The last five years preceding your retirement may be a crucial juncture—especially in terms of retirement planning. It is during this period that you'll need to ascertain if you are truly in a financial position to cease working within that timeframe. This assessment will largely depend on your level of preparation thus far and the outcomes of that preparation.
If you're financially ready, you may simply need to stay the course and keep moving towards your retirement objective. If you're not ready, however, you might be looking at more than five years of work—or a modification to your originally envisioned retirement lifestyle.
Here's an action plan you can employ to assess your readiness as you enter the five-year stretch.
- For those planning to retire in five years, now is an opportune moment to undertake a realistic retirement needs analysis.
- Project your annual spending using your current budget as a base.
- Stack up your estimated expenses against the retirement income you can realistically expect.
- Anticipate your life expectancy and secure your assets against lengthy illnesses.
- If your expenditures are too high or your income too low, changes may be necessary, or you may need to adjust your retirement timeline.
One of the reasons many people struggle financially during retirement is because they fail to perform a thorough retirement needs analysis. At its simplest, such an analysis may involve multiplying your current income by a suggested percentage, say 75% or 80%. This is under the presumption that your expenses will decrease post-retirement—an assumption that often isn't the case.
To gain a more accurate understanding of your retirement financial needs, your analysis should be comprehensive. This implies considering all facets of your financial landscape, including factors that could impact your cash flow and spending.
Below are some pertinent questions to contemplate.
With just five years left before you plan to retire, the primary goal is to evaluate if you can afford to retire by that point. To make this assessment, the first factor to consider is the length of your expected retirement.
Clearly, no one can accurately predict this but you can make a reasonable appraisal based on your overall health status and family history. For example, if your relatives typically live into their 80s and you're in reasonable health, it may be safe to assume you'll join them.
While evaluating life expectancy, also contemplate whether your family is predisposed to expensive, chronic illnesses. If that's the case, ensuring your retirement assets is likely to be a high-priority item in your analysis. You might want to consider long-term care (LTC) insurance to cater for nursing home care or similar services, should you need them in the future.
Using your retirement savings to cover these expenses could quickly deplete your funds. This is particularly true if you have significant assets, implying that qualifying for Medicaid-supported nursing home care is unlikely. Conversely, you are not so affluent that your assets can smoothly cover whatever health issues you may face. If you're married, think about the potential scenario where one partner falls ill, using up the savings meant to financially support the other partner following the death of a spouse.
Part of your retirement needs analysis involves predicting your retirement expenses, which is a relatively straightforward task. This entails creating a list of the potential expenses and the projected cost associated with each.
An effective strategy is to extrapolate from your current budget, subtracting or reducing costs that will phase out, e.g., gas for work commuting, while including and increasing costs to be introduced or ramped up during retirement, like higher utility bills or vacation travel.
When aggregating your financial resources, remember to factor in any property that can generate income or that can be sold to convert into cash, such as real estate.
Subsequently, calculate the guaranteed income you expect to receive in retirement. This encompass:
- Your monthly Social Security benefits. You can estimate your Social Security benefits using a calculator found at the Social Security Administration (SSA) website.
- Any pension payments from your current or previous employers.
- Any revenue from an annuity you own that is paid out at regular intervals.
- Proceeds from the sale of any property, or continued payments from such, that you plan to use to support your retirement, including real estate royalties or rental properties.
- Once reaching the required minimum distributions (RMDs) age, estimate the forced withdrawal amount and incorporate this into your guaranteed income for that time frame.
Additionally, itemize any other savings and assets that could be accessed in retirement:
- Amounts saved in retirement accounts such as IRAs and 401(k)s.
- Inherited IRAs and miscellaneous inherited retirement accounts. Note that the distribution norms for inherited retirement accounts were altered by the Setting Every Community Up For Retirement Enhancement (SECURE) Act. Prior to this Act, non-spouse beneficiaries could distribute their inherited assets over their lifetime. Post SECURE Act, such beneficiaries have a decade from the retirement account owner's demise to fully distribute such assets.
- Funds in other savings or investment accounts.
- Your Health Savings Account (HSA), if applicable.
- The worth of your home or any other real estate assets.
- Any other valuable assets, for instance art.
The stipulated age for RMDs was raised to 73 following the endorsement of the SECURE Act 2.0. If you attained this age on or after Jan. 1, 2023, distributions from your eligible retirement account(s) are obligatory by April 1 of the ensuing year. Previously, the regulation required individuals reaching the age of 72 between Jan. 1, 2020, and Dec. 31, 2022, to commence RMDs.
After you've mapped out your expected expenses and the regular income you'll receive, the subsequent step involves calculating the additional funds you'll need to withdraw from your enumerated retirement savings and other assets for your upkeep.
Here's a sample calculation, premised on the following assumptions:
- The individual intends to retire in the next five years.
- Their yearly retirement expenses will be 75% of their income before retirement.
- They anticipate a retirement span of 20 years.
- They currently earn $250,000 annually, with an expected annual salary increment of 5%.
- Their projected annual Social Security income is $24,528.
- Their current retirement savings amount to $1.5 million, expected to grow annually at a rate of 8%.
Given these parameters, the calculated results would look as such:
Image by Sabrina Jiang © Investopedia 2021
You can get a calculator for this calculation at http://www.choosetosave.org/.
Despite our assumed pre-retiree having an above-average income and retirement savings, the calculation suggests they are set to replace merely around 64% of their pre-retirement income. This falls short of their target 75% replacement rate. Therefore, they need to consider making some revisions if they plan to retire in five years.
Your specific scenarios and conditions will likely yield different outcomes. For instance, do you have more or less in savings? Will your Social Security income be higher or lower? Will your additional source of income be more or less? Is your expected retirement duration longer or shorter? Any of these elements could alter the final calculation.
If your retirement needs analysis indicates that you're on the right track - congratulations! You should continue contributing the suggested amounts—or more, if feasible—to your savings and appropriately adjust your portfolio based on your retirement timeframe.
If your analysis displays that you're not financially equipped to retire in five years, consider these options:
- Can you adapt your anticipated retirement lifestyle to considerably decrease your yearly expenses?
- Can you enhance your retirement account contributions over the next five years to generate enough income for your retirement?
- Could part-time work during retirement provide additional income?
If there are limited possibilities to decrease your expenses or boost your income, delaying your retirement might be your best choice. The longer you work, the more time you have to accumulate savings, leading to fewer years depending on your retirement savings for survival.
The necessary retirement funding depends on various factors. A common guideline suggests that you should accumulate sufficient money to preserve your current lifestyle. Some professionals estimate this amount to be within 70% to 80% of your present income. It's important to note that some individuals may need more, while others can manage on less. The most effective way to quantify your retirement fund need is to evaluate your expected costs, including housing, food, healthcare, travel, debts, and other expenses.
Regularly revisiting your retirement strategy and accounts is often beneficial as changes are bound to occur over time. These may include variations in your income, personal circumstances, family dynamics, and more. Bear in mind that as you progress in age, your risk tolerance tends to diminish. Hence, you might prefer more secure investments that don't exhibit the volatility of the ones chosen during your younger years. However, the crucial point for reassessment might be the last five years preceding your retirement because it's when you can realistically evaluate if your planned exit from the workforce is feasible. If not, adjusting your retirement date and making relevant changes becomes obligatory.
Reevaluating your retirement plan and accounts routinely is highly recommended. The last five years prior to your proposed retirement date, however, could be the most critical. The reason is that various factors—like your employment, family circumstances, or personal aspirations—may have changed. By this stage, you'll have a clear sense of whether your retirement plans are achievable or if retirement continues to remain a valid option. Be ready to pivot if circumstances don't line up as expected. It might necessitate altering your retirement date or making supplementary modifications, such as rebalancing your portfolio.
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