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“Pre-retiree” is too broad a term. Theoretically, everyone is either a pre-retiree or a retiree. For the purposes of this column, I’m defining a pre-retiree as a person in the final five years before retirement.
In my experience, this is the point when a light bulb flashes, retirement is within reach, and folks start to get serious about their planning. If that feels like you, read on.
Below are five mistakes I often see pre-retirees make. Not everyone will regard them as mistakes, however. That’s the tricky thing about personal finance — what is a mistake for most may make sense for you.
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So forgive my broad brush. Just don’t compare me with Suze Orman.
1. Trying to make up for lost time in a Roth
Every week, I see people trying to close this gap by maxing out the Roth portion. I believe that, more often than not, this is a mistake.
As you approach retirement, it is likely that your tax rates are as high as they’ve ever been. In the period between when you retire and when you tap Social Security and your retirement accounts, your rates are likely as low as they’ll ever be.
That’s the time to get money into the Roth. You do this via a Roth conversion, not a Roth contribution. The distinction is important.
Imagine that you buy Cheerios every week. They’re typically $5. Putting money into the Roth right before retirement is like walking into a grocery store that is charging $7 and deciding it’s a good idea to stock up. You want to stock up when the Cheerios go on sale for $3.
That tax sale occurs after you retire, so long as you have savings outside of your retirement accounts. More on that in the next section.
2. Not prioritizing liquidity
Just as it may be a mistake to save all of your money into a Roth right before retirement, it’s also a mistake to have all of your savings in retirement accounts.
Part of what allows you to have that tax sale in retirement is to tap non-retirement accounts, which are often taxed at more preferential rates.
In the post-COVID housing boom, I helped a couple move from Washington, D.C., to Richmond, Virginia. They had millions saved in their retirement accounts but were stressed about moving and closing costs because they didn’t want to tap the accounts and pay income taxes.
If I had been working with these folks for the five years prior, I would have had a portion of their savings going into a non-retirement account.
This may not be “optimal” on a spreadsheet, but it will pay off in the flexibility it offers and in future tax benefits.
It’s not fun, or easy, running a tax calculation every time you want to spend a pretty penny in retirement.
3. Investing the way you always have
Our business is focused on people in or about to be in retirement. But when we work with clients’ kids, I advocate closing your eyes, investing as much as you can, as aggressively as you can stomach, for as long as you can. It’s a volume game.
However, when you’re five years from retirement, you should not still be swinging for the fences.
The five years before and after retirement are when sequence of returns risk is greatest. In English, this is just the risk of bad timing. What if the market crashes right before or right after you retire? That’s when it will hurt you most.
Ironically, once you are deeper into retirement, it actually may make sense to increase your stock exposure once again. This is because stocks are a good hedge against longevity risk and the risk of a major health expense late in life.
Your financial plan can help dictate a proper asset allocation. It will also show you what “your number” is. More on that part below.
If you don’t have a financial plan or want to double-check your numbers, there’s a free version of the software we use.
4. Not knowing your expenses
If you don’t know your expenses, it’s impossible to know whether you can retire. The only exception I have seen to this is when your pension and or Social Security are larger than your expenses. If that’s you, I’m honestly surprised you’re still reading this.
Most of our clients have earned the luxury of not needing to know their expenses. They earn a good living that allows them to save and spend freely. Things change when the paycheck or business income stops.
Typically, the roadblock to knowing your monthly outflows is the activity itself and the fear that the number is far north of what you’ve been telling yourself. Better to just pull off the Band-Aid.
I’ll make it easy for you:
Look at annual bank statements across two years. Add the total debits. Divide that number by 24. That’s it. You’re done.
The bank account captures many things the credit cards may not, such as insurance payments, utilities and so on.
Yes, I know there was a big vacation and the house needed a new water heater, but next year, there will be another big expense and hopefully another vacation.
5. Not knowing where the finish line is
Imagine running a marathon but not knowing how long you have until the finish line.
That’s how many, maybe even most, people approach retirement. According to the Employee Benefit Research Institute (EBRI), the median planned retirement age in the United States is 65. The actual median retirement age is 62.
Of those who retired earlier than expected, I could not tell you how many felt confident that they had enough to maintain their lifestyle in retirement.
What I can tell you, even in the wealthy demographic we serve, is that almost no one comes in knowing how much they need or when they can actually retire.
We provide those projections to them. That is their finish line. It does not mean that they won’t run right through it, but it does mean that once they get there, if they’re tired, if they’re sick, if they’re sick and tired, they can quit.
I spent my first six years in this profession registered with ING. It was the same time they were running the “What’s your number?” ad campaign. These were the commercials where folks were walking around cities with big orange blocks with their “number.” This is what they needed to be able to walk away.
If you know this number or can figure it out, it provides incredible peace of mind to know you are working because you want to, not because you have to.
This article is for informational purposes only. Investment strategies, asset allocation decisions and tax planning considerations depend on individual circumstances, income levels and current law. Readers should consult their own advisers before making financial decisions.
