Five Critical Steps to Take If You Plan to Retire in the Next Five Years
While many effective investment strategies thrive on automation, such as consistent payroll deductions and incremental savings increases, the momentous transition into retirement demands a far more engaged and deliberate approach. For those eyeing retirement within the next five years, proactive planning is not just advisable—it’s essential.
Christine Benz, Morningstar’s respected director of personal finance and retirement planning, champions a preemptive strategy. Her core advice: visualize your ideal retirement lifestyle now, while you still have ample time to make crucial financial and lifestyle adjustments to achieve it. This involves more than just numbers; it’s about aligning your aspirations with your financial reality.
Here are five critical steps to undertake in the immediate future if you plan to retire within the next five years:
1. Re-evaluate the Role of Work in Retirement
For many, the idea of “retirement” no longer means a complete cessation of work. Whether it’s a part-time role, consulting, or a passion project, a supplemental income stream can significantly simplify your retirement spending plan and offer a sense of purpose. However, it’s crucial that this potential income doesn’t become the linchpin of your entire retirement strategy. While a 2022 AARP study found that 79% of workers aged 50 and older planned to work in retirement, only 34% actually did. Unforeseen health issues or a challenging job market can quickly derail these intentions. Plan as if you might not work, but welcome the flexibility and financial cushion if you do.
2. Meticulously Track Your Expenses
One of the most revealing exercises for pre-retirees is a thorough audit of current spending habits. Beyond knowing your monthly outgo, differentiate between fixed expenses (mortgage, insurance) and variable costs (travel, dining out). Consider how your spending will inevitably shift in retirement. Work-related expenses—commuting, professional attire, daily lunches—will likely decrease, but other costs, like healthcare, leisure activities, and potential travel, may rise significantly. Getting a precise grasp of your future spending needs is paramount for determining if your current savings trajectory is on track. For instance, if your pre-retirement household spends $60,000 annually, aim to understand which portion (e.g., 70-80% of that figure, or $42,000-$48,000) will constitute your core retirement budget, excluding one-off expenses.
3. Verify and Optimize Your Social Security Strategy
For the vast majority of Americans, Social Security benefits form a cornerstone of guaranteed retirement income. It’s imperative to create an account on the official Social Security Administration (SSA) website (ssa.gov). This allows you to verify your earnings history, correct any discrepancies, and, most importantly, model various Social Security claiming dates. Your “full retirement age” (FRA) varies by birth year—for example, it’s 66 for those born between 1943 and 1954, and gradually increases to 67 for those born in 1960 or later. Claiming benefits as early as age 62 can permanently reduce your monthly payout by up to 30%, while delaying beyond your FRA, up to age 70, can increase it by approximately 8% for each year delayed. Understanding these implications is crucial for maximizing this vital income stream.
4. Critically Assess Your Current Retirement Savings
Once you have a clearer picture of your anticipated retirement spending and your projected Social Security income, you can determine the gap your personal investment portfolio needs to fill. A commonly cited guideline for sustainable withdrawals is the “4% rule,” suggesting you can safely withdraw about 4% of your initial portfolio value annually, adjusted for inflation, for a 30-year retirement. For example, a $1 million portfolio would theoretically support $40,000 in annual withdrawals. If your calculations show that your desired spending exceeds roughly 4% of your current portfolio, it’s a clear signal for action. Consider boosting your savings significantly, re-evaluating your investment strategy, delaying your retirement date, or adjusting your anticipated spending in retirement. Fidelity, for instance, suggests aiming to have saved 10 times your annual salary by age 67 to support a comfortable retirement.
5. Strategically Derisk Your Investment Portfolio
As you approach the retirement threshold, typically within 5-10 years, it becomes critical to recalibrate your asset allocation to safeguard your accumulated wealth from significant market volatility. This means gradually shifting a portion of your portfolio from higher-risk equities (stocks) to lower-risk fixed income (bonds) and cash. This strategy aims to mitigate “sequence-of-returns risk,” which is the danger of experiencing substantial investment losses early in your retirement. Such losses can severely deplete your capital when you need it most, making recovery challenging. A common derisking strategy, often called the “bucket strategy,” involves segmenting your assets: keeping 1-2 years of living expenses in cash, 3-5 years in stable bonds, and the remainder in a diversified stock portfolio. This allows you to draw from safer assets during market downturns, giving your equity investments time to recover.
By embracing this proactive and detailed approach to retirement planning, you will not only gain a clearer sense of when you can retire but also precisely what that retirement will look like. More importantly, it empowers you to make necessary course corrections, transforming your retirement aspirations into a tangible reality.
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By Margaret Giles of Morningstar
