstar White Paper 35

Medical Inflation General Inflation (CPI-U) versus Medical Inflation gmedical inflation has averaged +5.42% per year, versus +3.63% for the CPI-U, therefore, has been growing about 50% faster than general inflation 15% 12% 9% 6% 3% y = 0.7011x + 0.0288 R² = 0.5907 0% -3% 0% 3% 6% 9% 12% 15% General Inflation ( in CPI-U) Source: Bureau of Labor Statistics. 36

Different Inflation Baskets gthe average annual change in the CPI-E has been 3.07% versus 2.92% for CPI-U Expenditure Weights from CPI-U Expenditure group CPI-U CPI-W CPI-E CPI-W CPI-E Apparel 3.5% 3.6% 2.4% 0.1% -1.1% Education and communication 6.7% 6.7% 3.8% 0.0% -2.9% Food and beverages 15.0% 15.7% 12.8% 0.7% -2.2% Housing 40.2% 39.2% 44.5% -1.0% 4.3% Medical care 6.9% 5.6% 11.3% -1.3% 4.4% Other goods and services 5.3% 5.1% 5.4% -0.2% 0.1% Recreation 5.9% 5.5% 5.3% -0.4% -0.6% Transportation 16.5% 18.7% 14.5% 2.2% -2.0% Source: Bureau of Labor Statistics. 37

Base Expectation of Retiree Spending??? Spending Increases Throughout Retirement (because of the changing consumption basket) 38

Inflation Risk: The Three Stages of Retirement Go-Go: Retirees maintain lifestyle, travel, the group that does not consider themselves "old". Slow-Go: Between the ages of 70 and 84, brought on by the body saying Slow Down, 20%-30% budget decline. No-Go: 85+, significant changes in retirement lifestyle is generally brought on by health issues. Source: "The Prosperous Retirement, Guide to the New Reality", Michael Stein 39

Annual Real Dollar Change in Consumption Lifetime Real Income Need, Age 65 Retiree $1.2 $1.1 $1.0 $0.9 $0.8 $0.7 $0.6 $0.5 65 70 75 80 85 90 95 Age 25k Spend 50k Spend 100k Spend Source: Estimating the True Cost of Retirement by David Blanchett, Morningstar White Paper 40

Actual Retiree Spending + = What retirees spend money on costs more But they actually spend less Spending declines on average 41

Spending Less: Why? Choice Necessity For illustration only. 42

The Length of Retirement 43

Longevity Risk For illustration only. 44

Inefficient Retirement Planning Defined Benefit Plans Defined Contribution Plans For illustration only. 45

Life Expectancy (Years) for a 65 Year-Old Life Expectancies Keep Increasing 25 20 15 Female Male 10 1900 1950 2000 2050 2100 Year Source: Social Security Administration 46

Cohort life expectancy at age 65 but the Gains are being Realized Mostly by the Wealthy 24 23 22 21 20 19 18 17 16 15 14 1912 1922 1932 Year Earnings in top half of distribution Earnings in bottom half of distribution Source: Waldron (2007) 47

Difference versus Average Life Expectancy for a 55-Year-Old and Now a Large Gap Exists in Life Expectancies by Income Level 8 6 4 2 0-2 -4-6 5.5 3.3 3.1 2.1 1.8 1.2 0.0 0.4 0.8 1.1-0.1-0.9-0.9 Males -1.5-2.4-2.0-1.7-2.2-3.1-4.6 1 2 3 4 5 6 7 8 9 10 Income Decile (poorest) (richest) Source: Bosworth and Burke (2014) 48

What the are Odds?... The Probability of a 65 Year Old Living to Age 95 Male Female Both 1 Average American Healthy American 7% 13% 1% 19% 20% 29% 6% 43% Healthy American in 2028 25% 33% 8% 50% Source: Social Security Administration, Society of Actuaries 49

Do You Feel Lucky? 50 For illustration only.

Annuities: The Only Way to Guarantee Income for Life Immediate Annuity $ Income 65 70 75 85 90 95 100 VA+GLWB $ Income 65 70 75 85 90 95 100 Deferred Income Annuity For illustration only. 51 $ Income 65 70 75 85 90 95 100 Age

Who Benefits from Annuitization? Preferences Retirement Income Stability Preference Bequest Preference Situation Purchase Age Existing Amount of Guaranteed Income Retirement Readiness Increase in Payout Rates Subjective Life Expectancy Risk Level of Non-annuitized Portfolio For illustration only 52

The Best Annuity Around For illustration only. 53

Conclusions 54

Combined Impact of the Cost of Retirement + + = Projected returns are lower Retirees are living longer Retirees spend less throughout retirement Total cost is lower 55

Disclosures The above commentary is for informational purposes only and should not be viewed as an offer to buy or sell a particular security. The data and/or information noted are from what we believe to be reliable sources, however Morningstar Associates has no control over the means or methods used to collect the data/information and therefore cannot guarantee their accuracy or completeness. The opinions and estimates noted herein are accurate as of a certain date and are subject to change. The indexes referenced are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results. The charts and graphs within are for illustrative purposes only. Monte Carlo is an analytical method used to simulate random returns of uncertain variables to obtain a range of possible outcomes. Such probabilistic simulation does not analyze specific security holdings, but instead analyzes the identified asset classes. The simulation generated is not a guarantee or projection of future results, but rather, a tool to identify a range of potential outcomes that could potentially be realized. The Monte Carlo simulation is hypothetical in nature and for illustrative purposes only. Results noted may vary with each use and over time. The results from the simulations described within are hypothetical in nature and not actual investment results or guarantees of future results. This should not be considered tax or financial planning advice. Please consult a tax and/or financial professional for advice specific to your individual circumstances. 56