Had the same problem. Talked to a techie person in a Mac reseller. According to him, updating IOS directly on the phone may result in some corruption of the software. The best thing to do is to update via the iTunes in the computer.
To overcome he problem, you can try this:
1. Manually back up iPhone into the computer
2. Then, it the Restore button. This will completely delete everything in your iphone (Do make sure you have backed up your phone!!) and the latest version of IOS will be installed. This may take a few minutes.
3. When this is complete, and the iphone icon pops up again, you will have two options: 1. Set up as a new iphone or 2. Restore backup.
4. Hit the restore backup button. This will take a few minutes.
5. As far as I can tell, all my previous data (contacts, photos, etc were back in the phone.
6. More importantly I can now drag and drop music from the itunes in my Mac directly into my phone
7. YESSSS!!!