It’s “go time” if you’re planning to retire in 2015, or even in the next few years.
As millions of baby boomers flip the switch from gainfully employed to living off their savings, the financial decisions they face are countless and complex.
They must convert their nest egg into income, for starters, and manage their withdrawal rate to ensure they don’t outlive their savings.
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They must also determine when to begin claiming Social Security and whether their asset allocation still reflects their long-term goals and tolerance for risk.
In short, the months leading up to retirement are when the rubber meets the road.
“The preretiree should begin to establish a budget based upon actual spending during the last 12 to 18 months of employment,” said Neil Brown, a certified financial planner with Burkett Financial Services. “They should record their expenses and determine if this is a reasonable amount, given their soon-to-be disappearing paycheck.”
To stress-test your budget, he suggested practicing living off an amount equal to your guaranteed sources of retirement income for at least six months, including pensions, Social Security, annuities or—for the lucky few—trust funds.
Mind the gap
In the expense column, don’t forget to include car loans, credit card bills, property tax, mortgage payments, groceries, gifts, entertainment, gas and insurance premiums. And allow plenty of wiggle room for what will likely be your biggest cost during retirement: health care.
Fidelity Benefits Consulting estimates that an average 65-year-old couple with traditional Medicare insurance coverage who retires this year will need $220,000 to cover medical expenses through retirement. That does not include costs associated with nursing-home care.
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Whatever gap exists between your guaranteed sources of income and your monthly expenses is the amount you’ll need to generate from your personal accounts.
That may require taking greater risk in your investment portfolio or lowering your withdrawal rate and living on less.
Financial advisor Paul Zemsky, chief investment officer for multi-asset strategies at Voya Investment Management, said the nearly retired should resist the urge to become too conservative with their portfolios.
With medical advances today, retirees may well live 30 years or more in retirement and thus need to continue investing for growth to protect against inflation and longevity risk (the risk of outliving your savings).
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But with rock-bottom interest rates keeping bond yields painfully low, they may need to consider fixed-income alternatives to balance their portfolio, he said.
“Bond yields are at the lowest level that most retirees have seen in their lifetime,” Zemsky said. “At a time when millions of Americans are entering retirement eligibility, the markets are not providing as many income opportunities.”
Zemsky currently recommends high-yield alternatives including dividend paying stocks, managed payout funds (which seek to provide retirees a stable income) and master limited partnerships, or MLPs, which invest in slow-growth, relatively stable U.S. energy firms, such as those that operate oil and gas pipelines.
Taxes are an important consideration, as well, when developing a retirement budget, said Bob Adams, a certified financial planner with Armstrong Financial Planning.
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Many retirees fall into a lower bracket when they stop collecting a paycheck, which can favorably impact their future retirement income.
Others may find that the required minimum distributions from their individual retirement account, which begin at age 70½, are sufficiently sized to bump them back up into higher tax-rate territory—or even indirectly subject them to the new 3.8 percent Medicare surtax.
Retirees should factor in such tax changes well in advance, said Adams.
As you cross the threshold into retirement, you’ll also want to ensure that your nest egg is well insulated.
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Brown, at Burkett Financial Services, suggests fortifying your cash reserves so you aren’t forced to sell stocks into a down market to meet your income needs.
While those still working are generally advised to keep three to six months’ worth of living expenses in an interest-bearing account, Brown suggests new retirees keep between 24 and 36 months of expenses in high-quality short-term bonds, money market funds, certificates of deposit and cash.
Your Plan B
If you can’t make ends meet during the trial run, your choices are simple: Either lower your fixed expenses or work longer.
Retirees should rid themselves of credit card balances and other high-interest debt before they quit work, but they can potentially stretch their savings further by eliminating life insurance coverage—generally not needed after the kids are grown—keeping one car instead of two, cutting back on cable television and downsizing to a smaller home.
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If your house has appreciated significantly, you might also consider a reverse mortgage, which enables homeowners age 62 and older to convert part of their equity into cash.
Instead of making monthly payments to the lender, as per a traditional mortgage, the lender makes payments to the borrower throughout their lifetime. You need not repay the loan until you leave the house or pass away.
But be forewarned: If you fail to keep up with utilities, homeowners insurance and real estate taxes, the bank can foreclose on your home.
Ultimately, the best way to cover any savings shortfall is to continue working, Brown said, noting that working can include part-time gigs or consulting jobs.
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A few extra years on the job will not only give your tax-deferred savings tools more time to benefit from compounded interest but also enable you to supplement your 401(k) plan and individual retirement account with larger catch-up contributions.
Importantly, postponing your retirement may enable you to delay Social Security benefits, as well, which is your last, best opportunity to compensate for undersaving, Adams said.
The size of your Social Security check increases by a certain percentage for each month you delay taking benefits beyond your full retirement.
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For example, those entitled to a $1,000 monthly benefit at full retirement age of 66 would collect only $750 per month at age 62. By postponing until age 68, they would receive $1,160 monthly, and by waiting until age 70, they would receive $1,320.
Lastly, working until at least the age of Medicare eligibility, 65, can have a profound impact on your future expenses.
“Before deciding to retire, be sure you fully evaluate your financial ability to do so.”
Fidelity estimates that couples who opt to retire this year at age 62 will spend an additional $17,000 per year—or $271,000 throughout retirement—to cover costs associated with private health insurance premiums.
That you want, or planned, to retire at a certain age is not reason enough to leave your employer. Only when your savings are sufficient, and you’ve tested your nest egg to be sure, is it safe to walk away.
“The transition into retirement is an emotional one and should not be underestimated,” Adams said. “Before deciding to retire, be sure you fully evaluate your financial ability to do so.”