Many investors spend their life planning for retirement. They invest in their 401(k)s, they put money in their IRAs, and they keep their sights set on their long-term goals. But as you approach your mid-60s, the big “R” is just around the corner. You have worked your entire life to get to this point, so what is the next step? Before you plan your farewell party at the office, 60-somethings should follow some critical steps that should set them up comfortably for the future.
Step 1: Determine if you can afford to retire.
It might sound surprising, but most people do not know how much they spend a year. Knowing where your money is going is a crucial step in controlling your expenses. Once you know how much you spend, you need to estimate how much money you will receive from Social Security and other sources of guaranteed income. Do not forget to take into consideration taxes. If your income in retirement is more than your expenses, you should be set.
Our advice is to talk with a financial adviser a minimum of five years before you plan to retire, but an optimum time would be 10 years before you retire. An adviser will run cash-flow projections to determine if you are on target with your retirement assets. An adviser will estimate if your assets will let you accomplish your retirement goals, like traveling or purchasing your fishing boat, and if your assets will last through your life expectancy. You need to know if your investments can last you 20 to 30 years. With retirement, generally you do not get a do-over. If you were to run out of money, it may be difficult to go back to work. You may find you can make changes now, such as downsizing your house, that will allow you to accomplish more of your goals. If you were to cut your monthly spending by $1,000 a month, that can be forever. That would be $1,000 less you will need when you retire, and $1,000 more you could save every month for the next 10 years until you do retire.
Step 2: Adjust your investment strategy.
In your younger years, you were likely more aggressive with your investment choices. Generally strategies that have been in place need adjusting as you approach retirement. You should reassess your current strategy. Investors often find they are either too conservative or too aggressive because their investment style has not changed as their life has changed.
Our Ten Year Rule that states any money needed in the next 10 years should be in fixed-income investments, and any money you do not need within the next 10 years should be in growth investments. Ideally, in your mid-50s, you need to start planning for liquidity needs in your mid-60s, which is why we suggest talking with a financial adviser 10 years prior to your target retirement date. In addition to planning for liquidity needs, you may consider shifting a portion of your investments into more conservative, less volatile instruments. You may look more closely at dividend paying stocks.
Step 3: Determine what to do with your 401(k).
Generally, our advice is to roll over your savings into an IRA, because it will continue to grow tax-deferred, and an IRA offers a wider range of investment choices than a company-sponsored plan. If you have more than one 401(k) from your working years, having your assets combined in one IRA is often easier to manage because you can see your portfolio as a whole.
You can keep your assets in your former employer’s 401(k); however, we do not like this option for several reasons. Generally, a company-sponsored plan will have limited investment choices. One reason to stay may be that you have access to a unique investment that you cannot get in the marketplace. Most often, this is not the case. Additionally, when you leave the company, it may be more difficult to contact the Human Recourses Department to make changes to your investments.
You also have the option for a cash distribution, but we strongly advise against this as a distribution of pre-tax contributions and earnings will be taxed as ordinary income. However, we do not say never. Some companies offer shares of the company stock in their qualified plans, generally purchased at a lower price than the current market value—both at the time of purchase and now as it has appreciated. There is a little-utilized rule called the net unrealized appreciation rule that could save you significantly on taxes if you own a lot of company stock. Net unrealized appreciation is the difference in value between the average cost basis of shares and the current market value of the shares held in a tax-deferred account. Upon the distribution the net unrealized appreciation is taxed at short- or long-term capital gains rates according to how long you hold the shares.
The net unrealized appreciation strategy allows you to take a distribution of the company stock and pay ordinary income tax only on your basis at the time of the distribution. For this reason it may be better to transfer the company stock to a regular brokerage account instead of rolling the stock over to a tax-deferred IRA.
For example, if you worked for Coke, let’s say you have $100,000 in Coke stock that you originally paid $10,000 for. Utilizing the net unrealized appreciation rule, you opt to have the stock distributed to you when you retire and pay tax on the basis, which is the $10,000 you originally invested. If you took the stock and pay ordinary tax now on the $10,000, assuming a 30% federal tax rate and a 6% Georgia tax rate, that would be $3,600. If you then hold the Coke stock for one year, then sell the stock, you would pay a 15% tax on the long-term capital gains, about $18,900. Alternately, if you opt to roll the shares to your IRA you will eventually be taxed at your ordinary income tax on distributions, which would be a total of $36,000 in taxes. You could save nearly half of the tax by using the net unrealized appreciation rules. To see if this could work for your situation, you should consult a C.P.A or your tax adviser.
Step 4: Decide the most advantageous time to start receiving Social Security benefits.
If you are going to retire at 62, take Social Security at 62. Generally, the payback is around 11 years. Any money you take between 62 and full retirement age at 66 is money in your pocket. If you wait until you are 66 to receive your full benefit, you will have to live an additional 11 years to break even to earn the money you could have had between ages 62 and 66.
For example, if let’s say at 62 you are eligible for $750 a month and at 66 you would receive $1,000 a month. If you began taking benefits at 62, at $750 a month you would have received $36,000 by the time you are 66. If you wait until you are 66 to receive $1,000 a month, you have to live until age 78 to make up for the $36,000 you could have already received.
If you decide to keep working in retirement, you do not want to take Social Security benefits if you make more than $14,160, otherwise it would be taxed twice.
There are several more steps that 60-somethings should take prior to retirement that we will cover in the coming weeks. However, this is a good, solid start for those who are looking to retire soon.