While there is no lack of long-term investment advice for young and mid-career professionals–contribute to your retirement accounts early and often!–there is a lot less information for those right on the brink of retirement.
This can make the transition to retirement feel a bit fraught. Many new retirees either go a little overboard with spending because they finally can, while many others become paranoid about spending too much.
The five years before you retire is a great time to revisit your investment strategies, make plans for how you’ll access your money, and tweak your assumptions about the next step. Here’s how you can do that.
Set up your investment buckets
Do you know where your money will come from in the first few years after you hang up your hat? Maybe you have a decent-size nest egg, but what happens if the market takes a major downturn the year you plan to retire? You might be able to keep working as you wait for the market (and your investments) to recover, but what if you’re not able to stay in your job?
The way to avoid this kind of worry is to set up buckets for your investments based on time. In other words, you want to age your money so that it’s ready when you need it. For effective retirement planning, you will want to have your money set aside in three buckets.
- Short-term investments: This bucket is for the money you intend to use for living expenses for the first 1 to 5 years of retirement. Since you want this money to be ready and accessible, you want stability and liquidity—meaning you’ll invest in cash equivalent assets that protect the principal. Your short-term investments might include CDs, U.S. Treasury bills, and money market funds.
- Medium-term investments: The money you intend to use for retirement income for years 6 to 15 of your retirement will go in this bucket. Since you’re not planning on using this money for a little while, you can afford to be a little more aggressive while still aiming to protect the principal. Generally, your medium-term investments will include a mix of bonds and stocks, but leaning more toward the lower-risk bonds.
- Long-term investments: Just because you’re not 30 anymore doesn’t mean you can’t still invest like a whippersnapper. This investment bucket consists of money you don’t intend to touch until at least 16 years into your retirement, which means you have time to allow this money to ride out any market fluctuations—and take advantage of the higher-risk/higher-return assets like stocks.
Rebalance your investments
Each year, you will rebalance these buckets as appropriate. When your long-term investments are going gangbusters, you’ll move some of that money into your medium-term bucket, and move some of the medium-term money into the short-term bucket. This way, you’ll always have accessible money in your short-term investments for your living expenses, and you can keep a weather eye on your medium- and long-term investments.
Setting up your investment buckets before you retire will not only give you peace of mind about where you money will come from in those first few years, but it will also set you up for investing success during your retirement.
Plan for Social Security
The amount of money you receive from Social Security depends on your earnings history and your age when you apply for benefits. The Social Security Administration uses your 35 highest earning years in your career to calculate your benefits. If you have worked fewer than 35 years, the calculation uses 0s for the missing years. This means one of the best ways to increase your Social Security benefit is to make sure you have worked at least 35 years.
Your age at Social Security enrollment is the other factor that determines your benefit. Normal retirement age is between 66 and 67, depending on the year you were born. Beneficiaries receive their full benefit if they apply for Social Security at their normal retirement age. You can apply for benefits as early as your 62nd birthday, but taking them early will permanently reduce your monthly check. The earlier you take the benefits, the higher your reduction.
However, you can also wait to take benefits until as late as age 70. Each year that you wait to take benefits between your normal retirement age and your 70th birthday increases your benefits by approximately 8% per year.
Social Security benefits are guaranteed. (Really! If Social Security goes bum-over-teakettle, it will be because the U.S. government is collapsing. That may not be an impossible scenario, but it’s still pretty unlikely—and if it does happen, we’ll have bigger problems than Social Security to worry about.) That means waiting to take your benefits is guaranteed to net you more money and is the best way to ensure consistent income no matter how long you live.
You can check your earnings records and projected benefits at mySocialSecurity.
Put money aside for healthcare expenses
An individual 65-year-old retiring in 2024 will need about $157,500 for healthcare in retirement, even though they qualify for Medicare. Unfortunately, healthcare tends to be among the largest expenses in retirement, and many retirees are not necessarily prepared for the high costs.
One of the best ways to plan ahead for this expense is with a Roth IRA. Since Roth-style retirement accounts are funded with money that has already been taxed, the funds grow tax-free and can be accessed tax-free in retirement.
If you have a major medical need, you can use your Roth IRA funds to pay for it, without affecting your taxes in retirement. Since Social Security benefits are taxed, avoiding a major change in your taxes when you have to take a large chunk of money from your investments will help maintain your steady retirement income.
On the other hand, Roth IRA funds do not have to be used for any particular purpose. If you are hale and hearty for your entire retirement, your Roth IRA funds can be used to pay for a Jet-Skiing vacation to celebrate your 100th birthday.
Counting down until retirement
Looking forward toward the next chapter of your life is both exhilarating and scary, especially if you’re not sure how your money will work in retirement. Taking your preretirement years to set up investment buckets for your retirement, plan your Social Security benefits timeline, and put aside money in a Roth IRA to help you pay for future medical expenses will help you feel more ready for retirement.
And of course, getting your financial ducks in a row leaves you time and brainspace to plan for the fun you intend to have after you retire. Bring on the Jet Skis!
