When it comes to planning for retirement, the conversation usually centers around accumulating wealth.
Many people spend the majority of their careers focused on building enough savings to hopefully leave the workforce.
However, as retirement approaches, the mindset needs to shift.
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In the five to 10 years before retirement, the goal should shift from growing assets to determining how those assets will generate income and support long-term goals.
Oftentimes, this transition is overlooked, and mistakes made during these years can have a significant impact on a person’s ability to retire comfortably and maintain their lifestyle.
One of the biggest mistakes people make during this stage is assuming they still have plenty of time to figure everything out. The final five to 10 years before retirement are when important decisions about income needs, investment risk, Social Security and withdrawal strategies come into focus.
Another common mistake is assuming that a large retirement savings account is the only prerequisite to retirement. While reaching a certain savings goal is a great accomplishment and can provide confidence, it’s not an accurate measurement of preparedness.
Many pre-retirees focus on how much they’ve saved without thinking about how that money will support their lifestyle in retirement. Without a detailed cash flow analysis that accounts for inflation and future expenses, even those with large retirement accounts may find themselves unprepared.
Wealth protection is important
A major market downturn can have a much greater impact on someone who plans to retire within the next 10 years than on someone who is still decades away from leaving the workforce. Therefore, pre-retirees should evaluate whether a portfolio’s risk level still aligns with their personal timeline and income needs.
Failing to account for these factors can leave some retirees with a false sense of security. For example, some pre-retirees think withdrawing 4% from their retirement accounts each year will provide a stable income stream.
While that may be the case in some circumstances, this strategy doesn’t account for every market environment. A significant market decline in retirement, in addition to inflation and ongoing withdrawals, can put additional strain on a portfolio, impacting long-term stability.
As a result, stress-testing how savings will generate income in a variety of scenarios can be just as important as the amount of savings.
While every plan is different, there are three specific areas people who are five to 10 years from retirement should begin reviewing.
1. How much income will you need?
The first step is having a realistic understanding of how much income will be needed throughout retirement. Housing, healthcare, travel, hobbies and daily living expenses should all be factored into a retirement budget with regard to inflation.
Pre-retirees in this phase should also evaluate whether their investment strategy still aligns with their retirement timeline, risk tolerance and income needs.
The investment strategy that was used during your working years may not be appropriate as retirement nears. Once the need for income becomes more immediate, such as in retirement, protecting against major losses while managing volatility becomes the main priority.
2. Where will your income come from?
The next step is identifying where retirement income will come from, particularly for tax efficiency. Having different types of retirement assets, such as traditional IRAs, Roth IRAs and non-qualified investments, can offer more flexibility when managing taxes throughout retirement.
3. Do you have a retirement plan in place?
Finally, pre-retirees should have a comprehensive retirement plan in place before exiting the workforce. This plan should serve as a road map, accounting for income needs, spending expectations, taxes, investment risk and long-term goals.
Retirement is often viewed as a financial milestone, but the final preparations that should be made in the final decade of your career aren’t talked about nearly as much.
While reaching a target number of retirement savings is important, understanding how those savings will generate income and withstand market volatility while supporting long-term goals is the key to a sustainable retirement.
By taking the time to address these questions in the decade leading up to retirement, pre-retirees can transition into retirement with more confidence and a better understanding of what lies ahead.
