Retiring in the Next 12 Months? Answer These 3 Questions Before Your Paycheck Stops

If you're retiring in the next 12 months, you have a lot to be concerned about — volatile markets, dropping interest rates and a midterm election year.

But it's not the markets or the politicians that affect your retirement the most — it's the decisions you make in the final year before you retire.

Decisions, like Social Security, which are basically irreversible. And decisions, like how much you plan to spend and when you adjust your investments, that will determine which path your retirement takes.

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These decisions often hurt, not because you made the wrong choice, but because you didn't take action at the right time.

Here are the three questions to answer before you can consider yourself ready to retire.

Question No. 1: How much monthly income do I need to retire?

One of the biggest unknowns when it comes to retirement is how much money you need — not whether you have $1 million or more in your 401(k), but how much monthly income you need to retire — what I call your retirement spending plan.

Creating a retirement spending plan sounds like a daunting task, but it's not too bad if you break it down to three main areas: lifestyle spending, health costs and taxes.

You don't need to track your spending or create a budget from scratch to determine how much you'll need in retirement. You already have a natural way to figure this out — your monthly take-home pay.

Generally speaking, what goes into your checking account gets spent, so look at your monthly take-home pay and plug in that number as your lifestyle spending amount.

Your take-home pay is missing two key ingredients to your retirement spending plan and you'll need to add those in — health insurance costs and tax costs.

To determine your health insurance costs, look into the cost of your retiree health insurance plan (if you're fortunate enough to have one), or call a local, independent health insurance broker who can tell you the likely costs of health insurance before you reach Medicare at 65, and afterwards when you're part of the Medicare insurance system.

You could research these costs on your own, too, at Healthcare.gov for your pre-Medicare insurance, and Medicare Plan Finder for post-65 insurance costs.

To determine your tax costs, I prefer to use the type of forward-looking tax projections that an adviser can show you. This should give you extra details you need to make ongoing tax-planning decisions that could lower your lifetime tax bill.

If you're projecting your tax costs on your own, without access to those types of tax projections, then you could estimate your tax costs with the easy method — look at your last year's tax return and find the "effective tax rate" your tax preparer or tax software calculated for you.

You could then apply that percentage to your lifestyle and health costs to determine your likely retirement tax costs going forward.

When you understand how much you want to spend in retirement, it's time to find out how much income you'll get in retirement and when it starts.

Question No. 2: When should I start taking Social Security in retirement?

Your Social Security decision could easily be the most impactful decision you make. Dr. Larry Kotlikoff, Professor of Economics at Boston University, found that Americans are often missing out on $180,000 in benefits over their lifetime because of the decisions they make.

Before you make your Social Security decision, it's good to get accurate math around the key factors that determine whether you made the right choice or made a mistake with your Social Security timing.

The first thing people do when deciding Social Security timing is often creating a break-even calculator in which they see they'll need to live into their late 70s to break even. Seeing that, they say, "What are the odds I'll make it that long?" and then they file for Social Security early — and that's where the $180,000 mistake comes in.

Not that filing early was a mistake, but that they filed with incomplete data. They found the break-even age, they figured that the odds of reaching that number matter — and then they didn't bother learning those odds.

If you're using a break-even calculator, you deserve to know the odds you'll reach the break-even age. It'll take you less than five minutes at a place such as Longevityillustrator.org — and the results will be eye-opening.

Another mistake that leads to the $180,000 in lost income is when people treat the Social Security decision of each person in a couple equally.

When there are two of you, one of your Social Security benefits is likely larger. While Social Security benefits grow by 7% to 8% per year for waiting, 7% to 8% on a larger number is a larger number.

There will eventually become one of you, and the higher Social Security benefit will stay with the surviving spouse, while the lower benefit will end.

The two benefits aren't treated equally by the Social Security rules, and if you want to get the most out of Social Security, make decisions that take advantage of those rules.

The smaller benefit doesn't grow as much and doesn't last as long. This encourages you to take the smaller benefit sooner, perhaps sooner than you had originally planned.

The larger benefit grows more and lasts longer. This encourages you to take the larger benefit later, perhaps later than you had originally planned.

Keep those differences in mind when you plan when to take Social Security.

Now that you know how much income you need and how much income you'll get from your Social Security, it's time to change your investments to match your retirement cash flow needs.

Question No. 3: How should I adjust my investments before I retire?

I met several investors in the summer of 2020 who called me with very similar stories. They were planning to retire in January 2021, and in January 2020, 12 months away from their retirement dates, they were each invested 100% in the stock market.

These investors figured that growth investments had done well for them and that they could get another full year of growth in their 401(k) before they would change their investments to be more conservative when retiring.

Then COVID hit, the U.S. stock market dropped 30% by late March, and they panicked and sold everything to cash — just before the stock market jumped 20% in three days the last week of March.

Then their company (they all worked at the same place) announced they were laying off 20% of the workforce, and their planned retirement of January 2021 became July 2020.

They called me within days of one another, asking the same question: "What do I do with my investments now that I'm retired earlier than I expected and my accounts are 30% lower than I planned?"

So many people are like these investors. They believe the time to adjust their investments for retirement is on their retirement date. But they found out, unfortunately, two very real truths about retirement:

• The stock market doesn't care about your retirement date
• Your retirement often arrives earlier than you expected

These investors were relying on averages and assumptions to get them through that last year of retirement. They assumed, since the market has gone up 70% of the time, that the market would go up the last year of their retirement.

Since the S&P 500 has averaged approximately 10% per year, they were trying to boost their 401(k)s by another 10% before they dialed back the risk.

Oddly enough, their assumptions were correct. The S&P 500 finished up 18.4% in 2020.

What got in their way wasn't the stock market; it was how they reacted to the stock market. While they'd gone through market drops before, they'd never retired before. They didn't realize ahead of time how they'd react when faced with a big market drop less than a year before their retirement date.

That's why you need to rely on a proven process, not averages and assumptions, when it comes to your retirement investments.

Don't blindly assume the market is going to be up the year you retire. Don't assume that you'll switch your investments wholly from growth to income investments on your retirement date.

Instead, use a process such as the one I share in my book, Retire Today. Focus first on your spending needs, then on how you'll set up your lifetime income, such as pensions and Social Security.

Get your investments ready to fill the gap between the spending you want and the income coming in — not the day you retire, but even up to three to five years before you retire.

When you're this close to retirement, you have a lot to be concerned about — the stakes are high, and the ability to mess things up is always lurking.

If you're retiring in 2026, 2027 or even 2028, it's time to get ready for retirement today. Focus first on your spending needs and your income sources. Then get your investments ready to retire before you retire.

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