As you’re getting closer to approaching your retirement, the last five years before you retire take on incredible importance in your retirement planning.
During these precious years, you potentially have the highest earning potential of your career and should be taking full advantage of this. At the same time, your fixed expenses may be lower than in previous years if you’ve already paid off your mortgage or no longer have children to support.
According to the 2022 Retirement Confidence Survey by the Employee Benefit Research Institute, 36% of retirees say their retirement savings are not on track to provide enough income for their full retirement.
#1: Supercharge Your Retirement Savings
Getting closer to retirement means banking on the opportunity to divert as much as you can into retirement savings. This is where you’re able to leverage the power of compounding.
The first and best area to start with is to maximize your contributions to tax-advantaged retirement accounts like 401(k) plans and Roth 401(k) accounts. These employer-sponsored plans offer two major benefits in your pre-retirement years.
Firstly, consider the ability to contribute larger amounts than other tax-advantaged accounts like IRAs.
Secondly, many employers provide matching contributions, typically matching a percentage of what you contribute up to a certain level. This is essentially free money that can turbocharge your savings if you take full advantage of it.
Let’s say your employer matches 100% of contributions up to 6% of your salary. If you earn $200,000 per year, contributing $12,000 (6%) allows you to receive an additional $12,000 from your company’s match.
In this scenario, contributing $12,000 to your 401(k) would result in a total contribution of $24,000 including your employer match.
#2: Pay Down Debts
Along with maximizing your retirement savings, the five years before retirement are a good time to pay off high-interest debt, such as credit cards and personal loans.
Start by creating a debt repayment plan that prioritizes high interest debt and focuses on paying off the balances with the highest interest rates first. You can also consolidate your debt into a single, lower interest loan or balance transfer credit card.
For lower interest debts like your mortgage, assess whether it makes sense to pay it down. You’ll want to look at factors like the tax deductibility of your mortgage interest and your expected investment returns from your investment portfolio and retirement accounts.
One argument in favor of paying off your mortgage before retirement is that the less debt you have in retirement, the less money you need in your portfolio.
For example, if your mortgage payment is $3,000 per month, that’s $36,000 per year. By paying off your mortgage before you retire, you free up that money for other things in retirement.
In this example, if you have 10 years left on your mortgage when you retire, you’ll need to draw $360,000 from your retirement savings just to pay off your mortgage.
Another important factor to consider is human behavior. While the math may tell you that you’ll get a better return by investing instead of paying off your low interest rate mortgage, the reality is that most of us won’t follow through on that plan.
We’ll get distracted and spend this money on something else, like a new SUV, or splurge on extravagant vacations.
#3: Asset Allocation and Rebalancing Your Portfolio
As you get closer to retirement, don’t neglect to review your portfolio’s asset allocation. During your working years, your portfolio is likely to have a more aggressive investment mix favoring stocks over bonds and other lower risk investments.
As you move closer to retirement age, preserving capital and generating a steady income that can sustain your rate of withdrawal from your portfolio may likely come into focus. This typically means adjusting your asset allocation to decrease risk.
Rebalancing your portfolio basically involves reviewing your investments periodically and making adjustments to make sure they’re still aligned with your target asset allocation.
For instance, you can rebalance your portfolio by selling some of the assets that have grown beyond your target allocation and investing the proceeds in underweight asset classes.
#4: Model Your Retirement Projections
Do a comprehensive review of your expected retirement finances and lifestyle expenses.
You’ll want to have a detailed picture of your income sources, living costs, taxes, and other cash flows so you can see that your savings will last through a lengthy retirement and support your retirement lifestyle.
Start by estimating your desired retirement lifestyle and all associated costs — housing, travel, healthcare, hobbies, and other areas you want to fund (such as financial support for children or grandchildren).
Compare this to your anticipated income streams like Social Security, pensions, investment and retirement account withdrawals, etc. You’ll also need to factor in taxes and include state taxes if you live in a state which taxes retirement income.
#5: Maximize Your Employer’s Insurance Coverage
Healthcare costs can be a significant expense in retirement.
A 2022 analysis by Fidelity Investments estimated that a 65-year-old couple retiring in 2022 would need around $315,000 to cover healthcare costs in retirement.
Utilizing the years before retirement to maximize your employer’s insurance coverage is an area you should be taking advantage of.
While you’re still working, this period allows you to take care of any outstanding medical procedures using your existing insurance provided by your employer.
Health Savings Accounts (HSAs) allow people with high-deductible health plans (HDHPs) to contribute pre-tax funds to savings accounts to cover qualified medical costs.
They offer triple tax savings, where you can contribute pre-tax dollars, pay no taxes on earnings, and withdraw the money tax-free now or in retirement to pay for qualified medical expenses.
Contributions are tax deductible and investment earnings accrue without taxes. The best feature is that account holders maintain access to funds indefinitely.
#6: Map Out Your Retirement Vision
The last area to prioritize in the five years before retirement may be the most important, which is clearly defining your vision for retirement.
All too often, people reach retirement without carefully considering what they truly want this next major life phase to look and feel like. Dedicate the time leading up to retirement to envision how you’ll actually be spending this time.
If you plan to relocate to another city or state, or even internationally, take it a step further and immerse yourself in that environment. Make visits to spend significant time there, meet and talk to the locals, and get a sense of the place’s vibe and culture.
Understand the cost of living, amenities, and lifestyle.
For example, if your dream is to retire to the beach town of Cabo San Lucas, Mexico, be sure to go in with your eyes wide open and have a clear understanding of the real costs for housing, healthcare, transportation, and the lifestyle there.
Get familiar with the expat community resources, healthcare system quality, residency procedures, and all the tax implications.
And it’s always a good idea to discuss your visions with your partner to make sure both your expectations are aligned.
Use this time leading up to your retirement to plan effectively so you can set the stage to living the retirement lifestyle you imagined.
