Retirement can seem like a distant goal until suddenly it isn’t. When you only have a few years left until retirement, the financial decisions you make take on new meaning. Once you’re within the five-year window, this is a good time to review your plan to make sure you’re on the right track. It’s helpful to understand why the last five years before you retire are crucial. Talking to a financial advisor can give you clarity about what is working and what isn’t in your plan.
Timing is important for retirement planning
If you’re younger, time is on your side when it comes to investing for retirement. The more time you have to save and invest, the greater the chances of your money growing. If you wait to save for retirement, you may have to catch up later. As you approach the final five years before retirement, starting late can put you at a serious disadvantage. There are two reasons.
First, you have less time to benefit from compound interest. Even if you max out your annual contributions to a 401(k) or IRA, including catch-up contributions because you’re 50 or older, it may not be enough to make up for lost time in the market.
The second reason is related to the first. It’s natural that as you get older, you start to shift more of your assets into safer investments. Switching to more conservative investments like bonds can reduce the risk of losing money near retirement. However, it also allows you to accept higher returns, which your portfolio may need if you started saving late.
Why the last five years before your retirement are crucial
The last five years before you retire are essentially a test of your previous preparation and planning. With five years left until you retire, you have one big question to answer: Can I afford this?
Whether the answer is yes or no depends largely on what you have planned in advance. The most important factors that can influence retirement preparation include:
-
What you have saved in company retirement plans or IRAs
-
The amount of debt you owe, other than your mortgage
-
Your expected expenses in retirement, based on your preferred lifestyle
-
How long your savings will have to last depends on your retirement age
If you planned well and followed your plan consistently, you may not need to make major adjustments in the last five years before retirement. However, if there are gaps in your plan or you haven’t even started planning yet, you may need to do more to prepare for retirement.
Checklist for 5 years until retirement
If you still have five years until retirement, it’s helpful to know what you should do to assess your readiness. Here are some of the most important things you need to address to ensure you can retire comfortably and on time.
Check your savings: To be where you want to be in retirement, you need to know where you are right now. Specifically, it’s about understanding how much you have saved for retirement and how much you still need to save over the next five years to reach your goal.
Analyzing the numbers with a retirement savings calculator can help you see how close or far away you are from your goal. You can use the resulting number to design the next steps in your financial plan.
For example, if you’re behind, you may need to significantly increase 401(k) or IRA contributions. Or you may need to adjust your investment strategy to achieve higher returns in the remaining years until you retire.
Know your sources of income: It’s a good idea to know what sources of income you can count on after you actually retire. Depending on your situation, this may include:
-
Withdrawals from a 401(k) or similar workplace plan
-
Traditional or Roth IRAs
-
Retirement income if your employer offers a retirement plan
-
Social Security Benefits
-
Federal Employees Retirement System (FERS) benefits.
-
Income from rental property if you own real estate
-
Pensions
You may also have income from other sources, such as inherited retirement accounts or a health savings account (HSA). An HSA is not a retirement account per se because it is intended to be used for eligible medical expenses. However, once you turn 65, you can withdraw money from an HSA for any reason without penalty. You only pay ordinary income tax on distributions.
Taking inventory of your potential sources of income can give you a better idea of how much you may need to spend. It can also help you determine things like when you should start withdrawing from tax-deferred plans, how much you should withdraw, and when is the best age to claim Social Security benefits.
Retirement Expenses Estimate: Income is one side of your retirement budget and expenses are the other. If you have five years until retirement, this is a good time to think about what kind of lifestyle you want and what your savings will allow you to afford.
Typical retirement expenses include housing, utilities, groceries and health care. Your budget can also extend to travel, leisure activities or new hobbies you’ve always wanted to try. If you create a mock budget and then compare the numbers to your expected monthly income, you can see how far the numbers differ.
You can also take it a step further and try to live on your retirement budget for the last five years before you retire. This can help you gauge how realistic it is. If you expect to spend less in retirement than you do now, test-running your budget can give you a little more money left over to save each month.
Consider long-term care needs: The costs of long-term care can easily wipe out your retirement savings. If you are in the five years before retirement, this is a good time to assess your personal risk.
Medicare doesn’t cover long-term care costs, but Medicaid does. There is a catch, however, because qualifying for Medicaid usually means you have to deplete your assets. If you don’t want to do that, you can think about taking out long-term care insurance in the five years before you retire.
Long-term care insurance can pay out benefits to cover necessary care services. If you’re not sure whether you need long-term care, you may want to consider hybrid insurance that also includes life insurance. If you do not claim the nursing care benefit, the insurance company can still pay out a death benefit to your beneficiaries.
Check your tax situation: Managing tax liability in retirement allows you to keep more of your savings. You may consider making some tax moves in the last five years before retirement that may enable you to pay less to the IRS later.
For example, you could convert your traditional IRA to a Roth IRA to benefit from tax-free withdrawals in retirement. Converting a traditional IRA to a Roth doesn’t allow you to escape taxes entirely; Exchanges are subject to the same tax regulations as withdrawals.
However, once you convert to a Roth account, you will no longer pay taxes on distributions in the future. This could result in significant tax savings if you expect to be in a higher tax bracket in retirement.
Bottom line
The last five years until retirement can fly by, and you shouldn’t waste any time finalizing your plans. Taking the time to evaluate where you are and where you want to go can help ensure you don’t fall short when it comes time to leave the workplace behind for good.
Retirement planning tips
-
Creating a five-year retirement plan can also include planning for contingencies. Talking to a financial advisor can help you develop a Plan B if you’re concerned that anything could affect your retirement plan. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with up to three verified financial advisors working in your region, and you can have a free discovery call with your matching advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
-
Investing in tax-deferred accounts like a 401(k) or IRA is a smart move for retirement planning. If you want to add another savings option to the mix, you could consider opening a taxable brokerage account. Taxable accounts are subject to capital gains tax when you sell investments for a profit. However, they do not have the same annual contribution limits as tax-advantaged accounts and there are no early withdrawal penalties.
Image credits: ©iStock.com/PeopleImages, ©iStock.com/AzmanL, ©iStock.com/Onfocused
The post How to Master the Last 5 Years Before Retirement appeared first on SmartReads CMS – SmartAsset.