5 Financial Moves You Should Make Five Years Before Retirement
Here you are, five years from retirement. The reality of the end of your career is finally hitting home, but you may not feel completely ready to quit work yet.
But with adequate planning and preparation, it is possible to feel confident about your life and finances as you approach retirement. Here are five goals that most workers should plan on reaching when they are five years from retirement.
1. Calculate Your Post-Retirement Budget
It may seem too soon, but now is an excellent time to re-evaluate how much money you will need to live on comfortably in retirement. Many workers assume that their expenses will go down in retirement, since they will no longer need to pay for professional clothing, commuting, business travel, and the like. However, depending on how you intend to spend your time in retirement, your expenses could go down by less than you anticipate, or even go up if you plan to travel more or enjoy expensive hobbies.
In order to calculate your post-retirement budget, start by listing all of your monthly expenses that will stay the same, including rent or mortgage, car payment, utilities, groceries, personal care, taxes, and insurance.
Then tease out what expenses you incur from working. These might include car maintenance, professional clothing, dry cleaning, dining out, tolls/parking, and professional subscriptions. Don't forget to include the kinds of purchases that are not necessarily work-related, like convenience foods or getting a stress-relieving massage, but that you will have less of a need for in retirement.
Finally, calculate how much you expect to spend on retirement-related expenses, such as hobbies, memberships, or travel.
These three numbers can give you a sense of how much you are currently spending, what not working will save you, and how much you need to have set aside for activities in retirement. Now is the perfect time to start scaling back on the monthly expenses that will stay the same if you are worried about affording your retirement activities.
2. Take Advantage of Catch-Up Provisions
Calculating a post-retirement budget is often a good motivator to start putting more money aside for retirement. Don't assume that five years before you retire is too late to do any good. You still have time to grow your nest egg, particularly if you can take advantage of the catch-up provisions in your tax-advantaged retirement accounts.
Tax-advantaged accounts like 401Ks and IRAs have contribution limits that put a cap on the amount of money you can place in them each year. For the majority of taxpayers, the 401K contribution limit is $18,000 per year, and the IRA contribution limit is $5,500 per year. However, taxpayers over the age of 50 may contribute a total of $23,000 per year to their 401Ks and $6,500 per year to their IRAs (as of 2016).
Coming up with that kind of scratch to send to your retirement account might be a tall order, but don't forget that both 401K plans and traditional IRAs are tax-deferred. That means you can deduct your contributions from your annual taxes, thereby lowering your current tax burden.
3. Pay Down Your Debt
Entering into retirement while carrying debt can seriously weigh you down, so the five years before retirement is a great time to tackle it.
Start with your consumer debt, such as credit cards or a car loan. These are probably charging higher interest than you could earn through any investments, so eliminating all of your consumer debt will help your money go further and save you a great deal over time.
It's also a good idea retire your mortgage before you stop working (although you should prioritize paying off consumer debt before your mortgage). Owning your house free and clear in retirement offers you more options to handle whatever happens next.
4. Calculate Your Social Security Benefits
All of the arcane details of claiming Social Security could fill a book (ahem), but it is a good idea for workers nearing retirement to get a basic understanding of what benefits will be available to them based on various retirement timelines and spousal coordination.
In order to determine your benefit, the Social Security Administration uses a complex formula to adjust your earnings to account for average wage changes (this is known as indexing), and then calculate your specific benefits. The Social Security website offers several user-friendly calculators and applications to help you figure your potential benefits. Specifically, the SSA benefits calculators allow you to enter your information to learn what you can expect from your benefits.
In addition, signing up for a "My Social Security" account can provide you with a great deal of specific information about your particular earnings record and projected benefits. It's an important planning tool for anyone within five years of retirement.
5. Start Planning Your Income Withdrawal Strategy
Many retirees don't really think about how they'll draw down their assets in retirement, assuming that they can just take a small 3% to 4% of their nest egg each year.
There are two problems with this scenario. First, if you have a less than robust nest egg, the small percentage you have to live on might not be enough. Second, if you have to withdraw money during a major market downturn, your nest egg may not recover.
Instead, you can plan ahead with the bucket method for retirement income, which starts with the assumption that retirees will have to ride out some market volatility during their retirement. With this method, you split your portfolio into separate income "buckets," each of which will be intended to handle a different time period in retirement. A common allocation would look like this:
Bucket 1: Years 1—5
This will be the money you live on in your first years post retirement, while the majority of your nest egg remains invested in longer-term assets. Since you want both stability and liquidity in this time period, the money in this bucket will be placed in cash equivalent assets, such as CDs, U.S. Treasury bills, and money market funds.
Bucket 2: Years 6—15
You won't be tapping this money until you have gotten a few years into your retirement, so you can afford to be a little more aggressive with your investments. This means your second bucket will generally consist of a mix of bonds and stock, leaning more toward the safety of bonds. You want to reasonably protect your principal here, but still allow your money some room for growth.
Bucket 3: Years 16+
You can afford to be aggressive in this bucket of your portfolio, since you have time to let your money grow. This bucket will consist of higher-risk/higher-return assets, such as stocks and other types of equities, since you have at least 15 years to both ride out market volatility and reap potential benefits.
Five years before retirement is the perfect time to start planning your retirement income withdrawal strategy, so you can make decisions without feeling the time-crunch of a looming retirement date.
This Is Your Victory Lap
The five years before you retire can be a challenging and emotional time. Feeling prepared for the financial aspect of retirement can give you the freedom to enjoy the last few years of your career.
Will you be ready to make these key retirement moves when you're five years away?
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