AARP Smart Guide to Pre-Retirement

5 YEARS TO RETIREMENT

Safeguard your savings

If your investments have performed well in recent years, you may be tempted to keep a large percentage of your money in the stock market. But with retirement just a few years away, you need to protect your nest egg from a prolonged market downturn. Otherwise, you could be forced to sell stocks or mutual funds at a loss to pay bills, which could permanently damage your portfolio and put you at risk of running out of money in retirement. 

Start stashing three to five years of living expenses in more conservative investments such as a high-yield savings account, money market fund, certificate of deposit (CD) or short-term Treasury bills, says Nero, explaining, “You’re building a bridge for the next five years.” Many high-yield savings accounts and CDs are currently paying rates of 4 percent or more. You can compare savings accounts and CDs at Bankrate, NerdWallet or DepositAccounts.

Review your health care options

If you plan to retire before age 65, it isn’t too soon to start thinking about how you’ll pay for health care until you’re eligible for Medicare. Options include continuing your employer coverage through COBRA, which allows you to keep coverage for up to 18 months; signing up for an Affordable Care Act Marketplace plan; or enrolling in your spouse’s employer-provided plan if your spouse plans to continue working after you retire.  

Some of those options can be expensive, however. For example, while COBRA allows you to continue using your current health care insurance, you’ll be required to pay 100 percent of the premium, which means you could end up paying more than $700 a month for self-only coverage or more than $2,000 a month for family coverage.

Running the numbers now will help you determine how much you’ll need to save and whether you can afford to retire before you’re eligible for Medicare.

Project how much you’ll receive from Social Security

If you don’t already have an online account with Social Security, set one up at www.ssa.gov/myaccount. Once you’ve set up an account, you can use the website’s online tools to estimate how much you’ll receive from Social Security based on different claiming strategies for yourself and your spouse. “You have to find the optimal benefit for your retirement,” says James Shagawat, a CFP in Paramus, New Jersey.

Your benefits are based on your highest 35 years of earnings, so this exercise will help you determine whether you need to work a few more years to maintain your standard of living in retirement. This is particularly important if you left the workforce for a few years at some point in your career to care for children or aging parents. You should also review your earnings record for any errors that could reduce the size of your benefits. Errors could occur if a former employer used the wrong Social Security number to report your earnings or you changed your name and failed to report it to Social Security.

Build a retirement budget and try it out

Doing a retirement test-drive can provide reassurance that you’ve saved enough to weather an early retirement (in the event of a layoff, for example) — or provide a wake-up call if you need to save more.

Put together a detailed budget of your expenses and estimated income sources, says Rosenstrock. Start with mandatory costs, such as housing, transportation and health care, then add discretionary expenses, such as travel and gifts for the grandchildren. Then add up the amount you expect to receive from Social Security, pensions, savings and other sources. Vanguard, TIAA and Principal provide free worksheets you can use to track expenses in different categories.

Once you’ve estimated your monthly expenses in retirement, try living on that amount for a few months, Nero suggests. That will give you a more realistic idea of how much you’ll need to withdraw from your savings and other sources to maintain your standard of living in retirement.

Plan for taxes in retirement

At this point, you may have much of your retirement savings stashed in a traditional 401(k) plan. While those contributions reduce your taxable income, you’ll have to pay taxes on withdrawals in retirement. “Too many people forget you have to pay the government at some point,” Caro says. If you’ve accumulated a significant amount of money in tax-deferred accounts, your required minimum distributions (RMDs) — currently when you turn 73 — could push you into a higher tax bracket and trigger taxes on your Social Security benefits, plus a surcharge on your Medicare Part B premiums.

If your employer offers a Roth 401(k) plan — 93 percent of 401(k) plans do, according to the most recent survey from the Plan Sponsor Council of America — diverting some of your contributions to that account could pay off, particularly if you think you might be in a higher tax bracket when you retire, a 2024 analysis by Charles Schwab found. Roth 401(k) plans (and traditional Roth IRAs) aren’t subject to RMDs, and withdrawals are tax-free, including investment returns, as long as you’re at least 59½ years old and have owned the account for at least five years. 

Make an appointment with a financial planner

Even if you’ve managed your portfolio in the past, now is a good time to consult a professional, Caro says. “When you have five years to go, it’s good to start a relationship with a financial planner before you really need it.” A financial planner can help you determine whether the amount of income you can expect to receive from different sources — such as Social Security, pensions and retirement accounts — will be enough to cover how much you expect to spend in retirement, says Brady. Many planners use sophisticated software to assess your whole portfolio and then leverage their expertise to determine what financial moves you should make before retirement.

Look for a fee-only CFP who will act as a fiduciary, which means the planner will put your interests first. You can search for one at Let’s Make a Plan or FPA PlannerSearch.

Scout out potential retirement destinations

Once retired, are you planning to move somewhere warmer, cheaper or closer to family? Start visiting potential locations to determine whether they’re a good fit.

If you have the time, consider booking a short-term rental so you can stay longer than a week and live like a local. Pay close attention to living costs — not just real estate prices but also property taxes, homeowners insurance, even groceries, which can vary significantly.

Access to health care will become even more important as you age, so research the quality of hospitals and health care providers. Medicare offers an online tool you can use to assess the quality of care at more than 4,000 Medicare-certified hospitals.

Consider a phased retirement

Giving up a regular paycheck can be jarring, even if you’ve accumulated a large nest egg. A growing number of workers approaching retirement are making the transition easier by switching to a part-time position at their company, starting a side hustle or finding a job in the gig economy. This kind of phased approach can allow you to continue to work but on your own terms, and the extra income will extend the life of your savings since you won’t need to withdraw as much money to pay bills in retirement.

With five years to go, you have ample time to discuss part-time opportunities or consulting jobs with your current employer. If you’d like to try something new, start developing the skills you’ll need to succeed in that line of work. The Bureau of Labor Statistics’ Occupational Outlook Handbook provides information on required training, skills and other qualifications, as well as median pay and job growth rates, for more than 800 occupations, from paralegals to flight attendants to financial planners to real estate agents.

1 YEAR TO RETIREMENT

Consolidate your retirement accounts

Consider rolling retirement accounts from former employers into one individual retirement account. You’ll have a broader selection of funds, and it will be easier to keep track of your investments.

If you’ve lost track of a former employer’s plan, the Department of Labor offers a tool you can use to search for it. Capitalize, a company that helps individuals roll over employee-sponsored retirement assets, estimates that U.S. workers have left behind 29.2 million accounts holding a total of $1.65 trillion in assets.

Track down lost pension benefits

If you worked for a company that provided a pension, you may be eligible for benefits, even if the company has gone out of business. When a company is unable to meet its obligations, the federal Pension Benefit Guaranty Corporation (PBGC) takes over the plan and pays out benefits, up to an annual limit set by law.

The PBGC provides a database you can use to find pension benefits you may have earned. The directory includes the names of individuals who couldn’t be found when an employer terminated its pension plan.

Use the bucket system to build your retirement portfolio

Ideally, you’ve shifted more of your portfolio to bonds, money market funds and other low-risk investments as you’ve approached retirement. But investing most of your portfolio in safe investments comes with its own risk: Your portfolio may not keep pace with inflation, increasing the risk that your retirement savings won’t last.

To get around this problem, many financial advisers recommend dividing your portfolio into three “buckets.” In the first bucket, you stash enough money in ultrasafe investments, such as bank savings or money market funds, to cover your expenses for your first five years of retirement. In the second bucket, you invest money that you’ll need for retirement years six to 10 in short- and intermediate-bond funds. The third bucket, which is dedicated to money you won’t need until year 11 or later, should be invested in stocks, stock mutual funds and other assets that provide long-term growth.

If you deplete your first bucket before your sixth year of retirement, you can shift assets from the other two buckets, ensuring you’ll always have enough cash to ride out any market downturns.

Take advantage of your employer-provided vision and dental benefits before you retire

Generally, traditional Medicare doesn’t cover routine eye or dental care, and while many Medicare Advantage plans provide coverage, it’s usually limited to providers in the plan network, which may not include your preferred optometrist or dentist. So make appointments for eye and dental exams and other procedures while you’re still covered by your employer’s insurance plan.

Don’t leave money on the table

Carve out time to sit down with a benefits manager in your company’s HR department. Discuss your retirement timeline: Will working a few more weeks or months increase your monthly pension payout or make you eligible for a bonus, profit-sharing payment or 401(k) match? Also find out if your company compensates workers for unused vacation days when they retire. If it doesn’t, use the rest of your vacation time before you leave.

If you’re eligible for a pension, talk to human resources about your payout options: lump sum versus an annuity, for example. Bottom line: “Get all of the money due to you,” says Shagawat.

Spend down your flexible spending account

Unlike health savings accounts, you can’t roll over unused funds in your flexible spending account (FSA) for health care, so make sure you use up the money in the account before leaving your job. If you don’t, you’ll forfeit the unused funds.  

The list of eligible FSA expenses is long, and includes everything from contact lenses and hearing aids to pain relievers and cough medicine. To find a list of eligible expenses, go to www.fsafeds.gov.

Finalize your health care coverage

If you’ll be eligible for Medicare when you retire, start researching coverage options, including Medigap, Medicare Advantage and Part D prescription drug plans. Since Medicare Part A, which covers hospitalization, is usually free, most individuals sign up when they turn 65. But because you’ll have to pay premiums for Part B, you’ll probably want to postpone enrolling until you stop working. To avoid gaps in coverage, enroll the month before you retire.