This guide is for individuals within 10 years of retiring or within the first 5 years of retirement.
This phase of life is known as the retirement risk zone - it is the period of life during which your retirement accounts are most sensitive to fluctuations in the stock market.
It is also the period of time during which many of the most influential retirement planning decisions of your life will be made.
Decisions around Social Security, Medicare, exact retirement age, how much money to withdraw in retirement, investment allocation changes, and handling major taxable events.
Research has shown that proper decision making in these areas can increase your retirement income by as much as 38%.
This extends the lifespan of your assets and provides you flexibility and optionality in retirement.
This guide will cover the major retirement planning items to consider as you navigate this phase of your life.
You can also watch this free video guide that will elaborate on the subjects discussed in this article.
Let's dive in.
Would you like to spend $3,000/mo? $5,000/mo?
How much do you spend now?
Will you spend more, or less, when you retire?
Correctly navigating the decisions ahead (both in your life and in this guide) hinge on this question.
Whether you are 3, 5, 7, or 10 years from your desired retirement date, the first question you should ask yourself is - if you chose to retire today, what amount of spending could your retirement savings support?
If you would like $5,000 each month to live on, and your current retirement savings would only support $3,000 per month of income over your life expectancy, it becomes clear that those retirement savings are insufficient.
Armed with that information, you can make a list of the decisions and variables that you can tune that will increase the value of your retirement accounts: increasing savings, seeking higher investment rates of return, seeking out a raise, working longer, etc.
All these items can be quantified, and their effects modeled so that you can understand the impact each of those decisions might have individually, or all together.
With that model, you can then start to nibble at question number 3.
You need ballpark answers to questions 1 and 2 in order to make a wise decision about when to retire.
If, from questions 1 and 2, you become aware that your current retirement account value is not sufficient to support the type of income you need/prefer for the rest of your life, you do have actionable decisions that you can make to improve on that situation.
Conversely, if you determine that your current retirement account value is sufficient to support your desired lifestyle in retirement, maybe you'd like to explore the idea of retiring early.
In either scenario, you can only make an informed decision that is not gambling or guesswork by putting the time and thought into questions 1 and 2.
Last but not least, you should plan to take enough retirement income that you can enjoy your life, but not so much that you run the risk of depleting your retirement savings while still alive.
So how do we accomplish these retirement planning objectives?
If it was not clear enough above, the most important thing is that you get clear on your desired / necessary amount of spending in retirement.
The best way to do that is to track your current spending, and then organize it into two categories:
What I need to spend in retirement and what I would like to spend in retirement.
Many things you currently spend money on won't be concerns when you retire.
Many things you DO spend money on currently will stick around.
At the same time, some items will change or adjust - things like health insurance - which your employer probably paid most of - transitioning into Medicare - which you will pay all of.
So begin by tracking your spending using electronic budgeting tools such as Rightcapital, Everydollar, or YouNeedABudget.
At the root of this bookkeeping exercise is the fact that, in retirement, you will need an income strategy that produces enough money to live on using AFTER TAX DOLLARS.
And because you will no longer have your employer’s steady paycheck to rely on, you will need to produce that retirement income yourself using retirement savings from retirement accounts.
Retirement planning is so important because it is something we can control.
We cannot control the rate of return on our investments, whether our peak earning years will coincide with bull or bear markets, or whether we will suddenly inherit a large sum of money.
What we can control are our decisions.
That doesn't mean we should not invest, or that we should turn a blind eye to our investments.
Smart investment management is critical to the success of your retirement plan.
It's simply that markets are largely outside of our control.
Fortunately, many non-investment related decisions can powerfully impact the success of our retirement plan and the value of our retirement accounts.
The image above (which comes from this study referenced by the American College) shows 6 areas that, when optimized, could provide a nearly 38% increase in your retirement income.
Let's go through a few of these items.
Unless you have pension income, for most of us Social Security payments will be our primary source of guaranteed, stable, predictable income.
It's a complex program where incorrect decisions can result in less retirement money and decreased retirement security.
Questions that must be considered include
~ When is it ideal for me to claim benefits?
~ How will my claiming age effect my spouses social security benefits?
~ How will my claiming age effect survivor and children benefits?
~ If I will have other income in retirement, how will my social security benefits be taxed?
Because social security benefits will form the "base" of your retirement income pyramid, you will need to understand and project what those benefits will be in order to understand how much income to draw from other retirement savings.
Drawing retirement income from traditional IRA or 401k accounts impacts the taxation of social security very differently than drawing income from ROTH IRA accounts.
Because ROTH IRA withdrawals are tax free, they can help you reduce the amount of your social security income that you pay taxes on.
If you don't have significant ROTH retirement savings, ROTH conversions leading up to retirement can be a wise strategy.
But this can be a tricky puzzle to navigate, because the timing of ROTH conversion becomes important as you near Medicare claiming age...
Which leads us to:
As with all public benefit programs, Medicare claiming is a confusing maze fraught with landmines.
If you make too much money in the years leading up to Medicare, you are punished with higher Medicare premiums.
If you perform ROTH conversions, say from a traditional IRA to a ROTH IRA, that causes an increase in taxable income for the year, which when done too close to Medicare claiming age can result in higher Medicare premiums.
On top of that, when claiming Medicare, one might need to make decisions around supplementing, or privately insurance, or, if you are a federal employee, possibly maintaining your federal employee health benefits alongside Medicare.
These are important decisions with long term consequences that you should consult an expert on.
As previously stated, when building your retirement plan, you must plan to withdraw enough money that it can support your expense load AFTER TAXES.
Proper tax planning can have a serious impact your retirement plans.
Learning to manage the social security tax torpedo - when each additional dollar of income above a certain threshold causes MORE than 1 dollar to be taxed - will help you keep more money.
Learning when to perform ROTH conversions - which create current year taxable income, but grow tax free and can be withdrawn tax free - will reduce your income tax in retirement.
Learning which retirement accounts (Traditional, ROTH, After tax, or fully taxable) to take distributions from and in which order can increase the longevity of your retirement money.
I cannot state it enough - one of the primary objectives of retirement planning is to learn to draw income in excess of spending that is NET OF TAXES so that you don't accidentally deplete your retirement savings too early and end up short on funds when you most need them - towards the end of your life.
Tax planning PROACTIVELY - in advance - is one of the most important elements of your retirement plan that you can directly control.
If you have been a great saver over the course of your life, you earn yourself the privilege of needing to take less risk with your investments in order to achieve your retirement goals.
If you've struggled to save for retirement you may need to take more risk because your plan may be more reliant on investment returns due to limited funds.
In either scenario, you have investment decisions within your control that do not solely rely on investment rates of return that can improve your retirement outcomes.
NOTE: If you want a better grasp on the types of risk I am referring to, please read this guide here.
An investment allocation is the "syllabus" or general guidelines at the category level that determine the optimal way for your money to be invested.
Think - what % of my net worth should be in real estate vs bonds vs stocks vs gold.
Your investment allocation will be determined by the amount of risk that you need to take, as well as the amount of risk that you as an individual can handle.
When deciding what % of your money should go into what investment vehicle, you should factor in the following things:
Each of these things is an investment, that produces income, and has its own level of liquidity risk, risk of loss of principal, and risk of reduction or loss of income.
Too often investors do not factor these things in and may take on an inappropriate amount of risk in brokerage or investment accounts because they overlook other areas of their wealth.
Different types of investment accounts have different features -
Taxable brokerage accounts allow for Long Term Capital Gains treatment, dividend income treatment at 20% rate, and for tax loss harvesting.
Traditional IRA's and 401k type accounts allow for a current year tax deduction AND invested money to grow tax deferred.
ROTH IRA and ROTH 401k type accounts allow for after tax money to grow tax free.
Optimizing your asset "location" allows you to utilize the unique tax advantages of each account type.
For example: oftentimes it can be wise to hold equities in taxable brokerage accounts in order to take advantage of long term capital gains tax rates, allow for dividends to be taxed at 20%, and strategically tax loss harvest.
Concurrently, bonds and buy and hold investments are wise to hold in tax deferred or ROTH accounts because interest income is taxed at income tax rates.
Strategically choosing your asset location in advance or performing conversions between account types will allow for optimal distribution of your retirement money - which in the end means you can craft a plan that will allow you to keep more of your hard earned, hard saved retirement money.
Investing is a business.
It has a high barrier to entry in terms of education.
It deserves a healthy respect for the level of commitment and experience required in order to produce great results.
Decisions like whether to invest in mutual funds, or exchange traded funds, or individual stocks and bonds, in which accounts, and in which amounts, and at what price are complex.
Based on the history of stock market returns, everyone in the united states should be rich.
But that is not the case.
That's because investing is complicated - it's fraught with emotional decision making, tax landmines, nebulous regulatory rules, and institutional players who are happy to eat individual investors for lunch.
Simply because it is easy to open a brokerage account or swap funds within a 401k does not mean that it is wise for individual investors to do so.
As such, unless you plan to treat it like a business and dedicate the time and attention that you might dedicate towards the raising of a newborn, or to building a brand-new business from the ground up, in nearly all cases I recommend delegating investment management and individual investment selection to a fee only fiduciary financial advisor.
At the end of the day, it's the mistakes that will blow up your retirement plan and put your financial future at risk.
You do not get do overs.
If you make a mistake when moving money out of an employer sponsored retirement plan causing tax consequences, you cannot ask the IRS for a second chance.
If you make an unwise investment decision due to lack of experience, you cannot plead with the brokerage company to reverse the transaction.
For those reasons (and more), I always recommend working with a fee only fiduciary financial advisor or financial planner.
Here at Peak Financial Planning we have created quite a few resources that help explain:
a) What a fee only fiduciary financial advisor or financial planner is
b) How to qualify a fee only fiduciary financial advisor
c) How to understand how financial advisors are paid
d) What questions to ask a fee only fiduciary financial advisor
e) And how to research fee only fidcuciary financial advisors that you are speaking to using public databases
Or, you can watch this free masterclass video where we cover all those subjects in one succinct presentation.
If you'd like to have a conversation about working with Peak Financial Planning to create the right retirement plan or retirement INCOME plan for you, you can:
Or schedule a free consultation directly to my calendar here
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