Preparing for retirement requires a detailed financial plan to ensure you can cover expenses, manage taxes, and achieve your goals without the risk of outliving your savings. Financial experts emphasize that the final one to two years before leaving the workforce are critical for organizing your finances and making key decisions.
The transition from accumulating wealth to drawing it down can be unsettling. Mary Clements Evans, author of “Emotionally Invested,” notes that many people are anxious about this shift. However, a structured approach can provide the confidence needed to navigate this new phase of life.
Key Takeaways
- Create a comprehensive inventory of all income sources, including retirement accounts, pensions, and Social Security.
- Develop a strategy to eliminate high-interest debt and build a substantial emergency fund before you stop working.
- Strategically decide when to claim Social Security, as this can significantly impact your lifetime benefits.
- Conduct a trial run of your retirement budget to ensure your projected income meets your actual spending needs.
- Consult with financial, tax, and legal professionals to finalize your portfolio, tax obligations, and estate plan.
Understanding Your Complete Financial Situation
The first step in pre-retirement planning is to create a complete inventory of your financial assets. This involves locating all retirement accounts from current and previous employers. Consolidating old 401(k)s or other workplace plans into a single account can simplify management and provide a clearer view of your total savings.
It is essential to list every source of income you will have in retirement. This includes pensions, annuities, rental income, savings accounts, and any other investments. Richard Pon, a San Francisco-based certified public accountant, advises retirees to remember the tax implications of each income stream.
He explains that while withdrawals from a regular savings account are tax-free, income from Social Security and required minimum distributions (RMDs) from traditional retirement accounts is generally taxable. Selling investments can also trigger capital gains taxes, reducing the net amount available for spending.
Portfolio Rebalancing
The years immediately preceding retirement are an ideal time to review and rebalance your investment portfolio. As you get closer to relying on these funds, many financial advisors recommend shifting towards a more conservative allocation to reduce risk and protect capital. This often means reducing exposure to stocks and increasing holdings in bonds and other less volatile assets.
Consolidating Your Accounts
Before leaving your job, take advantage of access to your human resources department to gather information on all your workplace retirement plans. Tracking down accounts from past jobs and rolling them over can prevent them from being forgotten. A consolidated portfolio is easier to manage and allows for a more cohesive investment strategy.
Managing Debt and Savings Before You Retire
Entering retirement with significant debt can put a strain on a fixed income. Financial experts strongly recommend creating a plan to eliminate outstanding balances on credit cards, car notes, and personal loans during your final years of employment. Paying off high-interest debt frees up cash flow for essential expenses and discretionary spending.
Kimberly Palmer, a personal finance expert at NerdWallet, suggests that paying off a mortgage before retirement is also a worthwhile goal, though not always achievable. Eliminating this major monthly expense provides significant budgetary flexibility, even though property taxes and homeowners insurance costs will remain.
The Importance of an Emergency Fund
Lauren Stansell, Chief Planning Officer at Yeske Buie, recommends that pre-retirees build an emergency fund sufficient to cover at least one year of living expenses. This fund, held in a liquid account like a high-yield savings account, acts as a buffer during market downturns, preventing the need to sell investments at a loss to cover unexpected costs.
Strategic Decisions on Income and Benefits
One of the most critical decisions for a retiree is when to begin receiving Social Security benefits. While you can claim as early as age 62, your monthly payment will be permanently reduced. Waiting until your full retirement age (typically 66 or 67) or even age 70 results in a significantly larger monthly benefit.
"When you might want to quit working may not be the same time you want to start collecting benefits," says Martha Shedden, president of the National Association of Registered Social Security Analysts. She notes that for couples, the spouse with the higher benefit should generally delay collecting for as long as possible to maximize the survivor benefit.
According to one report, 96% of people fail to financially optimize their Social Security claiming strategy, which can result in a loss of around $110,000 in benefits per household. To make an informed decision, it's crucial to set up a MySSA account on the official ssa.gov website. This tool provides personalized benefit estimates and allows you to compare different claiming scenarios.
Test-Driving Your Retirement Budget
Many people assume their expenses will decrease in retirement, but this is not always true. Increased free time can lead to higher spending on travel, hobbies, and dining out. Clements Evans advises conducting a trial run of your retirement budget for several months before you leave your job.
To do this, calculate your expected monthly retirement income and try to live on that amount. This exercise provides a realistic picture of your financial situation and highlights areas where you may need to adjust your spending habits. It is also an opportunity to negotiate recurring bills and cancel unused subscriptions.
Healthcare and Insurance Planning for Retirement
Healthcare is one of the largest and most unpredictable expenses in retirement. If you retire before age 65, you will not be eligible for Medicare and must secure your own health coverage. Options include continuing your employer's plan through COBRA or purchasing a plan on the Affordable Care Act (ACA) marketplace.
It is critical to understand the enrollment deadlines for Medicare to avoid lifelong penalties. While you still have employer-sponsored health insurance, schedule any necessary appointments, such as dental cleanings, eye exams, and physicals, to maximize your benefits.
The Need for Long-Term Care
Mark Gilfix, an estate planning attorney, points out a sobering statistic: "Over 70 percent of Americans over the age of 65 will eventually need some form of long term care." This type of care is not typically covered by Medicare. Pre-retirees should consider whether long-term care insurance is appropriate for their situation or if they need to budget for potential future costs.
Finalizing Legal and Tax Preparations
As retirement approaches, it is essential to review and update your estate plan. According to Gilfix, everyone should have three key documents in place:
- A living trust: To manage your assets and avoid probate.
- A durable power of attorney for finances: To designate someone to handle your financial affairs if you become incapacitated.
- An advance health care directive: To outline your wishes for medical treatment.
You should also organize important digital information. Create a secure list of account logins and passwords that your spouse or heirs can access. Setting up a "Legacy Contact" for your digital devices ensures that a trusted person can manage your information after you're gone.
Consulting with a Tax Professional
Retirement changes your tax situation significantly. Without an employer withholding taxes from a paycheck, you become responsible for making quarterly estimated payments. A tax professional can help you create a strategy for tax-efficient withdrawals from your various accounts and plan for major financial events like selling a business or home.
Maximizing Your Final Contributions
If you are age 50 or older, you can make "catch-up contributions" to your retirement accounts. This allows you to contribute an extra $7,500 annually to a 401(k) on top of the standard limit. Those aged 60 to 63 will be able to contribute an additional $11,250 starting in 2026. At a minimum, always contribute enough to receive your full employer match, as this is essentially free money.
