Financial planners generally view long-term security as a two-step process. You build assets during your working years and then spend them in retirement. Accumulate. Distribute. How well you manage to do both helps determine the quality of your later years. But there’s a third, often overlooked step that must be managed too.
This is the transition step, which occurs five to 10 years before you leave the workforce. It’s a critical period. Most people work 30 years without a real savings plan. They put away as much as they feel their income allows, based on rules of thumb and vague advice. In retirement, they take stock of their assets and plan to make do by following still other cookie-cutter guidelines such as the 4% Safe Withdrawal Rate.
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Yet this approach is loaded with uncertainty. It leaves most people under saved and provides no cushion on the back side should you live an exceptionally long and healthy life. Meanwhile, your retirement goals may shift. You may experience financial setbacks or health issues; your passions may change in unexpected ways. These can have a tremendous impact on your money needs.
To a degree, it’s all a big guessing game in your 30s and 40s. But by the time you reach your 50s reality usually has set in, says Katie Libbe, vice president of Consumer Insights at Allianz Life of North America. You know the track you are on. It’s time to start figuring out your resources in earnest—while you still have time to make adjustments. You have time yet to save more, spend less, postpone your retirement date and even reset your expectations. Libbe advises asking five questions in the transition period:
- Is my plan realistic? It all starts right here. As you turn 50 it’s time to stop dreaming and get real. Where are you after 30 years of accumulation? You should be able to project your income and future assets pretty reliably by now. Key variables will be how much longer you work and to what extent you can take advantage of tax-deferred “catch-up” savings opportunities. Working just two or three years longer, or part-time, changes a lot.
- Are my assets where they need to be? Asset allocation isn’t just about diversifying your holdings. It’s also about getting your assets into the right vehicles for short-term and long-term needs. You may have a handful of IRAs and 401(k) accounts to go along with taxable accounts, a home and other assets. These need to be reconciled for efficient retirement income. For example, short-term funds should be in a liquid, no-risk account and your home equity should be thought of as a last resort. If you use a financial planner, she should know where everything is.
- What are the tax implications? Efficient distribution of assets begins with tax considerations. A mix of taxable, tax-deferred and tax-free accounts will give you the most flexibility for navigating future changes in the tax code. Your distributions may also trigger taxation of Social Security and Medicare benefits. A tax-wise distribution strategy can stretch your portfolio up to seven years.
- Should I delay taking Social Security? Unless you are in poor health, the answer is almost always yes. Every year you delay taking Social Security benefits the monthly payment you are eligible for rises by about 8%. This is one of the main reasons that working longer (and delaying benefits) works so well.
- How does guaranteed income fit into the equation? Personal savings used to be icing on the cake. Fixed costs were usually covered by a traditional pension and Social Security; what you had saved was fun money. For most people that is no longer the case. Pension and Social Security benefits have severely eroded. You need to map out a source of a guaranteed lifetime income to cover your fixed costs. One way to do that is through an immediate or deferred fixed annuity.