Key Takeaways:
- Five years before retirement, your focus shifts from building savings to turning them into a reliable paycheck replacement by coordinating spending, Social Security, pensions, taxes, and withdrawals.
- Match predictable income like Social Security and pensions to essential expenses, then work out how much your portfolio must cover to fill the gap.
- Use these final working years to stress-test your retirement date, plan for healthcare and taxes, and build a plan you revisit regularly.
Five years before you begin retirement is when you need to plan for the shift from accumulating money to spending it to replace your paycheck. This change can be dramatic for many people as they have never experienced it before.
What must you plan for? You must coordinate spending, Social Security benefits, pensions, taxes, healthcare decisions, and how to withdraw from your retirement plan(s).
Step #1: Define Your Retirement Income Target
First step: how much will you spend once your paycheck stops? What is essential spending and what is non-essential spending?
Which expenses are expected to change once you are retired? Commuting, clothing, travel, healthcare, hobbies, taxes, housing, etc.
Which large-ticket items that tend to be irregular should you budget for? Account for new vehicles, home improvements, family support, and travel outside your regular monthly budget.
For inflation protection, choose a figure that represents a longer time span rather than what inflation is currently running at.
Step #2: Map the Income Sources That Will Replace Your Paycheck
When will you receive your monthly Social Security payment? What about pension payments? Retirement account payouts? Rental income? Part-time earnings?
Match predictable income from Social Security and pensions with essential ongoing spending. If there is a deficit, how much must come from other sources?
Review Social Security and Pension Timing
This issue is very important. Before claiming Social Security, determine how much you will receive by looking at what age you start claiming. The longer you wait before claiming, the more you get for the rest of your life.
If you are entitled to a pension, review when benefits begin, the amount you receive, and, if married, survivor benefits.
If you decide to claim Social Security until age 70, determine how much of your investment assets will be needed to fund your expenses until Social Security payments begin.
Identify the Portfolio Income Gap
How much will you spend each month vs. how much will you receive from Social Security, a pension, and other dependable benefits?
How much of your retirement/non-retirement accounts will you need to draw from each year?
Can your assets sustain the current withdrawals you are taking?
Step #3: Use Your Final Working Years to Strengthen the Income Plan
Can you contribute more to your retirement plan while still working?
Are you eligible for catch-up contributions for workers aged 60-63?
Are you setting aside money to build cash reserves for unexpected needs?
Can you reduce your expenses before retirement to increase cash flow?
Step #4: Build a Tax-Aware Retirement Withdrawal Strategy
How will your taxable situation change once you retire and Social Security, pensions, and retirement account withdrawals begin?
How will taxable, tax-deferred, and Roth accounts provide different sources of retirement income?
How will withdrawing money for your retirement affect your taxes from federal, state, Social Security, and Medicare?
Plan Beyond the First Retirement Year
Anticipate what your future required retirement distributions will be, when you will stop working part-time, when a pension will begin, or when a spouse will begin taking Social Security.
Should you participate in charitable giving? Will that help your tax situation?
Step #5: Determine How Healthcare Fits Into Retirement Income
Separate your expected healthcare costs, as they can balloon faster than other costs.
If you retire before Medicare begins, how will you handle your healthcare needs?
Prepare for Medicare enrollment by reviewing premiums, supplemental coverage, prescription coverage, and out-of-pocket costs.
Step #6: Stress-Test the Retirement Date Before You Commit
What if you retire early? Will your retirement plan still work? What about lower expected investment returns? What if you live longer than expected?
Stress-test your investment plan assets. What if the investment markets do poorly?
Have you looked at retiring later and what the extra years of earnings, retirement plan contributions, and delayed withdrawals do to your projections?
Confirm the Plan Can Adapt
Always keep an adequate emergency fund.
Which expenses could be reduced during difficult investment markets?
Planning is more important than a plan. A plan you don’t revisit is no plan at all.
What to Do 5 Years Before Retirement FAQs
1. What Should I Consider 5 Years Before Retirement?
Start your retirement planning early to reduce uncertainty and allow for adjustments while you still have some flexibility. Check where you stand at least once a year by reviewing your retirement plan and investment mix to ensure they still fit your goals. If you need to save more, look for practical ways to increase contributions across accounts such as workplace plans, IRAs, and (if eligible) an HSA. Think through Social Security timing, because claiming too early can reduce benefits and waiting (up to age 70) can increase lifetime income for some people. Plan for taxes ahead of time by using a mix of account types, and consider moves like Roth conversions only after weighing the tradeoffs.
2. What Is the Number One Mistake Retirees Make?
Failing to create a comprehensive income and distribution plan before they stop working.
3. How Do You Know It’s Time to Retire?
You know it is time to retire when your savings align with your living costs, and you feel ready to leave your job for health or lifestyle reasons.
4. How Much Retirement Income Should I Have Before I Retire?
Most people need 70% to 80% of their pre-retirement annual income to maintain their standard of living after stopping work. However, this is a general figure, and you should do the calculations based on your particular situation.
5. Should I Increase My 401(k) Contributions in the 5 Years Before Retirement?
Yes, you should usually increase your 401(k) contributions in your final 5 working years if your nest egg is behind, but check your tax and debt situation first.
Get Help Building Your Income Plan 5 Years Before Retirement
Use the 5 years leading up to your expected retirement to review your spending habits, guaranteed income (such as Social Security and pensions), investment withdrawals, taxes, and healthcare needs.
A qualified retirement planning specialist can devise a retirement plan that captures all of the issues stated above.
The goal of such a plan is to ensure you stay financially healthy during retirement, no matter how long it lasts. You must be willing to adapt to whatever the future holds.
For over 40 years, Retirement Solutions has helped women view their financial future with anticipation rather than apprehension. We do that by empowering our clients through education. We believe an educated client is a client who can make the right financial decisions. To introduce our services, we offer a no-cost, no-obligation 15-minute telephone conversation to understand your current situation and whether we can help you get where you want to be financially. Simply click the link in the upper right-hand corner of the Home page of the website, “Let’s Discuss Your Financial Future”. You talk, we listen.