Retiring in the Next 5 Years? Make These Five Decisions Now

In the five years preceding retirement, a person will make more important decisions about how to maximize their retirement than at any other time. Why? Because these decisions are not easily altered, and the impact will affect important income and expenses for the rest of their lives. Making the right decisions can provide substantially more income over a longer period of time – which is the ultimate goal.

Millions of people must make these decisions annually. Approximately 2 million Baby Boomers have been retiring every year since the oldest turned 65 in 2011. To effectively prepare for a retirement free of financial worry, here are five important decisions pre-retirees will need to master to be prepared for a confident retirement:

Know How Much You Need to Retire

For most retirees, this is the critical question they need to answer. It drives all other decisions, as “your number” depends on your spending level, investment returns, tax rate and how long you expect to live.

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To help determine your number, start by projecting your spending needs in retirement. Make a list of all current expenses, as well as anticipated future needs. For example, you may want to purchase a new car every five years or deposit $10,000 annually into a 529 college savings account for your grandchildren.

Next, take into consideration your sources of income in retirement. Income from sources such as pensions, part-time work and Social Security will first be applied to offset your expenses, leaving a remaining portion to be covered by your savings and investments.

For example, say a couple retiring at age 67 plans to spend $100,000 annually in retirement. They will receive a pension of $25,000 annually and combined Social Security income of $25,000 annually. To meet the remaining $50,000 of retirement needs, our couple would need a portfolio of approximately $2 million in assets. A portfolio of this size will cover their ongoing expenses at a conservative withdrawal rate of 4%, while the remaining principal continues to grow and can be passed on to their heirs.

Examine Your Asset Allocation and Fees

To maximize your portfolio’s long-term potential to produce income, it’s critical that your investments are not too aggressive or too conservative. As people grow older, they tend to place more money in cash and bonds, and less in stocks. This can be a prudent strategy, since a person nearing retirement has less time to recover from potential losses.

However, by cutting back too much on growth investments like stocks, retirees may cheat themselves out of the investment returns needed to preserve growth and maintain purchasing power. Most retirees plan to live off their investments for 30 years or more, and the amount allocated annually for spending needs to be indexed for inflation. I often advise clients to continue to invest 40% to 60% of their investment portfolio in stocks, even after they retire, to overcome the long-term drag of inflation.

In addition, excessive fees are a sneaky culprit eroding important returns. To protect against this risk, analyze all fees paid to your advisers, custodians and mutual fund families. And, while fees are an important consideration, make certain your financial adviser is providing the appropriate value for the services you receive!

Optimize Social Security Elections

More than 64 million Americans now receive Social Security. Optimizing these benefits can have a significant impact on your annual income during retirement. While most retirees are aware of the reduction in benefits from taking them too early, few understand the compounding impact of deferring Social Security benefits. For each year your benefit is deferred beyond your normal retirement age, your benefits will increase 8% annually.

For example, one person scheduled to receive $25,000 annually in Social Security benefits at their full retirement age of 66 instead will receive $33,000 annually if they wait until age 70. For a married couple, the benefit is even greater as a surviving spouse is able to retain the higher Social Security benefits for their lifetime as well.

There are hundreds of different filing strategies for Social Security. Astute financial advisers have the ability to triangulate the optimal strategy. Before the first person reaches age 62, review your Social Security options with a financial adviser and develop a plan to optimize these benefits.

Project Retirement Outcomes for the Rest of Your Life

Your money should last longer than you do. Before calling it quits from your career, engage a financial adviser to develop a year-by-year cash flow projection (we recommend to age 95), as well as the order each asset should be tapped. This exercise will help you understand the impact of your sources of retirement income, how expenses are allocated, and where investment returns contribute to your long-term success.

And here’s another benefit: By stress-testing these projections against past results, you will see the probability of your outcomes. Nothing is better than stepping into retirement with a high probability of trust to take the first step!

Explore the Final Contributions to Your Retirement Plan

Whether selling your business or looking to maximize the value of stock options, the potential of facing a large, one-time tax bill exists at the onset of retirement.

To protect your hard-earned retirement capital, make sure to fully contribute to 401(k) and other qualified (aka, tax-deferred) retirement plan(s) by your retirement date. By accelerating things such as your 401(k) deferrals, you can “top off” your retirement savings and lower your income ahead of a taxable event.

For small-business owners with these plans, there is a unique opportunity to use some cash flow from their business to maximize their profit sharing and defined benefit contributions in the year they sell their business.

For example, a dentist who sells their practice mid-year can save a significant amount of money in taxes. By making a $50,000 contribution to their profit-sharing plan, they can save close to $20,000 in taxes, assuming a 40% combined federal and state tax rate.

No matter your situation, taking the time in the five years before retirement to explore all possible options and make the right financial decisions can result in hundreds of thousands of dollars in extra income over the course of your retirement years. That difference will enable a retiree to enjoy these years without worry while also leaving plenty of assets for their heirs.