5 Factors to Consider 5 Years Before Retirement

The final five years before retirement are a time for strategic planning and calculated moves. As always, retirement planning is a balance of two things: not running out of money and having the freedom to enjoy your life. Use these last five working years to make sure you’re on the path to a happy retirement.

Why are the 5 Years Prior to Retirement so Critical?

In the world of retirement planning, the last five years can be key to unlocking the retirement you’ve worked so hard for. Five years out from retirement, you have a good sense of your lifestyle, retirement income streams, and cost of living expenses. You can use the knowledge you have today to identify any changes you might want to make while you’re still working to boost your retirement income, plan for the future, and stretch your retirement savings.

How Much Money Will You Need?

Determining your financial needs in retirement is a delicate dance between longevity, risk, and savings.  You may be asking yourself questions like, “how long will my retirement funds need to last?” or, “am I adequately prepared to weather inflation and unforeseen expenses?”.

Unfortunately, there is no magic 8-ball that will tell you the exact dollar amount you’ll need during retirement. It’s going to depend on your personal expenses, income, and lifespan. However, there are ways we can estimate how much money you may need. For a ballpark figure, the 4% rule is a good place to start.

The 4% Rule

The 4% rule is a widely-used guideline to help individuals determine a sustainable withdrawal rate from their personal retirement savings.

It suggests withdrawing 4% of the total retirement portfolio in the first year of retirement, adjusting this amount for inflation in subsequent years. For example, if someone has $1 million saved for retirement, they would withdraw $40,000 in the first year. The rationale behind this rule is based on historical market data and simulations, aiming to balance ensuring retirement funds last throughout one’s lifetime and allowing for a comfortable lifestyle. You can use this 4% rule calculator to estimate your retirement needs.

While the 4% rule offers an estimated income for retirement planning, it’s important to acknowledge it is not failproof. Factors such as market performance, unexpected expenses, health issues, and inflation can impact its accuracy. And many financial professionals today are beginning to question whether this rule has become outdated. That’s why it is recommended as a starting point but shouldn’t be your only method for planning your income during retirement.

To get a more personalized plan, working with a financial advisor is the next step. We can analyze your personal assets, income, investments, and more, to make projections based on your current situation. The great thing about working with a professional is they can help adjust your projections as your life circumstances or financial goals change over time. So while we don’t know the future, we can give you estimates based on your current financial standing and help you make smart choices about your money.

5 Factors to Consider 5 Years Before Retirement

1. Your budget: expenses and revenue

In my experience, most people live longer and spend more money during retirement than they expect. Very rarely do we see people spend less money in retirement than they did during their working years. Unless you have a lot of expenses that go away after you leave your 9-to-5, like going from two cars down to one, moving to an area with significantly lower cost of living, etc., what you currently spend is probably what you’ll spend in retirement.

How to estimate your expenses in retirement

Once you’re just 5 years away from retirement, estimating your post-retirement expenses is fairly straightforward. Review your last 12 months of expenses to see how much you spent. Be honest with yourself – the amount might surprise you! Don’t forget to include periodic expenses that don’t occur monthly (like property taxes or car maintenance).

Once you have a figure of what you spend per year, you can use that number to calculate roughly how much you will need to sustain your current lifestyle for the next 20 to 30 years.

Taxes in retirement

Yes, Social Security benefits are taxable income! And much of your retirement savings will be taxable, too. Throughout your career, when your paycheck came from an employer, you may have looked forward to bonuses and other income increases that allowed you to pay for vacations, renovations, and other large expenses. During retirement, when you’re paying yourself from your retirement savings, drawing extra income can mean significantly higher tax bills and even lasting increases in Medicare costs.

It pays to work with a financial professional to manage your retirement income and limit your tax exposure by planning ahead for large expenses (like renovations, travel, and vehicles), making strategic withdrawals, and utilizing tax harvesting strategies on your investments to reduce taxable income.

Social Security

Social Security can provide a reliable stream of income to supplement your retirement savings starting at age 62. If you’re still working, it’s not a great idea to take Social Security, even if you’re qualified to do so, because your benefit amount may be impacted. There are always exceptions to this rule, but my recommendation is to consider waiting as long as you can to receive the full Social Security benefit (the longer you wait, the larger your benefit will be, up to age 70).

The great thing about Social Security income is that you can’t outlive it. The Social Security Administration also makes adjustments for inflation, which makes it a reliable retirement savings supplement even as life becomes more expensive. You can calculate your estimated Social Security benefits on SSA.gov

Pensions

If your employer is providing a pension, you may not need as much in your personal retirement savings accounts. Pension plans provide a guaranteed stream of income for life, offering peace of mind and financial stability. You will want to note whether the pension passes to your spouse or descendants at the end of your life because this could impact how much income you’ll need to plan for your surviving spouse.

Retirement savings accounts

Your personal retirement savings may be stashed away in a combination of 401(k)s, 403(b)s, IRAs, or other investment accounts that you’ve been paying into throughout your life. When you reach age 50, the IRS allows you to contribute even more to your tax-advantaged retirement accounts in what they call “catch-up” contributions. Here are the current retirement account types and limits for 2024. You can save as much as you want outside of 401(k)s, IRAs, and HSAs–you just don’t get the same tax benefits.

Account Type	2024 Contribution Limits	Catch Up Amounts	Income Limits
401(k)	$23,000	$7,500	Annual compensation limit: $345,000. Total employee and employer contributions: $69,000.
403(b)	$23,000	$7,500	Total employee and employer contributions: $69,000. (Additional contributions may be allowed with 15 years of service; check your plan.)
Traditional IRA	$7,000	$1,000	No income limit as long as the taxpayer or spouse aren’t covered by a retirement plan at work; 6% penalty for over-contributing.
Roth IRA	$7,000	$1,000	Annual income cannot exceed MAGI of $161,000 (single)/$240,000 (married, filing jointly). 6% penalty for over-contributing.
Health Savings Account (HSA)	$4,150, individual; $8,300, family.	$1,000 individual OR family coverage.	Catch-up begins at 55.

2. Pay down high-interest debt

I can’t say this enough: don’t head into retirement with credit card debt! As you prepare to retire, take care of high interest debts as soon as you can. Make a plan to pay off car loans, credit cards, HELOC, and other balances because the interest you’re paying now eats into your ability to save for retirement and do more things you enjoy in the future. Once you are saving $1,000 to $3,000 per month instead of servicing these debts, you’ll be able to make a real difference in the quality of your retirement.

I want to note here, just because you have a mortgage or other debt doesn’t mean you can’t retire. However, you’ll need to consider those payments as an extra expense in your retirement budget. Part of the benefit of eliminating debts before you retire is that you don’t need to generate the income needed to pay them each month during retirement!

3. Manage your risk

With just five years before your retirement date, it’s important than ever before that you protect your hard-earned wealth from unnecessary risks. You’ll be living off your savings and investments soon, and you don’t have time to recover from losses like you did when you were in your thirties or forties.

Diversify your assets

With retirement on the horizon, you may want to think about moving some of your riskier investments into more conservative assets or diversifying your investments to protect against large market shifts. Or you may want to move assets between categories to make spending easier. Moving assets and rolling accounts into each other can have unintended tax consequences and the last thing you want is to get slapped with a surprise tax bill that eats into your hard-earned savings. Seek professional help with a financial or tax advisor before you convert or move any retirement assets.

Make sure you’re covered

Healthcare is a major expense during retirement. According to a Fidelity projected cost estimate,  a typical couple aged 65 who retired in 2023 faces medical expenses of approximately $315,000 during their retirement. And that’s not including long-term healthcare facilities or medications.

Medicare

Medicare is a federally funded health insurance program that provides medical coverage for individuals aged 65 and up. You can start applying for Medicare 3 months before you turn 65. Medicare Part A, which covers hospital care, can be premium-free if you’ve worked and paid Medicare taxes long enough. In fact, if you don’t sign up when you’re eligible, you can be penalized, so it’s important you don’t miss this deadline. (If you are still employed at 65, you may be able to get supplemental Medicare policies from your employer and can delay enrolling in Part B without penalty.)

However, Medicare is not free. Depending on which Medicare options you have enrolled in, your premiums will be deducted from your Social Security check, and you may owe deductibles and copays for various services. You can explore Medicare costs at Medicare.gov.

Long-term care insurance

The federal government estimates that 7 in 10 adults over 65 will need long-term care – whether at home, in assisted living, or at a skilled nursing facility – during their lifetime. And in Massachusetts, that care can cost anywhere from $50 per day for an at-home visit to $360 per day ($132,000 a year).

Medicare doesn’t cover these long-term care expenses. Without long-term care insurance, you may be on the hook for hundreds of thousands of dollars of care, exhausting your savings and eroding the legacy you planned to leave to your family.

4. Update (or create) your estate plan

Estate plans are a critical part of every financial plan, but only 33% of Americans have one! Your estate plan determines how your assets will be allocated after your passing, helps protect your wealth from taxes, and can keep your estate out of probate court so your heirs can access their inheritance sooner and without all the legal entanglement.

Maybe you’ll spend every last dollar you’ve earned and pass away with $0.01 left to your name – for some that is the goal! Even still, you’ll want your estate plan to outline who can make important decisions for you when you are unable to do so, and what sort of life-saving measures you want to receive.

If you haven’t already created an estate plan with a will, trust, advance directives, now is the time to do it. If you already have an estate plan, but it hasn’t been updated recently, take the time to get it current. Estate plans should be updated every five years or so to make sure they are an accurate reflection of your current wishes and updated regulations.

5. Plan your next chapter

The biggest advice I give my clients in the last 5 years before retirement is this: decide how you will spend your time in retirement before you reach it. Besides bucket-list items, you want to figure out what your day-to-day will look like without a 9-to-5 dictating your schedule. Your retirement could span 20 to 30 years or more, so it’s worth taking the time to consider the details of what you want your life to be.

Much like the four or more years spent at college to plan for your career, the five years before retirement are the time to plan for your life post-career. Ask yourself some questions like:

• What hobbies or pursuits will I continue in retirement?
• How much time each week will I devote to them?
• What goals will I work to achieve?
• What new activities am I interested in trying, and how can I start now?
• What will my social circle look like when I no longer see coworkers and clients every day?
• Are there social, volunteer, athletic, religious, or hobbyist groups I can join?
• If my spouse doesn’t retire at the same time I do, how will I spend my alone time?
• How will I maintain my health?
• What will I do to remain physically active and prevent decline?
• How will I keep my mind sharp?
• Who can I talk to when I’m feeling alone?

Some people find a large amount of fulfillment in work and struggle to replace that in retirement. Maybe you don’t want to stop working completely. You may decide to take a lower pressure role or switch to working part time for a few years. If you are unsure about how you will like retirement, I recommend a practice retirement. Take some vacation time to do some of the things you plan to do in retirement and see how it makes you feel.

My last suggestion is don’t wait until retirement to live. I think this is where a lot of people run into trouble. They wait until retirement to do all the things they haven’t done. Make a point to check things off your bucket list now, before retirement, so you aren’t loading a whole lot of life experience and expense on the back end. Afterall, our future good health and financial wellness are never guaranteed.

FAQs

1. How long does the average person live in retirement?

The average age of people retiring in 2022 was 61, according to a Gallup poll. If you retired at 61, average life expectancies suggest you would live 21 to 24 years in retirement.  Keep in mind, those average life expectancies include people who live to 62 and those who reach 110. My advice is to look to your parents, grandparents, and aunts and uncles to get a better idea of your own life expectancy. If your grandparents lived to 100, there’s a good chance your lifespan will be longer, too. If your family has a history of longevity, you may need to plan for a retirement lasting 30 years or more.

2. How many years does the average person work before retirement?

Assuming a person starts working at 18 and retires at the average age of 61, that equates to 43 working years. But that number could go up if a person started working earlier or delays retirement past the average.

3. What is the best age to retire and why?

The best time to retire is while you can do it on your own terms – and that age is different for everyone. I advise clients to retire before their health or other life circumstances force them to exit the workforce. (According to this Gallup poll, people retire on average 5 years earlier than they planned.)

4. What can you do if you are off track for your planned retirement date?

If you’ve crunched the numbers and it doesn’t look like you’ll reach your retirement goals, don’t put your head in the sand and hope the problem will solve itself. If you’re not where you want to be, there are steps you can take.

1. Start beefing up your savings and retirement accounts as much as you can. Take advantage of “catch up” contributions wherever possible.
   
2. Prioritize paying off debt. Removing those expenses can give you more breathing room in your retirement budget.

5. How can a Financial Advisor help?

A financial advisor can be especially helpful during the last five years before your retirement. As an advisor, I provide my clients with objective advice, help them set and achieve their goals, present them with a realistic picture of their finances, and guide them through tough financial decisions. You never have to follow our advice, but we offer our personal recommendations on how you can use your money to have the life you want.

For some, it can be challenging to make the switch from saving for the future to spending on the now. One of my favorite parts of the job is helping people know they CAN spend their money.  

A lot of people who would benefit from wealth management don’t actually feel wealthy. The reality is, you don’t need millions of dollars to work with a wealth manager. At Berkshire Money Management, we work with people who have $250,000 or more in investable assets. 

Conclusion

If you’re planning to retire in five years, now is the time to get to work. Getting serious about your retirement now will help you not only reach retirement with the savings you need, but enjoy your life now knowing that you’ll be ready for the next chapter. Schedule a free call to learn more about how we might be able to help.

Keep sight of your retirement progress!

Download our free retirement goals printable to track your progress toward retired bliss. This tracker will look great on your fridge, over your desk, or wherever you’ll see it every day.

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