Mapping the Road to Retirement A Fidelity Perspective Steps You Can Take to Improve Your Retirement Readiness. Every one of us wants to look forward to a secure financial future. Many are taking steps toward that goal, such as contributing to a 401(k), IRA, or deferred variable annuity. But whether you ve been saving for years or are just getting started, one fact is undeniable: to help make sure you re able to enjoy the retirement you envision, you have to have a plan. This guide is all about creating that plan. It also offers ideas for putting your plan into action. And it shows some of the ways that Fidelity can help you throughout the entire process of building your financial security.
1 Plan Seeing the Big Picture It s 30 years down the road, but retirement crops up as a worry we ll be relying on ourselves. FIDELITY INVESTOR Retirement in America is changing. Over the past two decades, there s been a seismic shift in how Americans approach retirement security. For generations, pension plans and Social Security were regarded as two key pillars of financial security. But the number of workers covered by traditional pensions has declined from 44% to 17% since the mid-1970s, 1 while such alternatives as 401(k) plans are increasing. And while the future of Social Security is surrounded by questions, almost every scenario envisions lower benefits. As Exhibit A shows, a large portion of older Americans rely more on earned income than on Social Security or pensions and retirement plan assets. Your most valuable retirement asset: a plan. No matter what kind of retirement you have in mind, the key to reaching it is planning. And the key to planning is to begin with an understanding of the various risk factors that are likely to affect your retirement readiness. There are two basic types of factors those you can control and those you can t. For most of us, planning begins with a realistic look at factors that you can t control, but you can plan for. In fact, by managing the factors in your control you can help reduce the likely impact of uncontrollable factors on the success of your retirement plan. There s also a shift in what retirement means. To some, it still means having more time for family, recreation, or travel. But to a growing number of others, retirement is more about having the time and resources to start a new career or explore new challenges. Exhibit A Older Americans are relying heavily on personal investments and earnings. Percent of income derived from indicated sources for single individuals or couples over age 65 reporting annual income of $41,000 or more. Source: Income of the Aged Chartbook 2002, Social Security Administration, September 2004. The $41,000 represents the top income quintile for single individuals or couples over age 65. 2
Factors outside of your control. The risk factor that may well have the biggest impact of all is longer life expectancy. Today, there s a 50% chance that one member of an average, healthy 65-year-old couple will live to be 92. 2 With that in mind, it s only reasonable to plan on needing approximately 30 years of retirement income even more if you re retiring early. A second major factor is the cost of health care. With medical advances, health care costs have gone up far faster than the overall inflation rate. The result: Americans are spending a larger percentage of their income on health care, and the percentage appears likely to continue to rise. Another factor is inflation. Although in recent years inflation has been a minor concern, even low inflation can cause visible erosion of buying power over ten years or longer. Lifestyle and investing factors. Two big factors that you can influence are the type of retirement lifestyle you envision and the age at which you retire. Of course, these are also the two areas where you re likely to have the most control and flexibility. Factors That Can Affect Your Retirement Readiness Factors you can t control Life expectancy Health care costs Inflation Market performance Factors you can influence Retirement lifestyle and activity costs Age at retirement Current income and expenses Savings rate going forward Appropriate use of tax-advantaged and taxable accounts and vehicles Asset allocation (both prior to and during retirement) Other sources of income during retirement The remaining factors have to do with current and future sources of income and with your retirement savings (see box at right). While some of these factors, such as the current value of any retirement savings, obviously aren t flexible, don t underestimate the potential value that can come from taking control of the others. For example, taking advantage of available taxadvantaged and taxable retirement savings opportunities that are appropriate for you can make a difference. So can appropriate asset allocation. Both of these are areas where many Americans have opportunities to improve their retirement readiness. 3
Setting Your Savings Rate I understand the importance of getting ready for retirement, but achieving it is another story. What I really need is clear help on how to get there. FIDELITY INVESTOR Learn the habits of successful savers. The first question many people have about saving money is the most basic one of all: where will the money come from? There are numerous steps you can take as you work out your own answer to this question. One of the most important steps is to review your household s level of personal debt. (Personal debt includes non-deductible, high-interest debt like certain credit card debt, personal loans, and auto loans but not a home mortgage.) High personal debt can be a major hurdle to saving money: every dollar that goes to paying interest on debt is a dollar that can t be invested for future growth. Working to bring down personal debt, either by limiting purchases or refinancing at a lower rate, is a good first step for any high-debt household to consider. Another step is to adopt some of the many effective techniques for finding hidden money in your budget. These range from reducing minor luxuries to deferring major purchases. The savings from each may seem small, but they can really add up over time. Save on a schedule. Another important step is to set up a regular savings plan. You can arrange for the contributions to happen automatically, so that making them doesn t have to be a chore. Again, even small amounts, set aside every pay period, can add up over time. Saving regularly also gives you the potential to take advantage of dollar-cost averaging. By investing a fixed dollar amount in a diversified portfolio on a regular basis, you will end up buying fewer shares when the share price is high, and more shares when the price is low. While dollar-cost averaging won t guarantee you investment gains in a declining market, it s widely recommended by financial advisors for those investing over the long term. Perhaps most important of all is to take action sooner rather than later. Even if you can t set aside as much as you d like, whatever you save now is likely to make things that much easier for you in the future. In the world of retirement readiness, small steps made today can yield bigger benefits tomorrow. Estimate how much you should be saving. A key concept in retirement readiness is your number : the dollar amount you want to have in savings on the day you retire. Based on your number, you can then figure your savings rate: the percentage of income you need to set aside each pay period. Any estimate of a person s number and savings rate needs to include all of the retirement readiness factors discussed earlier, which requires some sophisticated calculations. However, Fidelity has the tools to help you create a realistic, action-based plan that is customized to your situation. Even before you talk to a representative, you can get an idea of the savings rates for various situations by looking at Exhibit B (facing page). These rates assume that during retirement you ll need 85% as much income as you did before retiring. While this may seem high, bear in mind that while some expenses will be lower in retirement, others (such as health care) could be significantly higher. This number can vary with your personal situation and should be reevaluated closer to retirement. 4
Exhibit B Regular saving can be an easy and effective way to make progress on the road to retirement readiness. To use the tables: 1. Select a table for a particular age. 2. Select a current grossincome level. 3. Read across to a level of existing retirement savings. 4. Read down to find the appropriate savings rate. EXAMPLE: A 35-year-old who is currently earning $50,000 and has $100,000 in retirement savings should plan on setting aside 20% of gross income every year. The tables below show the percentage of income that a hypothetical individual or household in each circumstance would need to save in order to be on track to replace 85% of preretirement income. In each case, the tables assume that the hypothetical saver is investing the savings in a growth portfolio, plans to retire at 65, collects Social Security at age 65, and seeks to replace 85% of projected earnings. Savings Rates Based on Age, Income, and Existing Savings for a 35-year-old Current Gross Income Existing Retirement Savings $50,000 $350,000 $225,000 $100,000 0 $75,000 $600,000 $400,000 $225,000 $25,000 $100,000 $850,000 $600,000 $350,000 $100,000 savings rate 10% 15% 20% 25% for a 45-year-old Current Gross Income Existing Retirement Savings $50,000 $425,000 $375,000 $300,000 $225,000 $75,000 $725,000 $625,000 $525,000 $425,000 $100,000 $1,050,000 $925,000 $800,000 $650,000 savings rate 10% 15% 20% 25% for a 55-year-old Current Gross Income Existing Retirement Savings $50,000 $450,000 $425,000 $400,000 $375,000 $75,000 $775,000 $725,000 $700,000 $650,000 $100,000 $1,125,000 $1,100,000 $1,050,000 $1,000,000 savings rate 10% 15% 20% 25% This exhibit assumes retirement is at age 65. Social Security payments are also assumed to begin at age 65 and are based on 2004 Social Security tables. Analysis does not include pension income. Current income is adjusted each year by 1.5% over inflation until retirement. Illustrations assume a hypothetical investment in a portfolio of 70% stocks, 25% bonds and 5% short-term debt. Hundreds of simulations were run to produce these illustrations, and the results are based on a 50% confidence level of success, which assumes average historical market returns. At a 50% level of confidence, the hypothetical portfolio has the potential to last at least until age 92. See Important Legal Information page for further details about the indexes and methodology used to produce this table. Past performance does not guarantee future results. Performance returns for actual investments will generally be reduced by fees or expenses not reflected in these hypothetical illustrations. 5
2 Invest Allocating Your Savings When your savings plan is set up and running, there s a tendency to think you re all done. It s easy to forget that choosing how to invest can have a bigger effect than how much you save. FIDELITY INVESTOR An investor s contribution hierarchy. When it comes to determining how best to invest, the first consideration is what type of account you should use. While there is no one hierarchy for contributing to tax-advantaged retirement savings vehicles that is perfect for every investor, the following guidelines, based primarily on tax efficiency, may help you choose the order that s right for you. Keep in mind, there are other factors to consider, such as range and type of investment choices, fees and other costs. Surprisingly, millions of Americans who are eligible for workplace retirement plans don t take full advantage of them. About one-third of eligible employees don t even participate at all. 3 They re missing a great opportunity. If you or your spouse is eligible for a workplace retirement plan, as your first priority, Fidelity believes you should strongly consider contributing the full amount required to receive the maximum employer match offered by the plan. Some plans may match 100% of what you put in. That s like getting an instant 100% return on your investment. Not only that, but pretax contributions to such plans should not be subject to current income taxes, and any earnings within the account grow tax-deferred. Pretax contributions and earnings are subject to income taxes when withdrawn and may also be subject to a 10% penalty if taken before age 59 1 2. Second, consider unmatched pretax contributions to workplace retirement plans, after-tax contributions to Roth IRAs (or Roth 401(k)s starting in 2006), or deductible contributions to Traditional IRAs. Which one may be best for you will depend on such factors as what types of contributions you are eligible to make, contribution limits, and whether you believe your applicable income tax rate will be higher or later in retirement than now. If you believe it will be lower in retirement, your best option may be a pretax contribution to a workplace retirement plan or a deductible contribution to a Traditional IRA. If you anticipate that your income tax rate will be higher in retirement, your best option among these choices may be after-tax contributions to a Roth 401(k) or Roth IRA, since earnings should be income tax free provided certain conditions are met. If you anticipate that your income tax rate will be the same in retirement, all of these choices are roughly on par with one another from a tax perspective. Third, consider after-tax contributions to your workplace retirement plan (other than a Roth 401(k), which is in the first two categories), non-deductible contributions to a Traditional IRA, or a tax-deferred annuity purchased with after-tax dollars. 1 2 3 Employer-matched contributions Primary tax-advantaged accounts Other tax-advantaged options Employer-matched contributions to Workplace Retirement Plans (such as 401(k), 403 (b), 457, or SIMPLE IRA) This is the closest thing to free money in the retirement savings universe. Unmatched pretax contributions to Workplace Retirement Plans After-tax contributions to Roth IRA or Roth 401(k) Deductible contributions to Traditional IRA In choosing among these, consider such factors as your eligibility and your beliefs about your current and future income tax rates. See above for more details. After-tax contributions to Workplace Retirement Plans Non-deductible contributions to Traditional IRA Tax-deferred annuity Consider these options if you are ineligible for, or have already maxed out, any of the previously mentioned options. 6
Remember that once you reach age 50, catch-up provisions may allow you to save even more in your employer-sponsored plan or IRA. Note on taxable accounts: They also play an important role in any retirement savings plan. Their ranking relative to tax-advantaged vehicles is largely dependent on the tax efficiency of investments within the account and how long you plan to hold the investments before selling. Finally, Fidelity encourages you to consider consulting with your tax and/or financial advisor when evaluating your options, as well as revisiting your tax situation and retirement plan assumptions at least annually. Choosing investments: it makes a difference. Studies have shown that asset allocation choosing an appropriate mix of investments for your time horizon is one of the largest factors in determining long-term returns, along with how much you contribute to your savings. When it comes to choosing how your savings are invested, be careful not to shortchange your own interests by leaving long-term assets in highly conservative choices that offer little prospect of superior long-term growth. If you are further from retirement, a portfolio with a higher allocation to equities may be appropriate. As your target date approaches, you may want to shift gradually toward more conservative investments. But even in retirement, you ll want to consider keeping something in equities, because you ll want some of your assets to grow in order to support the later years of your retirement and keep pace with inflation. Exhibit C shows the principle of asset allocation in action, using historical investment results (remember that past results aren t a guarantee of future performance). The more conservative the mix of investments, the less dramatic the difference between the best 12- month period and the worst one during the 80 years being measured. More aggressive portfolios showed wider swings, but also posted higher long-term gains. The allocation that is appropriate for you depends on the time horizon and goals you have in mind, as well as your tolerance for risk. Don t forget about diversification, either. Within each asset class, it s a good idea to have multiple investments in order to limit your exposure to the risks of any one security (for instance, the default of a bond issue or the collapse of one company s stock price). One easy way to achieve diversification is with mutual funds. Asset allocation and diversification are areas where Fidelity can help, by providing guidance 4 in determining an allocation that may be appropriate for you. Exhibit C Mixing asset classes can help moderate risk. Historical Returns for Above Asset Allocations from 1926 to 2004 Highest 12-month Return 31.06% 76.57% 109.55% 136.07% Lowest 12-month Return -17.67% -40.64% -52.92% -60.78% Historical Average 6.19% 8.22% 9.26% 9.97% Annual Return Among the different Target Asset Allocations, the ones that are more heavily concentrated in equities have potentially more investment risk and less inflation risk than those that have none or lower concentration in equities. Return data for domestic stocks, bonds, and short-term asset classes range over a period from 1926 to 2004. Return data for the foreign stock asset class ranges over the period from 1970 to 2004. Domestic stocks are represented by the S&P 500 ; bonds are represented by U.S. Intermediate Term Government bonds; short-term assets are based on the 30-day U.S. Treasury bill; and foreign stocks are represented by the MSCI EAFE Index. For the historical asset allocation returns, the Foreign Stock category prior to 1970 is represented by the S&P 500. The highest 12-month return, lowest 12-month return, and average annual return for MSCI EAFE Index from 1970 to 2004 are 103.7%, -37.43%, and 11.09%, respectively. Source for index data is Ibbotson Associates. This is for illustrative purposes only and is not indicative of any investment. Past performance is no guarantee of future results. See Important Legal Information page in the back for additional background on this chart, including risks associated with investing in the various asset classes and additional index information. 7
3 Manage Staying on Track I think it s valuable to have regular checkups and be more systematic in checking in on my investments, especially as I get older. FIDELITY INVESTOR In order to keep your plan working for you, it s important to check back in now and then to make sure you re still on track. Fidelity recommends that retirement investors review their plans at least once a year (see box, facing page). It s also a good idea to review your plan and portfolio any time there are major changes in your living situation. Events such as marriage, divorce, a new house, a child starting college, or a change in income often lead to changes in the assumptions on which your plan is based. These in turn may indicate a change in your savings rate or other aspects of your plan. What to look for when reviewing your portfolio. The first goal of a portfolio review is to check for allocation drift. Over time, any asset allocation will shift incrementally, owing to the differences in performance among the various asset classes. A large shift can lead to a substantial difference between your planned and actual portfolio allocation. Your annual portfolio review gives you the chance to rebalance your portfolio so that it more closely corresponds to your target allocation. In addition, as you approach retirement, you may want to change your target allocation itself, gradually shifting away from an emphasis on growth and toward a more conservative mix, depending on your withdrawal needs. The smart way to rebalance. To rebalance the portfolio to your plan, the most obvious way would be to shift money from one asset class to another, but this can have significant tax implications if done in a taxable account. Another option is to temporarily direct your ongoing contributions into the underweighted asset class (or classes). For any taxable accounts, this method has the advantage of allowing you to adjust your asset allocation without incurring capital gains or other tax liabilities. Review the big picture, too. When reviewing your plan, ask yourself the following questions: Am I on track to meet my goal? Is my asset mix right for my time horizon? Am I taking advantage of appropriate taxadvantaged saving vehicles, catch-up contributions and taxable accounts for my situation? Am I managing my spending and debt in a way that allows me to save for my future goals? The answers can help give you the satisfaction of knowing that you re staying on track with a plan that is truly designed to make your retirement security a reality. 8
Management Calendar for Retirement Savings Monthly Check that the amount you re saving matches your target savings rate Review account statements Twice a Year Compare your current asset allocation to your target allocation Make any necessary adjustments by redirecting savings inflows to underweighted asset classes or shift money from one asset class to another Yearly Review your overall plan Evaluate savings rate and target allocation; adjust as needed Review retirement plan beneficiary designations Life Event Review your overall plan in light of any major life changes, whenever they occur 9
Taking Control Creating your own personal map to retirement readiness can be a crucial step in taking control of your financial future. As we ve discussed in this guide, there are three main phases to the process of achieving retirement readiness. 1Plan calculate your savings rate. Determine your desired retirement lifestyle and target date Understand the risk factors involved Identify options such as debt management to help make it easier to make regular investments 2Invest put your plan into action. Set up automatic investments keyed to your savings rate Take advantage of taxable and tax-advantaged savings vehicles that are appropriate for you Allocate assets appropriately, and diversify within each asset class 3Manage keep your plan on track. Review your plan at least once a year, overall and in detail Check your asset allocation and adjust as necessary Adjust or recalculate your savings rate as appropriate 10
Fidelity is Here to Help Creating and managing a retirement readiness plan can be complex and challenging although it doesn t have to be at all. Fidelity can help you every step of the way, from the preliminary planning stage through setting up regular contributions, determining an asset allocation that works for you, choosing investments, and staying on track. With dedicated retirement professionals and powerful planning tools, Fidelity can be your central resource for retirement readiness. It s easy to set up a practical savings plan with the help of a specially trained Fidelity retirement planning consultant. You can work with your consultant over the phone or in person at any of the more than 100 Fidelity Investor Centers located around the country. Once your plan is in place, you can monitor and manage it easily over the Internet. And you re free to contact your Fidelity Representative with questions or to arrange periodic additional consultations. TAKE THE FIRST STEP To talk to a representative, either for guidance 4 over the phone or to set up an appointment at an Investor Center, call 1-800-544-6666. Additional information about Fidelity s retirement planning tools is also available online at Fidelity.com/build. 11
Important Legal Information Tax information contained herein is not intended or written to be used, and it cannot be used by taxpayers, for the purposes of avoiding penalties that may be imposed on taxpayers. Such tax information is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Fidelity does not provide legal or tax advice. Fidelity cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws which may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation. 1 Percentage of private, nonfarm wage and salary workers participating in a defined benefit plan. Employee Benefit Research Institute Historical Statistics, April 28, 2004. 2 Annuity 2000 Mortality Table, Society of Actuaries. Figures assume a person is in good health. 3 Fidelity Building Futures Volume V survey of 10,000 401(k), 403(b), and 457 plans with 8.2 million participants. 4 Guidance provided by Fidelity is educational in nature, is not individualized and is not intended to serve as the primary or sole basis for your investment or tax-planning decisions. For Exhibit B, several hundred financial market return scenarios were run to determine how the asset mix may have performed. Monte Carlo simulations are mathematical methods used to estimate the likelihood of a particular outcome based on historical analysis. Historical performance simulations are conducted to determine the likelihood of various financial outcomes. Each Monte Carlo simulation reproduces random sets of results by generating random returns for the scenario. When analyzed together, these results suggest a probability of occurrence. The savings rates and amount of current savings that are listed are based on a 50% confidence level. This means that in 50% of the historical market scenarios, or 1 out of 2 times, a hypothetical portfolio based on the stated asset allocation would have performed at least as well as the results shown. We consider the 50% confidence level a representation of average market results. Increasing the confidence level would have provided a more conservative analysis. For example, a 90% confidence level represents market conditions that are generally significantly lower than the historical average and would have resulted in higher savings rate and current savings level results. It is important to understand the impact of different market conditions on your plan. The estimated returns for the stock and bond asset classes are based on a risk premium approach. The risk premium for these asset classes is defined as their historical returns relative to a 10-year Treasury bond yield. Risk premium estimates for stocks and bonds are each added to the 10-year Treasury yield. Short-term investment asset class returns are based on a historical risk premium added to an inflation rate which is calculated by subtracting the TIPS (Treasury Inflation Protected Securities) yield from the 10-year Treasury yield. This method results in what we believe to be an appropriate estimate of the market inflation rate for the next 10 years. Volatility of the stocks, bonds, and short-term asset classes is based on the historical monthly data from 1926 through the most recent year-end data available from Ibbotson Associates, Inc. Stocks, bonds, and short-term debt are represented by the S&P 500, U.S. Intermediate Term Government Bonds and 30-day U.S. Treasury bills, respectively. Annual returns assume the reinvestment of interest income and dividends, no transaction costs, no management or servicing fees, and the rebalancing of the portfolio every year. It is not possible to invest directly in an index. All indexes include reinvestment of dividends and interest income. Although past performance does not guarantee future results, it may be useful in comparing alternate investment strategies over the long term. Performance returns for actual investments will generally be reduced by fees or expenses not reflected in these hypothetical illustrations. For Exhibit C, generally, among asset classes, stocks may present more short-term risk and volatility than bonds or short-term instruments but may provide greater potential return over the long term. Although bonds generally present less short-term risk and volatility than stocks, bonds do entail interest rate risk (as interest rates rise, bond prices usually fall and vice versa) and the risk of default (the risk that an issuer will be unable to make income or principal payments). Additionally, bonds and short-term investments entail greater inflation risk, or the risk that the return of an investment will not keep up with increases in the prices of goods and services, than stocks. Finally, foreign investments, especially those in emerging markets, involve greater risk and may offer greater potential return than U.S. investments. Among the different Target Asset Allocations, conservative seeks to minimize fluctuations in market values by taking an income-oriented approach with some potential for capital appreciation; balanced seeks the potential for capital appreciation and some growth for investors who can withstand moderate fluctuations in market value; growth seeks capital appreciation for investors who can withstand significant fluctuations in market value; and aggressive growth seeks aggressive growth for investors who can tolerate wide fluctuations in market value, especially over the short term. The S&P 500 Index is a registered trademark of The McGraw-Hill Companies, Inc., and has been licensed for use by Fidelity Distributors Corporation and its affiliates. It is an unmanaged index of the common stocks of 500 widely held U.S. stocks that includes the reinvestment of dividends. The MSCI EAFE Index is an unmanaged benchmark index comprised of 21 MSCI country indexes representing the developed markets outside North America, including Europe, Australasia and the Far East. The Ibbotson U.S. 30-Day T-bill data series is a total return series that is calculated using data from The Wall Street Journal from 1977 to present and the CRSP U.S. Government Bond File from 1926 to 1976. The Ibbotson Intermediate-Term Government Bond Index data series is a total return series that is calculated using data from The Wall Street Journal from 1987 to present and from the CRSP Government Bond file from 1934 to 1986. From 1926 to 1933, data was obtained from Thomas S. Coleman, Lawrence Fisher and Roger G. Ibbotson s Historical U.S. Treasury Yield Curves: 1926 1992 with 1994 update (Ibbotson Associates, Chicago, 1994). All index returns include reinvestment of dividends and interest income. It is not possible to invest directly in any of the indexes described above. Investors may be charged fees when investing in an actual portfolio of securities, which are not reflected in illustrations utilizing returns of market indexes. As with all your investments through Fidelity Investments, you must make your own determination whether a particular investment is consistent with your objectives, risk tolerance and financial situation. Fidelity is not recommending or endorsing any particular investment in this research paper. Before investing, consider the funds investment objectives, risks, charges and expenses. Contact Fidelity for a prospectus containing this information. Read it carefully. Fidelity Brokerage Services, Member NYSE, SIPC Fidelity Investments Institutional Services Company, Inc., 82 Devonshire Street, Boston, MA 02109 406836 1.818038.100 RET-RRWP-0605