Planning the 5 Years Prior to Retirement

by Fritz Gilbert


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Have you entered, or are close to entering, "The Red Zone" of retirement? The five years prior to retirement are among the most important of your retirement planning.

I'm well into The Red Zone and would like to share some of the best advice I've read on the topic, as well as steps I'm taking in my personal planning for retirement. Finally, I've suggested several "To Do" items under each of the steps to help you get started on the critical tasks recommended below.

5 Steps to Take within 5 Years of Retirement

I don't know if it's due to demographics or "group think," but I've seen a lot of articles in the past few weeks about this topic (I've put links to them at the bottom of this article). Fortunately for you, I've reviewed them all and have highlighted the top 5 steps you should take within 5 years of retirement:

1. Make the Numbers Real

Even if you've been hesitant throughout your working years to understand "your numbers," you can no longer afford to stick your head in the sand. The bottom line is that you can't know when to retire without knowing how much you need to fund your lifestyle and how much income you can count on after you leave your job. Run a few online retirement calculators and compare the results. If you've been thinking about buying long term care insurance, evaluate it now and include it in your retirement spending plan. Learn about Social Security claiming strategies and build them into your retirement cash flow projection. Spend the time with the numbers or book some time with a professional Certified Financial Planner. Don't make the decision to retire until you've done this step.

What I'm Doing: I'm a bit of a number nerd, so I've built spreadsheets that project our cash flow out through age 95 under various market scenarios. My wife and I also tracked our actual spending for ten months to insure our estimates were realistic. For income, I'm targeting a 3% withdrawal rate (vs. the historical "rule of thumb" of 4%) from our investments due to my belief that equities will have a below average return in the coming decades.

To Do's: Read my When Can I Retire" series to determine when you can retire. Track your spending for a few months (use the "Spending Tracker" I built for my readers here). Put together your Net Worth statement, (use my template here) and project how much income you can expect in retirement. Test out an online retirement calculator. If you need to learn more about personal finance, check here for some online classes. If you'd rather hire a professional to do the work, click here.

calculator iconCalculator: How much income will my retirement savings provide?

2. Get Your Portfolio Ready for Withdrawals

After 30+ years of work and contributions to your savings, the time is coming when those "inflows" will become "outflows." I've not yet experienced that change, but I've heard from others that it takes some getting used to. Make sure you've built a one to two year cash reserve before you retire to help cushion any downturns and diversify your investments across an appropriate asset allocation to maximize your return while respecting your risk tolerance. Consider annuities if you need some predictable income to cover your base expenses. If you've got multiple investment accounts, consider simplifying and consolidating your holdings.

What I'm Doing: Having just sold our "primary" home, we generated a bit of cash and liquidity. We're intentionally going to carry the cash position as our two-year reserve into retirement and only invest any money that is in excess of the two-year reserve. We also analyze and adjust our asset allocation annually. Finally, I've written a "love letter" to my wife with instructions to have Vanguard's Personal Advisory service take over the management of our accounts if I were to die unexpectedly.

To Do's: Study up on Asset Allocation, and make sure you're adjusting your portfolio to the new risk tolerance levels you'll have in retirement. Focus on building up your cash reserve to avoid having to sell any investments during a downturn in the market. Better to build it up gradually over the five years prior to retirement than to be faced with having to sell during a bear market in your first few years after work (this phenomenon, called "sequence risk", is one of the highest risks you'll need to manage in retirement).

3. Decide Where You Will Live and Pay Off the House

Now is the time to decide where you're going to live in retirement. You've got a few years before you need to make the move, so take the time to really think through what you want your retirement to be. Do you want to move or stay put? Do you want a small place where you can stay six months and then travel the other six months? Or would you rather have a big house for all of the family gatherings, and have it near your kids? Spend some extended time in the areas you're thinking about. Rent a house for a week to get a feel for what it's like to live there. Start watching real estate listings to get a sense of the market. If you're going to sell your home, start sprucing it up now to avoid the last-minute rush of getting it ready for market. Once you've figured out what you'd like to do, consider paying off your mortgage to reduce your retirement expenses. If you're staying put and have a lot of equity in your home, learn about reverse mortgages and see if they make sense for you.

What I'm Doing: Three years ago, my wife and I bought a cabin in the North Georgia mountains as part of our eventual downsizing strategy (the strategy is outlined here). We spent a lot of time at the cabin and rented it out when we weren't using it to have our renters pay the mortgage for us. We intentionally targeted a price range, which would allow us to pay off the cabin after we sold our primary residence. We just sold our house in 7 days and will be applying the liquidity from the home sale into two areas: paying off the cabin and building our two years of cash reserve. I'll continue to work, commuting to the office from a small "city apartment" during the week. The plan is coming together, and it feels good. Make sure you develop and execute your plan during your final five years of work.

To Do's: Spend several weeks of this year's vacation at a place you're interested in potentially living during retirement. If there's a chance you'll be selling your house in the next five years, start building a list of items you need to spruce up. (Read this to see what we did to prepare the house for sale and this to see how we got rid of all of our stuff.) Then, spend a few weekends over the next year working on the projects that have the longest "shelf life" (e.g., they'll still look good when you sell the house). Review your mortgage statement to see how much of your loan you have left to pay off and then evaluate targeting this as a goal before you retire (the "return" on your money is essentially equal to your interest rate - you'll lose the tax deduction for the interest, but if you invested the same amount, you'd owe taxes on the investment return). If you don't have sufficient liquidity to pay off the house and build a two-year cash reserve, focus on the cash reserve first.

4. Catch Up

In your final years of work, you should attempt to live on your retirement budget and aggressively save the difference. Take advantage of "catch up" clauses, which allow you to fund more into your retirement accounts in your final years of work. If you have a Health Savings Account (HSA), consider saving the maximum every year before retirement to begin pre-building a hedge against retirement health care expenses.

What I'm Doing: For the past 30 years, I've increased my 401(k) contributions every year with my pay raise (if I got a 3% raise, I'd increase my 401(k) by 2% and "take home" a 1% increase). This has "forced" us to "live below our means" and has allowed us to reach the point where we're maxing out all possible retirement savings, including full utilization of the catch-up clause and HSA limits. In addition, we make regular monthly ACH transfers to after-tax investments (primarily in Vanguard mutual funds). Living below your means and aggressively saving are the keys to achieving an early retirement. If you've not done it in the past, start now.

To Do's: If you're in The Red Zone, it's time to stop making any excuses about low savings rates. Get aggressive now, or you'll work until you die. A bit dramatic, perhaps, but it really is time to get serious about reducing your spending and increasing your savings. I challenge you today to increase your current retirement savings by 1% this week and then take your next raise in its entirety and throw it into savings. Read this article to see how you could save several thousand dollars on your tax bill by taking advantage of catch-up contributions. Stretch yourself to try to max them out (hey, living on less will be good practice for your retirement, anyway!)

One of the most important ingredients for a comfortable retirement is to be debt free when you retire.
Will debt derail your retirement? This simple checklist can help you find out.

5. Find Something to Run "To"

When at work, work! Keep your focus on your job while you're still employed, but don't ignore retirement planning. After your days are no longer consumed by work, what are you going to do? As I wrote in "Will Retirement Be Depressing?", retirement increases the probability of depression by 40%. While some folks end up depressed, others find retirement to be the best years of life. What separates the two groups? It turns out the biggest factor is having something to "Run To" in retirement (instead of "Running From" work).

Below are the steps I suggested in the "depression" article, and they're relevant again in this "5 years" article. To increase your probability of a great retirement, think through the bullet points and pick a few to begin working on while you're in The Red Zone:

  • A strong focus on achieving balance in your life BEFORE retirement.
  • Intentionally accelerate your development of external interests in your final three to five years of work. Strive to find other areas in your life to develop and ramp these up as you approach retirement.
  • Develop alternative means to develop the socialization and self-esteem that work brings and begin that development as part of your retirement planning.
  • Begin populating a bucket list of items you'd like to do in retirement. Broaden it to include categories beyond travel. Stretch yourself.

What I'm Doing: I'm intentionally pursuing every one of the bullet points above. One example is writing this blog. I started it a year ago as a means of covering two of the bullet points (before I had even written the bullet points or learned that the concepts were important elements of a successful retirement). The writing of the blog covers "accelerate external interests" and "alternative means of socialization and self-esteem." I'm also keeping my eyes out for opportunities to get engaged in new opportunities in our new home of Blue Ridge, GA, and will develop those prior to retirement.

To Do's: Read "Will Retirement Be Depressing?" and then start developing a bucket list. Read ""What Life Is Really Like In Retirement" for an article Kiplinger's wrote about the topic. Read "The Purpose" (an article I wrote when The Retirement Manifesto was only one week old) and then think about what your own "Purpose Statement" should be for retirement. Intentionally seek out areas now that you can develop after retirement (relationships, organizations, hobbies, etc.). Start a blog!

If you're in The Red Zone, it's time to get serious about your retirement planning. Don't just "let it happen" and end up depressed. Use this phase in your life as an opportunity to plan something truly great. If you follow the 5 steps outlined above, you'll be well on your way to a truly great retirement, and I'll have moved just a bit closer to this blog's purpose of helping people achieve a great retirement!


Fritz Gilbert is the founder of TheRetirementManifesto.com. He's a 54-year-old corporate commodity trader with a lifelong interest in financial affairs.

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