5 Important Financial Steps to Take When You Are 5 Years Away from Retirement

Retirement Planning

Retirement planning is a long-term process that can take years and years of preparation. However, the last five years can be particularly important. As retirement approaches, it is essential to start taking steps to ensure a financially stable future. If you are five years away from retirement, you still have time to make significant financial decisions impacting your retirement savings. You can use this time to make up for any shortcomings in your retirement plan, save or invest more, plan your retirement distribution, and more.

financial advisor can help you understand critical financial steps you should take when you are five years away from retirementThis article also explores the five crucial financial steps you must take when you are nearing retirement.

What to do when you are five years away from retirement 

The five years before your retirement is a critical time from a financial planning standpoint. It is the period when you need to make important decisions about your retirement finances and lifestyle. You may need to evaluate your retirement goals, assess your present and future financial situation, and determine whether you have enough savings and investments to meet your retirement expenses. You may need to adjust your spending and saving habits to ensure a comfortable retirement. You may also need to make changes to your investment strategy as your risk lowers and consider ways to maximize your retirement income.

Additionally, it is important to consider the tax implications of your retirement income sources, such as Social Security benefits, retirement account distributions, and other investment income. You may also want to review your estate planning documents to ensure they are up-to-date and aligned with your current wishes.

It is also a critical time to ensure that you are on track to achieve your retirement goals and to make any necessary adjustments to your financial plan to ensure a comfortable and secure retirement. If you are wondering what to do five years before retirement, here are some steps that will help you evaluate your current financial situation, identify areas for improvement, and make necessary changes to ensure a comfortable and secure retirement.

1. Take a look at your finances, budget, and potential expenses in retirement 

Assessing your financial situation and budget before you retire is crucial because it helps you determine whether you have enough savings to support your lifestyle during retirement. Without proper planning, you may struggle financially and be unable to enjoy the retirement you had hoped for. Your pre-retirement years are supported by your salary. Even if you overspend one month, you have a steady source of income to support your needs and the possibility to earn more in the future. But in retirement, your income sources are limited. Therefore, you need to learn to survive on your saved-up retirement nest egg and be careful of how much you spend.

You can start by determining the type of lifestyle you are living right now and how you want to live in the future. Calculate how much money you need to support that lifestyle and how much you need to save to achieve your specific retirement expenses, such as housing, food, healthcare, travel, and entertainment. This can help you plan your budget accordingly and make any necessary adjustments. Assessing your situation will also allow you to identify any potential gaps in your retirement savings. If you find yourself lagging behind during this period, you have five more years to take steps to fill those gaps by saving more or altering your retirement plans. Based on your findings, you can decide whether to postpone or prepone retirement. This will also give you an idea of how much to draw from your retirement savings to cater to your monthly expenses and whether to invest in other income streams in case you need more money for your retirement goals.

2. Assess if you have room to save more in the last five years before retirement

Increasing your savings rate in these years may be advised as this may be your last chance to build up your retirement nest egg. By building a larger nest egg, you can potentially generate more income from your savings through interest, dividends, and investment gains. This can be particularly important if you find gaps in your retirement plan and fear outliving your money in retirement. Moreover, saving more in these years may also help you retire earlier, travel more, or pursue hobbies or other interests without worrying about financial constraints.

An important thing to note is that most people retire in their 60s. The full retirement age is 67 for people born in 1960 or later. But you can start receiving your Social Security benefits at 62. Assuming that you would retire somewhere in your 60s, you can take advantage of the catch-up contributions of retirement accounts like the 401k, Individual Retirement Account (IRA), 403(b)s, government’s Thrift Savings Plan (TSP), 457s, etc., in the years before you retire. These retirement accounts allow people aged 50 and over to make additional contributions to their accounts in a year. As of 2023, 401ks, 403(b)s, TSPs, 457s, etc., permit an additional catch-up contribution of $7,500 per annum. This is on top of the annual contribution limit of $22,500. The catch-up contribution for an IRA is $1,000 for 2023, with the total contribution being $7,500.

Catch-up contributions can give you more flexibility in retirement, as you will have more money to cover unexpected expenses or pursue hobbies and interests without worrying about money. Moreover, some employer-sponsored retirement plans offer matching contributions, and catch-up contributions can help you maximize these and further increase your retirement savings. With catch-up contributions and an employer’s match, you can contribute up to $73,500 to a 401k account in 2023. If you have not been able to save enough for retirement, catch-up contributions can help you make up for lost time and bridge the gap in your retirement savings. Therefore, make sure to utilize this time to save and invest more.

3. Pay off any debt during these years so you can retire debt-free

Debt can be a major source of financial distress. It can negatively impact your finances and overall well-being. It can be particularly hard to manage in retirement, where you have limited money to sustain your needs. Hence, settling all your debt at least five years from retirement is essential to ensure you do not have any high-interest financial burden in your golden years. Paying off debt, such as a credit card balance or high-interest mortgage, can reduce your monthly expenses in retirement and free up more money to put towards your retirement needs, such as healthcare. Paying off debt also allows you to minimize financial stress and focus on enjoying your retirement.

Additionally, paying off your debt improves your credit score, which opens the possibility of availing of a loan at a lower interest rate in the future. You may face unexpected financial emergencies in retirement that can force you to take on loans or rely on credit cards. You can borrow funds at a lower interest rate later if you have no outstanding loans. This can be beneficial in retirement as you will spend less out of your retirement nest egg.

Settling your debt at least five before your retirement will also free up money and help you contribute more towards your retirement corpus. You can start by settling debts with the highest interest rates first while making minimum payments on other debts. This strategy can help you save money on interest payments and pay off your debts more quickly. You can consult with a financial advisor to determine the best debt repayment strategy for your specific situation.

4. Change your asset allocation to accommodate your lowering risk appetite

As you approach retirement, your risk appetite may decrease as you become more focused on preserving your savings than earning high returns. With a shorter investment horizon and nearing retirement, one of the things to do within five years of retirement is to change your asset allocation. This is the time to reduce your exposure to high-risk investments like equity, alternative investments like hedge funds, etc., and increase your allocation to more conservative investments like bonds, money market accounts, certificates of deposits, etc.

Asset allocation refers to allotting specific percentages of your portfolio to different asset classes, such as stocks, bonds, and cash. A more conservative asset allocation might include a higher percentage of bonds and cash, which generally have lower risks and lower potential returns than stocks. One of the most commonly used asset allocation strategies is the rule of 100. According to this rule, you can subtract your age from 100 to arrive at your desired asset allocation. For instance, if you are 30 years old, you can invest up to (100 – 30 = 70%) of your money in equity and other high-risk classes and the remaining in bonds and cash. If you are 55 years old, you can invest (100 – 55 = 45%) of your money in equity and other high-risk classes and the remaining in bonds and cash. Although a general rule, the concept behind this strategy is to adjust your portfolio and align it with your altering risk appetite.

Five years before your retirement is a critical time. While you may utilize this time to increase your savings, you must also be careful not to expose yourself to too much risk. Adjusting your asset allocation can help you reduce your portfolio’s volatility and potential losses during market downturns while still generating income to support your retirement needs.

However, it is essential to note that a more conservative asset allocation may also mean lower potential returns and may not be suitable for everyone, depending on their individual financial situation and goals. It may be best to consult with a financial advisor to determine the best asset allocation strategy for your specific situation, considering your risk tolerance, financial goals, and retirement income needs.

5. Plan your retirement distributions and make sure they align with your liquidity needs

As you move closer to your retirement, you need to start paying attention to your liquidity needs and ensure you always have enough to cater for your monthly expenses. It can be hard to arrive at a monthly withdrawal figure that covers your needs and, at the same time, does not overwhelm you. Many people may get carried away and spend a lot of money in the initial years of their retirement. This increases longevity risk. Outliving your savings can have severe repercussions. So make sure to plan your distributions well in advance.

One of the most important things to consider five years from retirement is your tax liability in retirement. When you plan your retirement distributions, remember to time your withdrawals to take advantage of lower tax brackets and use tax-efficient investment vehicles, like the Roth IRA, that are tax-free in retirement. This will help you minimize your tax implications and maximize the amount of money you keep in your pocket. Determining a sustainable withdrawal rate that balances your income needs with your portfolio’s growth potential and risk level is also important. Remember, retirement can be a long time, and you still need to invest your money so it continues to grow in the face of inflation.

It is essential to consult with a financial advisor to develop a comprehensive retirement plan that considers your individual financial goals and situation. The financial advisor can also help you understand when to withdraw your Social Security benefits to maximize your check and how to plan your Required Minimum Distributions (RMDs) for traditional retirement accounts like the 401k and more.

To conclude

Retirement can be unpredictable and uncertain. But sound planning at every step can help eliminate some of this and offer you a clear map to follow in the future. It is essential to know what to do five years before retirement, and it may be best to focus on your asset allocation, debt situation, liquidity needs, and savings rate at this point in time. You must also evaluate your present financial situation, identify the gaps, and try ways to fix them. By following these steps, you can ensure sufficient income and financial security in retirement. It is also essential to consult with a financial advisor to devise a retirement plan that aligns with your requirements.

Use the free advisor match service to hire a financial advisor in your area who can guide you on what steps to take when you are 5 years away from retirement. All you have to do is answer a few simple questions based on your financial needs, and the match tool will help connect you with 1-3 advisors best suited to meet your financial requirements.

For additional information on retirement strategies based on your specific financial needs, visit Dash Investments or email me directly at dash@dashinvestments.com.


jonathan dash

Jonathan Dash
Founder and President
Email: info@dashinvestments.com