The last five years before you retire can be among the most critical in terms of retirement planning, as you need to determine during this period if you can really afford to leave your job. The determination will highly depend on the amount of preparation you have done to date and the results of that preparation.
If you are financially prepared, you may just need to maintain your plan and pursue your retirement goal. If you’re unprepared, you may be looking at more than five years or a change in your planned retirement lifestyle.
Let’s look at an action plan you can use to determine your level of readiness at the start of the five-year period.
Key points to remember
- If you’re hoping to retire in five years, now is the time to do a realistic analysis of your retirement needs.
- First, estimate how much you plan to spend each year. Then compare that to the income you can reasonably expect.
- If your expenses are too high or your income too low, you may need to make some adjustments, including to your retirement schedule.
How much money will you need?
Failure to do a proper retirement needs analysis is one of the reasons many people find themselves in financial difficulty during their life after work. At its most basic level, a retirement needs analysis can involve multiplying your current income by a recommended percentage, such as 75% or 80%. This is based on the assumption that your expenses are likely to decrease after you retire, which, unfortunately, is often not the case.
To get a more realistic picture of the amount of money you will need in retirement, your analysis should take a holistic approach. This amounts to considering everything aspects of your finances, including items that could affect your cash flow and spending.
Below are some questions to ask yourself.
How long do you expect to be retired?
With half a decade to go before your expected retirement date, the main focus is on whether you can afford to retire by then. To make this determination, you must first consider how long you plan to live.
Unless you are clairvoyant, there is no way to be sure. However, you can make a reasonable estimate based on your overall health and family history. For example, if your family members typically live into their 80s and you are in good health, you might want to assume that you will still be around at that age.
Do you need to insure your assets against long illnesses?
As you think about life expectancy, also consider whether your family has been prone to costly, long-lasting illnesses. If so, insuring your retirement assets should be high on the list of things to include in your analysis. You may want to consider long-term care (LTC) insurance to pay for nursing home care or similar services if you eventually need it.
Having to use your retirement savings to pay for expenses could wipe out your nest egg in no time. This is especially true if your assets are large enough that you are unlikely to qualify for Medicaid-supported nursing care, but you are not so wealthy that your assets will easily cover whatever happens to you. If you are married, think about what would happen if one partner fell ill and drained the savings intended to support the other partner after the death of a spouse.
What will your retirement expenses be?
Projecting your expenses in retirement can be one of the easiest parts of your needs analysis. It’s as simple as making a list of the items or experiences you plan to spend money on and figuring out how much they’re likely to cost.
One way is to use your current budget as a starting point. Next, eliminate or reduce expenses that will no longer apply (like gas you use to get to and from work) and add or increase items that will represent new expenses in retirement (like utility bills higher public or more leisure travel). .
When adding up your financial resources, don’t forget assets, such as real estate, that could generate income or that you could sell and convert to cash.
How much income will you have?
Next, add up the income you are guaranteed to receive in retirement. Including:
- Your monthly social security benefits. You can get an estimate of your Social Security benefits by using a calculator on the Social Security Administration website.
- Any pension income from current or former employers.
- All funds from regular payments from an annuity you hold.
- Any property, real estate or intellectual property, that you plan to sell or collect ongoing payments to help fund your retirement. This may include real estate, royalties or rental properties.
- Once you reach the age to be subject to the required minimum distributions (currently 72), get an estimate of the amount you will need to withdraw and add it to your guaranteed income for that period.
Also take inventory of any other savings and assets you have that you could draw on in retirement:
- Funds you’ve saved in retirement savings accounts, such as IRAs and 401(k)s.
- Legacy IRAs and other legacy retirement accounts. Be aware that distribution rules for legacy retirement accounts have changed with the SECURE Act (Setting Every Community Up for Retirement Enhancement). (Previously, some non-spouse beneficiaries were allowed to spread the payouts of their inherited money over their lifetime. With the SECURE law, these beneficiaries have 10 years from the death of the retirement account holder to receive all the distributions.)
- Money in other savings or investment accounts.
- Your Health Savings Account (HSA), if you have one.
- The value of your home or other real estate.
- Any other valuables, such as art.
Once you have established your projected expenses and the amount of income you will receive on a regular basis, the next step is to determine how much additional money you will need to withdraw from the retirement savings and other assets you have just inventoried. to meet your needs.
Here is an example of this calculation, based on the following assumptions:
- This person plans to retire in five years.
- Their annual retirement expenses will be 75% of their pre-retirement income.
- They expect to spend 20 years in retirement.
- Their current annual income is $250,000 and they will receive an estimated salary increase of 5% per year.
- Their estimated Social Security income is $24,528 per year.
- Their current retirement savings balance is $1.5 million, and they expect it to grow at a rate of 8% per year.
In this case, the results look like this:
Even though our hypothetical pre-retiree has above-average income and retirement savings, the calculation shows that he is on track to replace only about 64% of his pre-retirement income, far less than the replacement rate of 75 %. they were aiming. This means that they will have to make some adjustments if they want to retire in five years.
Your particular facts and circumstances will likely produce different results. For example, do you have more or less savings? Will you receive more or less from Social Security? Will your income from other sources be higher or lower? Is your projected retirement length longer or shorter? All of these factors could change the bottom line.
Are you on the right track, or not?
If the result of your retirement needs analysis shows that you are on the right track, congratulations! You’ll want to continue adding the recommended amounts, more if possible, to your savings and rebalancing your portfolio as needed to match your retirement horizon.
If the results of your needs analysis show that you are not financially ready to retire in five years, here are some things to consider:
- Could you make changes to your planned retirement lifestyle that would significantly reduce your annual expenses?
- Would you be able to increase the contributions to your retirement account enough over the next five years to produce enough income when you retire?
- Could you work part-time in retirement and provide additional income?
If there’s not much you can do to reduce your expenses or increase your income, your best option may be to postpone retirement for a few more years. The longer you work, the more time you will have to save money and the fewer years you will need to rely on your retirement savings to support yourself.