Here’s the retirement quandary for many Americans.
They spend years building good financial habits so, if all goes well, they have sufficient funds by the end of their working years. Then, when it’s time to transition, they often struggle in the shift from saving to spending their nest egg.
The no-stress years suddenly become the all-stress years.
“It’s disappointing to get to your first couple of years of retirement, and just constantly be stressed out about your income generation strategy from your portfolio,” said Andy Baxley, senior financial planner at the Planning Center.
But “there are things that can and should be done to mitigate that stress,” he said.
Here are some of his, and other experts’, greatest tips for a smooth retirement. Caveat: Not all of these steps fit every situation. So if you can afford it, consulting with a financial adviser is always a good way to go.
Step 1: Phase out of work gradually
Baxley believes in what he and others call a “phased retirement.” In other words, rather than retiring all at once, slowly phase out of work, “maybe going to third time or halftime,” or even find another job that would accommodate such a plan.
“Then that way, you’re kind of splitting the difference,” he said. “You’re starting to rely on your financial assets a bit but you’re also still earning a paycheck and that can really help to ease the transition financially but also emotionally as well.”
Step 2: Ramp up contributions to your retirement account
Julie Virta, a CFP at Vanguard, explained that folks tend to think they’ll spend less in retirement. But, contrary to popular belief, they often spend the same amount, especially if they have travel or other such plans.
Ideally, around five years out, soon-to-be retirees should begin ramping up contributions to IRAs and 401(k)s to increase their retirement fund, Virta said. That’s often a good thing not only for the nest egg, but also the state of mind. Also, tax laws currently allow people over 50 to put more into retirement plans pre-tax, per the IRS.
“[It] Gives them the opportunity to really bump up the savings in those five plus years ahead of the actual retirement,” she said. “It can also be a good time to look at your budget and see how you would spend from your portfolio without your earnings.”
Step 3: Create a ‘retirement paycheck’
One great way to turn down the stress meter: Baxley tells clients to “recreate the experience they had while still receiving a paycheck.” That means, receiving regular payments instead of drawing out a year’s worth of cash out of your retirement account.
“It’s easy to replicate how your paycheck is felt by just simply setting up automatic, monthly or even bi-monthly withdrawals from your IRA or from your 401(k),” Baxley said. “So that can be a way to make sure that the experience of growing income from your portfolio feels very similar to the experience that you had when you’re collecting a paycheck in terms of cadence and predictability and that sort of thing.”
Virta agreed, saying she typically advises clients to withdraw between 3%-5% of their total savings the first year of retirement. Then, she said, they should adjust for inflation, market returns, and retirement spending such as medical bills.
In some cases, retirees may have no choice but to begin withdrawing funds. Required minimum distributions kick in for traditional IRA, SEP IRA, SIMPLE IRA, and retirement plan accounts when you reach age 72 or “73 if you reach age 72 after Dec. 31, 2022.” See the the IRS rules here.
Step 4: Be mindful of taxes
Virta also advised soon-to-be retirees to take advantage of tax benefits in retirement and to have a specific drawdown strategy. She explained that clients could reduce their taxable income each year “by spreading out withdrawals and pulling money from both taxable and non-taxable sources before a required…withdrawal.”
In particular, they can take money from both a 401(k) plan and a Roth IRA, or other qualified dividends to maximize their effective tax benefits and reduce their effective tax rate. A tax adviser can help guide you through the process.
“I’d say the biggest mistake is you know, in not thinking about tax opportunities, your tax planning opportunities in your spending strategy,” Virta said.
Step 5: Optimize your Social Security benefits
Social Security plays a critical role in the shift from saving to spending, Baxley said, calling it “often the number one most impactful decision a retiree makes.” Some may claim Social Security at “full retirement” age, which is 67 for those born in 1960 and later. Others can claim later and watch the benefit grow.
There are a number of ways to go and, again, a financial adviser can help walk you through it.
Some folks, for instance, might want to take the reduced benefit at 62 if they have a short life expectancy or really need the money.
But sometimes, he said, it makes sense for them to wait longer. He noted that soon-to-be retirees get roughly an 8% bump in their benefits each year that they wait beyond full retirement age. For instance, someone might retire at 67 and wait 3 years to let their Social Security benefits accumulate before claiming at age 70.
“I always encourage folks to really separate, in their minds, their retirement date from the date they claim social security because ultimately, you can claim Social Security as late as age 70,” he said. “And if you’re in really good health, and heavily dependent on your Social Security for retirement income, it does make sense to wait that long.”