The 5 Years Before You Retire

1. Assess Your Retirement Readiness Realistically

Reaching a secure retirement can feel a little intimidating.

Honest self-assessment. The first step towards a secure retirement is understanding your current financial standing. This involves calculating your monthly expenses, estimating your guaranteed income (Social Security, pensions), and determining the size of your retirement nest egg. Use worksheets to get a clear picture of your income gap, the difference between your expenses and guaranteed income.

Calculate your needs. To estimate how much you'll need, divide your income gap by a savings return factor (3.3% for conservative, 5.0% for aggressive). This provides a rough estimate of your required retirement savings. Compare this to your current savings to identify any shortfall.

Don't panic, plan. Knowing your shortfall allows you to develop a targeted savings strategy. Remember, even if the number seems daunting, you have time to catch up. The key is to take a proactive role in your retirement and place yourself firmly in the driver's seat for the next chapter of your life.

2. Maximize Savings and Minimize Debt

An important part of preparing for your retirement in the next five years is making sure your financial choices are aligned with your goals and values.

Prioritize saving and debt reduction. With retirement looming, focus on two key financial goals: maximizing retirement savings and eliminating consumer debt. Consumer debt, with its high-interest rates, can significantly drain your retirement income. Prioritize paying it off to free up more cash flow.

Strategic allocation. Follow a strategic approach to saving and debt payoff:

• Save up to the employer match in your 401(k) plan.
• Eliminate consumer debt.
• Max out a Roth IRA.
• Max out your employer-sponsored retirement plan(s).

Budgeting is key. Creating a budget is essential for identifying areas where you can cut expenses and increase savings. Track your income and expenses, differentiate between needs and wants, and find creative ways to reduce spending. Even small changes can make a big difference over time.

3. Strategize Retirement Income Withdrawals

The fact that your money will continue to grow in retirement is the reason why determining how much you can afford to withdraw each year is more complicated than simply dividing your nest egg by the number of years you hope to live.

4% Rule vs. Bucket Method. Two primary strategies exist for retirement fund withdrawal: the 4% rule and the bucket method. The 4% rule involves withdrawing 4% of your assets in the first year and adjusting for inflation annually. The bucket method divides your portfolio into separate income "buckets" for short-, medium-, and long-term needs.

Understanding RMDs. Federal regulations mandate required minimum distributions (RMDs) from tax-deferred retirement accounts (like 401(k)s and traditional IRAs) starting at age 72. These RMDs can impact your withdrawal strategy, so factor them into your planning.

Annuities as an option. Annuities offer guaranteed income streams in retirement. While they have drawbacks, such as limited access to principal, they can provide peace of mind for those seeking a hands-off approach to managing retirement income.

4. Find a Trustworthy Financial Advisor

Partnering with a financial professional to prepare for retirement can help relieve your stress about the big decisions ahead of you, but how do you find the right adviser for your needs?

Skills and knowledge first. When seeking a financial advisor, prioritize their skills and knowledge over perceived trustworthiness. Competence is harder to fake than sincerity. Look for advisors with relevant certifications and a proven track record.

Understand compensation models. Different advisors are paid in different ways, which can influence their recommendations. Be aware of commission-based advisors, fee-only advisors, and fee-based advisors. Fee-only advisors, who are paid directly by clients, are often considered the most objective.

Ask the right questions. Interview potential advisors to assess their expertise, investment philosophy, and compensation structure. Ask for sample portfolios and inquire about their ideal client. A good advisor should be transparent, communicative, and aligned with your financial goals.

5. Understand Social Security Benefits

Social Security is in the news a lot, and that can make you worry.

Social Security's role. Social Security is a crucial component of retirement income for many Americans. Understand how the program works, including eligibility requirements, benefit calculations, and claiming strategies.

Timing is key. The age at which you claim Social Security benefits significantly impacts the amount you receive. Delaying benefits until your full retirement age (or even age 70) can result in a substantial increase in your monthly payments.

Spousal and survivor benefits. Be aware of spousal and survivor benefits, which can provide additional income for eligible spouses and surviving family members. These benefits can be particularly important for those with lower earnings or who have lost a spouse.

6. Minimize Taxes on Retirement Income

There is no avoiding the taxman, not even in retirement.

Tax diversification. Develop a tax-efficient retirement income strategy to minimize your tax burden. This involves understanding the tax implications of different income sources, such as Social Security, pensions, retirement accounts, and investments.

Roth accounts. Consider utilizing Roth IRAs or Roth 401(k)s, which offer tax-free withdrawals in retirement. Converting traditional retirement accounts to Roth accounts can also be a tax-saving strategy, although it may trigger a tax liability in the year of conversion.

Asset allocation. Strategically allocate your assets between tax-deferred, tax-free, and taxable accounts to optimize your tax situation. Place high-yield bonds in tax-deferred accounts and stocks in taxable accounts to minimize your overall tax burden.

7. Plan for Healthcare Costs in Retirement

Healthcare is likely to be one of your largest expenses in retirement, even with the help of Medicare.

Estimate healthcare expenses. Healthcare costs can be a significant drain on retirement savings. Estimate your potential healthcare expenses, including Medicare premiums, deductibles, copayments, and long-term care costs.

Medicare and Medigap. Understand your Medicare options, including Parts A, B, C, and D. Consider purchasing Medigap insurance to supplement Original Medicare and cover out-of-pocket costs.

Long-term care planning. Plan for potential long-term care needs, which are not covered by Medicare. Explore long-term care insurance or other strategies to protect your assets from the high cost of long-term care services.

8. Make Informed Housing Decisions

Unlike most of the other issues in this book, the questions raised in this chapter may require you to discuss options with your children or other family members.

Assess your current housing situation. Evaluate your current housing needs and expenses. Consider whether downsizing, relocating, or staying put is the best option for your retirement.

Mortgage considerations. Aim to pay off your mortgage before retirement to reduce your monthly expenses. If you're unable to do so, explore options such as accelerating payments or downsizing to a smaller home.

Reverse mortgages. Be cautious about reverse mortgages, which can be complex and costly. Understand the terms and conditions before taking out a reverse mortgage.

9. Address Family Financial Expectations

The intersection of money and family is a charged subject, and one of the many reasons Thanksgiving dinner can be so uncomfortable.

Prioritize your retirement. While it's natural to want to help family members, prioritize your own retirement security. You can't effectively support others if you jeopardize your financial well-being.

Set boundaries. Establish clear financial boundaries with family members. Communicate your limitations and avoid enabling unhealthy financial habits.

Open communication. Have open and honest conversations with your family about your financial situation and their expectations. This can help prevent misunderstandings and resentment.

10. Prepare for Unexpected Setbacks

There are no guarantees in this life, and so part of your retirement planning should include plans for how to handle a less-than-ideal beginning to your retirement.

Build an emergency fund. Create an emergency fund to cover unexpected expenses, such as medical bills or home repairs. This can help you avoid dipping into your retirement savings.

Develop a "Plan B". Create a contingency plan for potential setbacks, such as job loss, health issues, or market downturns. This might involve working longer, reducing expenses, or finding alternative income sources.

Stay informed and adaptable. Retirement planning is an ongoing process. Stay informed about changes in laws, regulations, and market conditions, and be prepared to adjust your plan as needed.

Last updated: February 25, 2025