What To Do 5 Years Before Retirement

You’re 5 years away from retirement! You could be feeling a lot of things right now– excitement, nervousness, relief, apprehension, stress. Whatever you are feeling a clear plan, knowing your options and working with an expert can provide peace of mind to retire with confidence.

Determine your purpose

A lot of people focus on just making it to retirement, but once you retire, what are you going to do with your time? If you don’t know what you want your retirement to look like, it can be very disorienting. The first step to an enjoyable retirement is knowing what you want to do with your time and who you want to do it with.

Tips to Know:

• Figure out what a new ideal day is now that you don’t have to work 9-5. Do you want to pick up a new hobby? Travel more? Do you have a charity you want to volunteer at more often?
• Some people have found talking to a professional counselor to be helpful in determining goals and purpose in this new life stage.

Calculate your retirement expenses

Before you can feel confident in retiring, you need to weigh the cost. A good way to measure the costs of retirement is by looking at your current expenses. Then you can subtract expenses that won’t be there, maybe a mortgage, and add new expenses like Medicare premiums or any big travel plans you would like to experience.

Tips to Know:

• Use your current budget as a starting point to determine the cost of retirement. Then eliminate or lower the expenses that will no longer apply (such as the gasoline you use to commute to and from work) and add or increase the items that will represent new expenses during retirement (such as higher home utility bills or more leisure travel).
• While you plan for your life expectancy, consider whether your family has been prone to costly, long-term illnesses. If so, insuring your retirement assets should be high on the list of items to include in your analysis. You may want to consider long-term care (LTC) insurance to pay for nursing home care or similar services should you eventually need them.

Retirement income

Now that you know what your retirement may cost, it is crucial to know what your cash flow will be in retirement. Retirement income is simply getting a monthly paycheck from what you’ve saved up instead of from your employer.

Start with pulling your social security statement to estimate your monthly benefit. Remember your spouse is eligible for 50% of your benefit or 100% of theirs, whichever is higher. Then add up any retirement or investment accounts you have (IRA, Roth IRA, 401(k), 403(b), etc.) and for quick estimate, use 3% as a minimum distribution. So, if you have $500,000 saved up in an IRA, 3% of that would be $15,000 a year gross or $1,250 a month on top of social security.

Tips to Know:

• Keep in mind the distribution rules around your retirement accounts. With IRAs and 401ks, you need to wait until you are 59½ to withdraw funds to avoid a 10% penalty but at 72, you have to start withdrawing funds from pre-tax accounts (traditional 401k and IRA) to satisfy the Required Minimum Distribution rules.
• Choosing to wait to receive Social Security can increase your benefit significantly. See the Optimize Social Security Elections section below.

Health care options

As you get older, your need for health care becomes greater. This makes having a plan in place for your health care costs crucial to ensuring that your retirement savings will last through your lifetime. Having to use your retirement savings to pay unexpected medical expenses could put your retirement income at risk.

This is especially true if your assets are significant enough that it’s unlikely you will qualify for Medicaid-supported nursing home care—but you’re not so wealthy that your assets will easily cover whatever happens to you.

Tips to Know:

• On average, a healthy 65-year-old couple retiring in 2019 can expect to spend more than $387,000 for retirement health care costs, not including long-term care.
• If you’re married, consider what would happen if one partner became sick and drained the savings intended to support the other partner after a spouse’s death.
• You can elect into Medicare 3 months before 65, 1 month during and 3 months after 65.
  • If you miss this window (and are no longer working) you will pay a higher premium for Medicare for the rest of your life so do not miss it!
• If your spouse is working, it could be beneficial to utilize your spouse’s policy before Medicare kicks in.
• Medigap policies may also be needed depending on your current health situation. They are simply policies that provide for certain medical care like pharmacy coverage or long term care that Medicare currently doesn’t cover.

Optimize Social Security elections

More than 64 million Americans now receive Social Security. Choosing when to start 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.

Tips to Know:

• 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 of waiting is even greater because a surviving spouse is able to retain the higher Social Security benefits for their lifetime as well.
• Use this Social Security Quick Calculator to estimate your monthly benefit checks. (Try entering various retirement dates to see how waiting or claiming earlier will affect your checks.)
• 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.

Create a tax strategy

Retirement means living on what you’ve got and paying as little tax as necessary, but tax planning can be complex. For example, do you know:

• Whether you’ll need to pay tax on your Social Security income?
  • This depends on how much income you have from other sources like part time work or qualified withdrawals from your 401k or IRA
• What are smart ways to minimize taxes when withdrawing retirement savings?
  • You can use strategies like tax bracket management or asset location to minimize the tax
• Why — and how — you can boost retirement finances with a health savings account?
  • You can use your HSA from before retirement for both your medical expenses and also normal retirement expenses. If you use your HSA for normal expenses that aren’t medical, you will owe taxes on those withdrawals.
• How to use a Roth IRA and why it’s important to start one years before retiring?
  • Money from a Roth IRA in retirement is tax free and won’t impact your social security check!

Having a clear tax strategy to keep the majority of your monthly income is critical to making your money last. Be sure to work with a qualified accountant or financial advisor before and in your retirement.

Key takeaways

Preparing for retirement can feel scary, especially when you are only a few years away. However, by being intentional in estimating your expenses and income, you can have a better understanding of what retirement will look like for you. Having a retirement plan in place will help you maximize your benefits and retire in peace.

Disclaimer: This post is for informational purposes only and is never to be taken as advice or a recommendation. Talk to a tax or legal professional to determine how this information best applies to your personal situation.