Executive Summary:
- As you approach retirement, it’s important to take steps to help ensure a smooth transition. This article highlights three critical steps you can take to get you ready for your work-free years.
- First, figure out what you’re retiring to: Beyond financial readiness, it’s essential to plan for how you’ll spend your time in retirement, ensuring you maintain a sense of purpose, fulfillment, and connection.
- Second, review your investments and adjust as needed: Assess your current asset allocation and make necessary adjustments to align with your risk tolerance and income needs as you near retirement.
- Third, plan your retirement paycheck: Develop a detailed strategy for how you’ll draw income from your retirement accounts, considering the frequency of payments and the tax implications of withdrawals.
Retirement is one of the biggest financial transitions there is, marking a major shift from your working years to your work-free years. As such, it’s critical to prepare, often decades in advance, for this big moment.
But, while many start preparing for retirement in advance by funding retirement accounts and paying off debt, there are a few critical (and timely) steps that can easily get overlooked. In this article, we will cover three critical steps to prepare for retirement in the next five years.
Let’s dive in.
Step #1: Figure Out What You’re Retiring To
It’s natural to view retirement readiness as a math equation: you figure out how much money you need to stop working (adjusted for inflation), hit that number, and then sail off into the sunset. But, the reality is that financial readiness is just one piece of the puzzle, and for many, it’s the simple part.
The more challenging piece of the puzzle is figuring out a) what you’ll do every day and b) how you’ll maintain a sense of purpose. For many soon-to-be-retirees, this may sound silly, as people often imagine filling their free time will be a piece of cake, especially when they’ve had such little free time outside of their careers.
But, the truth is that retirement is a major lifestyle change so it’s important to have a plan in place for how you’ll spend your time.
So, as you approach retirement, take some time to think about what you want your retirement day-to-day to look like. Do you want to travel? Volunteer? If so, where will you travel, and where will you volunteer? Will you pursue a hobby or passion project? Again, get specific: what hobby or hobbies will you focus on?
Zooming in even further, what will an average day look like for you? What time will you wake up? How will you start your day? Answering each of these questions can help prepare you to make the transition as smooth as possible.
Additionally, consider how much physical activity and social interaction you will need.
Unfortunately, many retirees struggle with depression, stress, and anxiety, so finding activities that keep you active and engaged with others can greatly enhance your overall retirement experience. Also consider that, for many, work not only filled the majority of their time but also provided a sense of friendship and community through their coworkers. In addition, many received a sense of purpose through work as they were continually working toward and achieving goals and improving their craft. So, it’s essential to be mindful of the different areas of your life that work impacts and have a plan for how you will recreate that in retirement.
Ultimately, remember that planning for retirement goes beyond just financial readiness—it’s about designing a life that brings purpose and fulfillment. By considering how you’ll spend your time and maintaining connections, you can create a truly rewarding retirement.
For more insights on navigating the complexities of retirement, check out our previous post: Struggling in Retirement? How to Make the Most of Your Golden Years by Understanding and Navigating the 4 Phases of Retirement from Dr. Riley Moynes.
Step #2: Review Your Investments & Adjust As Needed
Next, as you approach retirement, it’s critical to review your investments and adjust as needed, specifically review and adjust how your investments are allocated.
But First, What is ‘Asset Allocation?’
Put simply, asset allocation is the process of dividing your investments among different types of assets, like stocks, bonds, and cash, to balance risk and reward based on your financial goals and risk tolerance.
In other words, your asset allocation is the mixture of stocks and bonds within your investments.
For many, when they are young and have a long time until retirement, their assets will be allocated more aggressively, often ranging anywhere from 100% stocks to 80% stocks and 20% bonds. Alternatively, those approaching or in retirement often dial down their stocks, adding more bonds to help limit the swings within their portfolio. This often ranges anywhere from 70% stocks and 30% bonds to a more balanced portfolio, with 50% stocks and 50% bonds.
All that said, the interesting thing about asset allocation is there’s really no one-size-fits-all.
For example, there are young people with a long time horizon who simply aren’t interested in the volatility that can come with a more aggressive investment portfolio, so they dial back their stock allocation early on. Alternatively, some retirees are comfortable taking more risk or simply have such significant assets that they can weather any volatility that could come their way without the impacting their financial plan. So, they may opt for a more aggressive asset allocation, realizing that they will have a more volatile portfolio over time, but they can often expect greater returns over time, though nothing is guaranteed.
The point is, while there’s no standard portfolio for every retiree, it is critical to review your investments and adjust as needed.
Here are some things to consider as you review and adjust:
- Your Risk Tolerance: As you approach retirement, it’s important to assess how comfortable you are with the possibility of losing money in the short term. If the idea of seeing your investments drop in value keeps you up at night, you might want to consider shifting to a more conservative asset allocation. On the other hand, if you’re confident in your ability to ride out market ups and downs, you may decide to maintain a higher percentage of stocks.
- Your Income Needs: Consider how much income you’ll need to generate from your investments once you retire. If you’ll be relying heavily on your portfolio for income, a more conservative allocation with a higher percentage of bonds or dividend-paying stocks could provide more stability and predictable income. However, if you have other sources of income, such as a pension or Social Security, you might be able to take on more risk in your investments.
- Rebalancing: Over time, as different parts of your portfolio grow at different rates, your asset allocation can drift from your original plan. Regularly reviewing and rebalancing your portfolio ensures that it stays aligned with your goals and risk tolerance. This might mean trimming some of your winners and buying assets that haven’t performed as well to bring your portfolio back into balance.
- Tax Implications: Keep in mind that selling investments to adjust your asset allocation can have tax consequences in certain accounts like trust accounts or taxable brokerage accounts. Be sure to factor in any potential capital gains taxes when making changes to your portfolio.
- Consulting a Financial Advisor: Lastly, if you’re unsure about the best asset allocation for your situation, or if you’re finding it challenging to make these decisions on your own, consulting with a financial advisor can be invaluable. They can provide personalized advice based on your unique financial situation and help you create a plan that aligns with your retirement goals.
Ultimately, taking the time to carefully review and adjust your investments as you near retirement can help ensure that your portfolio is positioned to support your lifestyle and goals in the many years to come.
Step #3: Plan Your Retirement Paycheck
Lastly, as you approach retirement, it’s time to plan your retirement paycheck.
One of the biggest shifts you’ll experience from working to not working is that you’ll no longer receive a paycheck from your employer. And while this may seem obvious, it’s important to spend some time planning how you will create your new retirement paycheck.
In other words, what accounts will you distribute funds from each week, month, quarter, or year to cover your living expenses? How much do you need? What account will the money go into? How will you handle one-off expenses?
As you create a plan, get as detailed as possible by answering these three questions below:
1. How much do you need? One of the big questions to answer in retirement is how much money you will need to cover your lifestyle. For many it can be fairly simple: take what you were earning before retirement, add any new retirement expenses (think: bigger travel budget), subtract out any retirement savings or contributions you were making during your working years, and subtract out any expenses that fall off during retirement (think: paid off mortgage). That’s the amount you will need to generate with your retirement paycheck.
It’s also important to consider any one-off expenses that may come up during retirement, such as buying a new car or home renovations. When creating a retirement plan, be sure to factor in these potential expenses so you can have a cushion for these expenses that fall outside your normal ‘retirement paycheck.’
2. How often will you get paid? Next, when planning for retirement, it’s important to consider the frequency of your income. For many people, sticking with a payment schedule they are used to is the best option. This could mean receiving payments every two weeks, as they did during their working years. However, it’s also important to note that certain types of retirement income, such as pensions and social security, are typically paid monthly. In addition, depending on how your investments are set up and allocated, you may not like the extra work that comes with creating your own retirement paycheck each month or every couple of weeks (selling investments, raising cash, etc) so you may decide that quarterly or even annually feels like a better fit. Whatever the case, the important thing is to get specific about how often you’ll be getting paid so you have a plan.
3. Where will the money come from? Lastly, spend some time planning the breakdown of your retirement paycheck. In other words, if you need $10,000 per month, where will that money come from? If you’ve got pensions and Social Security that total around $5,000 per month then you’re already halfway there.
As you create a plan, consider all the different types of investments you have and the tax implications of each. For example, many retirees have a mixture of tax-deferred (often called pre-tax or “Traditional” assets), tax-free (often called after-tax or “Roth” assets), and taxable accounts. As you create your retirement paycheck, remember that taking money from each of these different investment accounts will have different tax implications.
- Traditional assets will be taxed as ordinary income at your highest marginal tax rate.
- Roth assets will be completely income tax-free.
- Taxable assets will have a mix of ordinary income rates (at your highest marginal tax rate) and more favorable long-term capital gains rates, ranging from 0 to 20%.
So, as you create your plan, be mindful of where you are each year from a tax perspective.
If you have the opportunity to fill lower tax brackets with ordinary income, that can be a great plan. Alternatively, if your income for the year is pushing you into a higher tax bracket than you want, consider utilizing your Roth accounts to create tax-free income. In the end, while this step will likely take some time and planning, it can be well worth it to create a tax-efficient retirement paycheck.
Conclusion: Wrapping Up Your Retirement Readiness
Ultimately, preparing for retirement in the next five years requires careful planning and thoughtful adjustments to ensure a smooth transition into this new chapter of life.
By taking the time to understand what your retirement will look like, reviewing and adjusting your investments, and planning your retirement paycheck, you can position yourself for a financially secure and fulfilling retirement. Remember, the key is to start now and stay proactive, so you can enjoy your golden years with confidence and peace of mind.
This blog post was also published as an article on LinkedIn
Albion Financial Group is an SEC registered investment advisor. The information provided is intended solely for educational purposes and should not be construed as an offer or solicitation for the purchase or sale of any particular securities product, service, or investment strategy. Past performance is not indicative of future performance. Additional information about Albion Financial Group is also available on the SEC’s website at www.adviserinfo.sec.gov under CRD number 105957. Albion Financial Group only transacts business in states where it is properly registered, notice filed or excluded or exempted from registration or notice filing requirements.
