You've been saving up for one year, ten years, or maybe even the majority of your working life. Now, you're at the final stretch: your retirement is just over the horizon. While it may seem like you can relax a bit because the bulk of your career is behind you, you may want to think twice.
The closer you get to retirement, the more critical your decisions become. The last five years of your working life require careful financial planning and preparation. These years are instrumental to laying a strong foundation for your successful retirement.
If this sounds like a heavy weight to bear, you're in luck. Wealth Enhancement Group is an independent wealth management organization with direct access to people who know exactly what you need to consider as you prepare for your retirement.
What to Do 5 Years Before Retirement
This article is organized as a loose list. While it's not critical to go directly from one to the next, the concepts feed into one another. Remember that everything about your financial plan is interconnected; when you make a splash in one area, the ripples reflect throughout the rest. When it comes to your last five years before retirement, these ripples can be amplified.
With that said, let's take a look at what you need to do five years before retirement.
Plan Your Retirement Income Streams
The most foundational aspect of your retirement lifestyle is your retirement budget. This incorporates the inflows and outflows of cash that you'll experience on a daily basis, as well as larger, one-time expenses in the form of vacations and medical payments.
Your retirement expenses won't live in a vacuum. In order to determine your retirement budget, you need to understand and plan for your retirement income streams.
Your retirement paycheck has two obvious sources of fixed income: Social Security and pensions. While pensions are becoming less and less common over the years, Social Security forms the backbone of retirement income for many Americans.
Social Security Planning
There are four crucial steps to defining your Social Security strategy:
- Determine when to claim your benefits. The later you begin receiving benefits, the larger those benefits will be. However, the earlier you claim, the quicker you start receiving your benefit.
- Consider the impact of working in retirement. It's becoming increasingly common for retirees to continue working—often part-time. However, working after your full retirement age can directly reduce your benefits.
- Develop an effective tax strategy. For all but the lowest-income retirees, Social Security benefits are taxable. Depending on your provisional income, up to 85% of your benefit can be taxed.
- Keep track of how your marital status can change your plans. Social Security spousal benefits are available to married couples, and divorcees or widow(er)s can have even more complicated strategies.
Retirement Investment Planning
Other than Social Security and pensions, retirement income mostly comes from withdrawals from your savings or retirement investment accounts. When thinking about your portfolio, you need to balance a few key factors:
- Strategic distributions. Look at the value of your portfolio and determine, on a total return basis, how much you can distribute each year while maintaining and growing your principal over time. As a rule of thumb, withdrawing between 3.5% and 4% each year is reasonable for a balanced portfolio, but your situation may be different.
- Tax-savvy strategies. Understand the importance of tax withholding, tax diversification, and timing your withdrawals as foundational pillars to your tax-savvy retirement income strategy.
- Portfolio rebalancing. As you withdraw from your investments—and as markets shift—your asset allocation may drift away from its original design. Periodically rebalance your portfolio in retirement to keep it aligned with your risk tolerance and long-term objectives.
Now that you understand the fundamentals of retirement income planning, it's time to take your budget for a spin.
Test Drive Your Retirement Budget
Retirement is a strange transition for many. You go from the accumulation and earning phase of life, which you've been in for decades, to the distribution and spending phase. Prolific savers might find themselves reluctant to start spending—rest assured, because that's totally normal!
As you get closer to your retirement day, you'll need to first project how much you'll be spending each year after you retire. This is easier said than done because it's difficult to accurately assess how much you'll spend in retirement. The expense budgeting process gets easier the closer you get to retirement, but you still might not have a perfect idea of what your lifestyle will be like.
How to Develop a Retirement Budget
When developing your budget, it's important to be honest with yourself. Make sure that your assets and income can support your desired lifestyle—not just your minimum required budget. But remember to be easy on yourself throughout the process. It can be difficult to accurately assess how much you'll spend in a future unknown retirement environment.
Pro tip: When calculating your budget, don't forget quarterly, annual, and other irregular expenses like insurance. Many people forget to account for these significant expenses if they calculate their expenses during a month in which they don't pay them.
After you've determined your numbers, take your retirement budget for a test drive! Pretend that you're retired and live with that budget for a week. Take some notes on the process and reflect on how it feels to live within your planned retirement budget.
This exercise can be very insightful. Some may find that they can actually spend a bit more liberally than they initially expected. For others, this might be a wake-up call that they either need to save more, adjust their expected budget, or even delay their target retirement day.
Understand Deductible vs. Non-Deductible Debt
Debt is a controversial subject. Some leaders in financial media insist that all debt is bad; others encourage debt under specific circumstances. Our stance is that not all debt is created equal. To master your retirement transition, you need to know the difference.
Deductible debt refers to debt for which the interest paid can be deducted from your taxable income. For instance, mortgage interest, business debt interest, and interest on certain types of student loans can potentially reduce your tax liability.
On the other hand, the interest paid on non-deductible debt can't reduce your taxable income. Non-deductible debt typically includes personal loans, credit card debt, and other consumer loans. Although, the specifics vary.
For many clients, we suggest paying off non-deductible debt as early as possible before retirement. By eliminating these debts, you'll free up more of your income towards covering essential living expenses and more productive investments.
Build Cash Reserves
Immediately prior to your retirement, you can also consider building cash reserves to give you a buffer against market volatility when making withdrawals. Aim for building a reserve equal to at least one year—and preferably two years—of your portfolio spending needs.
When calculating how much you should have in your reserve, look to your budget. Tally up your total monthly expenses, including food, housing, insurance, and more, and subtract your total fixed monthly income that comes from Social Security, pensions, and other annuity-like payments. This will give you the amount you'll be withdrawing each month from your retirement investment accounts to make ends meet. Multiply this monthly value by 12 to get your one-year cash reserve needs, or by 24 for two years.
But What Will You DO When You Retire?
Before you retire, take the opportunity to consider how you're going to use your time. While it may seem like the sky's the limit, understand that your opinion of your favorite activities could be influenced by their perceived scarcity while you're working. In other words, you can only play so much golf!
As we mentioned above, working during retirement can impact your retirement plan, especially as it relates to Social Security. However, this doesn't mean that you can't decide to work in retirement if you want to. In fact, many retirees now rely on part-time work as a common source of retirement income. People generally aren't opposed to working—they just want it on their own terms. If you're considering working in retirement, just be aware that the amount you earn could reduce your benefits elsewhere.
Changing Your Plan and Adjusting Your Goals
Life isn't straightforward, and sometimes your plans have to change. After practicing your retirement budget, you may find that you need to adjust your goals. If you need to eliminate expenses, don't be disheartened by starting small: End unnecessary streaming services, reduce your monthly subscriptions, and bundle payments for services into annual payments to achieve discounts.
If you try the easy fixes and realize you need to make more fundamental changes to your retirement plan, meet with an experienced, qualified advisor to see if you're missing anything. Remember, while this is probably the first time you've planned for an impending retirement, advisors may have done it hundreds of times before!
At this stage in your life, saving more money might not be easy. If you don't have confidence that your retirement plan is going to work out, please reach out to a financial advisor with Wealth Enhancement Group as early as you can. It's never too late to start planning, but the quicker you get started, the more optionality you'll have. Don't hesitate—reach out today!
