By Justin Pritchard, CFP®
About to retire? Moving into the next chapter of life can be exciting, scary, satisfying, and challenging—all at the same time. Your finances are just one part of the equation, and it’s critical to have everything working smoothly as you move through retirement. This is a time in life when you can’t afford catastrophic setbacks, and you’d rather spend your time on more important things.
This guide is designed to help you retire smoothly. Whether you take on all of these items at once or spread them out over time, you can improve your chances of a rewarding time in retirement.
Note the Important Dates
Set reminders for yourself or enter crucial milestones in your calendar. You may be busy doing fun things or dealing with health issues in the coming years, and you need to avoid missing critical deadlines. Some of the most important retirement-related tasks are below.
Sign Up for Social Security (4 Months Prior)
It’s smart to apply for Social Security four months before you want to receive your first payment. Social Security retirement benefits can start as early as age 62, but you pay a price (reduced benefits) for claiming early. Find out when you reach full retirement age, and consider delaying benefits until age 70 if you want to maximize the amount you receive.
If you’re planning to retire early, that’s great. You don’t necessarily have to take your Social Security retirement benefits at the same time you retire (so it’s okay to retire before age 62.) In fact, stopping work and waiting to get benefits may provide some opportunities to manage your taxes in retirement.
Sign Up for Medicare (3 Months Prior)
Once most people reach age 65, it’s time to use Medicare for health insurance. It’s important to sign up at the right time—otherwise, you risk paying additional penalty premiums or facing a gap in coverage. It’s smart to start the process three months before you reach age 65 if you’re retired. If you’re still working and you have healthcare through your job at age 65, ask your health insurance provider how to handle your 65th birthday.
Continuation of Healthcare Benefits Ending (18 Months)
If you’ve used COBRA or a state program to continue your health care after retirement (but before Medicare), note when those benefits end. Again, if you’re anywhere near age 65, be sure to ask your health provider what to do (continuing your benefits can actually trip you up and cause problems later). Continuation often lasts 18 months, so if you’re still not eligible for Medicare after that, you may want to look at private healthcare plans for individuals and families through a state marketplace.
Required Minimum Distributions (Age 72)
Once you reach age 72, you may need to take required minimum distributions (RMDs) from your retirement accounts. That includes accounts like a 401(k), 403(b), TSP, pre-tax IRA, and more. Technically, you may have until April of the year following the year you turn 72—yes, that’s as confusing as it sounds. But you can do it the easy way, if you want, and just start taking RMDs when you’re 72.
There’s a steep penalty for missing an RMD. You may have to pay 50% of the amount you were supposed to take, so it’s a good idea to automate these distributions. Also, waiting until the last minute can be problematic, so give yourself some buffer time to make sure everything happens properly.
There may be other significant milestones involved, depending on your circumstances and your financial plan. Triple-check everything so you can enjoy your retirement years.
Review Your Investment Risk
You may have accumulated a substantial amount of savings for retirement, and those assets need to last for the rest of your life. That’s tricky because you may need to keep growing that money—but big losses can cause serious financial damage.
The early years of retirement are some of the most important when it comes to investment risks. Scholars like to talk about the “sequence of returns” you receive in retirement. Put simply, if you suffer major losses in the early years, you increase the risk of running out of money during your lifetime. But losses later in life tend to be less problematic.
The takeaway: Big losses when you’re about to retire are a big deal. Evaluate your risk, and decide if it makes sense to change anything.
Tip: There’s a free risk tolerance quiz in the middle of this page to help you think about risk. It’s designed with input from psychologists and is not the traditional investment questionnaire. Most people spend about six minutes on the questions.
Continue reading below, or watch the companion video for this page.
Make an Income Plan
Once you stop working, your paycheck stops.
Start by adding up all of your guaranteed income. This is the base of your income, and typically includes things like:
- Social Security Income
- Annuity payments
So, if you have $1,500 each month in Social Security plus $1,000 per month from a pension, you’ve got $2,500 of monthly income to start with.
But those guaranteed income sources might not cover all of your expenses. If that’s the case, you’ll need to withdraw funds from your retirement savings.
Then estimate your withdrawals. Unless you’re fabulously rich, you will most likely spend from your retirement savings. “Living off the interest” isn’t a reality for most people, but that’s okay—there is plenty of research to suggest that you can spend from your assets without running out of money. It’s best to do a retirement plan with detailed projections and cash flows, but a rule of thumb can give you a ballpark estimate of how much money you need to retire.
There are at least two popular methods for planning your withdrawals:
- The 4% rule
- A bucketing strategy
The 4% rule is an estimate of the amount you can “safely” pull from your savings over a 30-year retirement without running out of money (in most cases). Safely is in quotes because there are no guarantees in life. Still, there’s a good chance that this will work in most scenarios. Why is the number so low, and how does it work? Let’s take a look.
The 4% rule says you can withdraw 4% of your starting retirement assets and adjust for inflation (that’s why you start with a seemingly low number) over a 30-year retirement. Based on historical data, this withdrawal rate did not result in hypothetical retirees running out of money during their lives. And here’s the good news: The rule has been revised to be the 4.5% rule, and in many cases, you end up with more money than you started with.
Example: You have $1 million saved for retirement.
- In the first year, you can withdraw $40,000 (or 4% of $1 million).
- Prices rise over the year by 2%, so you’ll adjust next year’s withdrawal amount to keep up with inflation.
- In Year 2, you withdraw $40,800 (or $40,000 plus a 2% raise for inflation).
- The process continues
Expect to adapt: One of the best things you can do for yourself is to expect changes. If you reduce withdrawals during market crashes, you improve your chances substantially, and you might even be able to give yourself bigger raises when markets are strong.
Plan for Healthcare Expenses
You may have received health coverage from your employer during your working years, but things are different in retirement. You need to know what your options are and how much it will cost. A key question is whether you retire before or after age 65.
At 65, most people are eligible to enroll in Medicare, but if you’re ready to retire before then, you may need to use other sources. Options include:
- Temporary continuation of benefits from your employer’s plan (COBRA or state continuation)
- A privately-purchased healthcare plan (from your state’s marketplace, for example)
- Coverage under a spouse’s plan, if applicable
So, how much will healthcare cost in retirement? It depends on where you live, your health, and other factors. Several studies estimate the costs, and you can get insight into those numbers in this article on healthcare options and costs in retirement.
Before age 65, premiums can be quite expensive, so it’s important to know about those costs before you stop working. After age 65, Medicare can keep costs under control somewhat, helping you retire with decent medical coverage. Medigap polices can manage costs further. Be sure to plan for these annual expenses, as your employer may have been covering the majority of your healthcare expenses up to this point.
Plan Ahead for Incapacitation
As part of your planning for healthcare, it’s wise to expect a time when you won’t be able to make decisions or manage your finances. That might be a temporary period (related to an accident or illness), or it could be an event that lasts through the end of your life. Review your healthcare directives, power of attorney, and any estate planning you’ve done every few years.
Planning for these events makes life easier for your loved ones. It can potentially also help everybody financially, but most importantly, it reduces the burden at a time when those who care for you will be stretched thin.
If you haven’t started on these things, speak with an estate planning attorney licensed in your state. A financial planner can also share ideas and start the conversation, but you need help from an attorney for legal documents and advice on intricacies.
Don’t Forget Inflation
Over time, prices have historically risen—things get more expensive every year (although there are exceptions, such as technology goods). In recent years, inflation has been tame, but over the last 50 years, inflation was around 3.9% per year. Some economists expect prices to rise at a rate just over 2% in the next 10 years.
If you’re planning your spending, you need to account for rising prices. That means calculating withdrawals that can increase each year and considering investing in a way that helps to offset (or potentially even outpace) the rate of inflation.
Decide What to Do With Your Investments
Over your working years, you may have accumulated savings in a retirement plan like a 401(k), 403(b), or cash balance plan. You may also have a pension that’s available to take in a lump sum or monthly payments. What will you do with those critical assets that you’ve spent a lifetime building up?
It’s best to take your time and make decisions about these things before you’re about to retire. Start the process several months or years before your retirement date so that you’re not pressured to do something after you retire. Plus, retirement is a big transition, and it would be nice to have all of your mental and emotional resources available to experience that change (without additional administrative tasks taking up headspace).
With accounts like 401(k) plans, you generally have several options when you retire. As you evaluate the options, be mindful of fees and risks associated with making a change. Ask about any charges in your 401(k) and those charged in an alternative product. Study the pros and cons of making a change, and make sure you’re getting advice from a trustworthy source.
1. Roll Funds to Your Own Retirement Account
In many cases, it’s smart to move funds to your own retirement account, like an IRA. This allows you to control your money and choose where you invest. Plus, you cut ties with your employer and are not dependent on them (or at the mercy of their reorganizations and similar issues).
This generally does not cause tax consequences. Once you’re ready to withdraw from your IRA, then you would owe taxes. This approach allows you to plan and strategize when you have taxable income, and how much.
2. Leave Assets With Your Employer
While this is probably easiest today, it may limit your options down the road and make it harder to manage your money. Employer plans may restrict how and when you take withdrawals. They may have administrative hurdles when compared to working with an IRA, and the investment options and expenses might not be ideal.
The main reason to leave your money with an employer might be if you retire after age 55 but before age 59.5. In that case, you may have an opportunity to take income from the account without additional tax penalties. This strategy can potentially help you retire a few years earlier.
3. Cash Out
This is usually not the best option, but if you need all of the money right now, you can cash out. You may need to pay income tax on your withdrawal, and taking a large distribution may put you into relatively high tax brackets.
Some people are drawn to this option to pay off debts like a mortgage. That’s understandable, but make sure you at least run the numbers before you go this route. There’s a valuable benefit to being debt-free, but it may come at a cost, and you need all of the details to make an informed decision.
If you move funds to an IRA instead of cashing out, you can take cash as needed—without cashing out your entire account. You can arrange those withdrawals to fit with your income plan, arranging a monthly transfer to your bank account, for example. Also, you can get funds in a lump sum for things like major projects and unexpected expenses.
If You Have a Pension
If your employer provides a pension that pays out income for the rest of your life, you have a variety of additional decisions to make. Again, start thinking about these things and weigh the pros and cons long before you’re about to retire.
- Lump-sum vs. pension payments: You might have the option to take funds in a lump sum and roll the money to an IRA. To decide what’s best, look at the monthly payments you receive compared to the lump sum, and determine what provides the most value to you and your loved ones. This is a big decision, and demands careful attention.
- Which income options? If you choose to take income from a pension, get familiar with all of the payment options. The biggest monthly payment might be for your lifetime, but what happens after you die? For example, if you have a spouse and you want those payments to continue, you may be able to set up survivor benefits (whether your spouse gets 50%, 100%, or a different level after your death).
What About Buying an Annuity?
An annuity is an insurance contract that may provide things like income payments that last for the rest of your life. Your retirement assets might already be tax-protected, so an annuity does not add any benefit in that area.
Before you decide on an annuity, be aware that annuities pay significant commissions, so take any suggestions with a grain of salt. Investigate things like surrender charges, fees, caps, alternatives to annuities, and more. They’re not all bad, but they have provided fertile ground for abuse.
If you have your heart set on using an insurance company, you might do something similar to the first option above. You would transfer your funds to an insurance provider. Every situation is unique, but retirement planning with annuities might make the most sense when you set up immediate income payments. If you’re not doing that, you may need to ask difficult questions about why you’re using an annuity.
Remember Your Home Equity
Most people don’t think of home equity as a retirement asset. That makes sense because you need to live somewhere, and tapping your home’s equity can put your residence at risk. Still, it’s nice to know what resources you have available, and how you can potentially use those resources. For some people, home equity can provide backup funding for catastrophic medical events.
Two ways to put your home equity to use are downsizing and reverse mortgages.
You might downsize when you’re about to retire for several reasons:
- Simplify life
- Move somewhere you’d rather live
- Move to a smaller place that’s easier to mange
- Live somewhere without stairs (reduce the risk of injury later in life)
- Declutter while you’re still young (so the kids don’t have to deal with it)
- Eliminate wasted space if you’re not using your full home
Plus, there are financial reasons, which may help you retire comfortably on a fixed income:
- If you buy a less-expensive property, you might generate cash that you can use to supplement your Social Security or pension income
- A smaller property may have lower maintenance, heating, and cooling costs
- A more modest property could have lower property taxes
- Switching to a less-expensive home can enable you to stop paying a mortgage (if you have enough equity to pay cash for your next home)
If you have sufficient equity and you’re at least 62 years old, you might be able to use a reverse mortgage. While getting a mortgage at this stage in life probably doesn’t sound appealing, these loans are different from traditional mortgages—you don’t make monthly payments, for starters.
A reverse mortgage can provide income or a line of credit that you draw on as needed. If you’re coming up short on your monthly income needs, this strategy could help you retire when you want to.
As with anything in life, there are pros and cons of reverse mortgages. It’s critical to review how they work carefully. When you or the last borrower permanently leave the home (due to death, moving, or entering nursing care), your loan is due. The good news is that you should not owe your lender money, even if you “borrow” more than your home is worth—lenders can only collect from the value of your home.
Unfortunately, if there are plans to keep the home in your family, you’ll need a way to pay off that loan. Life insurance policies can help provide liquidity, or your heirs can arrange financing on their own. But if they’re unable to raise the needed funds, the house needs to sell.
All that said, if you don’t care what happens to the home after you leave, that makes the decision easier.
If you’re in a situation where you have just 15 or 20 years to save for retirement, home equity might be an important part of your plan.