Are you closing in on retirement? If your goal is to retire in the next five years, you are in that critical stage in the retirement planning cycle. You have to take care of details like your 401(k) distributions or rollover, exercise of stock options, pension distributions, and when to take social security payments. Then there's figuring out what you need to draw out of your investments when that big day arrives. What you do in the first five years after retirement will also play a key role over the following 25-30 years.
First, let's discuss your first steps five years before going off into retirement bliss:
The optimal withdrawal rate?
- Put more money away. I read an article that says we are saving too much for retirement. That is bunk! Let's say your retirement target is 65 years of age. Most of you will be able to and should contribute extra to your 401(k) after reaching 50 years of age. That amount is $15,500 per year plus catch up amount of $5,000. Over a 15-year time frame for someone who is 50 years old today, assuming a 7% annual return, the savings by age 65 amounts to over $500,000. Without the extra $5000 in contributions, you would only have around $376,000.
- Over the last year to two years before retirement, consider being more conservative in your 401(k). Don't leave a majority of these assets in employer stock! If the market takes a nosedive, you still have a great base to invest and live off of when you retire. Diversify.
- Remember to exercise those in-the-money stock options. Many folks get so excited about their last day at the office, they forget about exercising the valuable stock options while still profitable.
- Place money in an emergency fund with 1-2 years worth of living expenses in a cash or CD account.
Before I address the optimal withdrawal rate, let's discuss where your investments ought to be during a 30-year retirement. A good portion of your investments should be in equities, meaning at least 50%. Too much fixed income investments and you are in danger of losing purchasing power. Another allocation option would be alternative strategies like a market neutral mutual fund or hedge fund. Your costs of living will be going up everyday and has gone up everyday of your life. You will be especially vulnerable to rising healthcare costs. Investments that stay static won't be able to keep up.
So what is the optimal withdrawal rate? My thinking has changed on this as more and more of my clients have retired. I used to say 4%-5% a year, nothing more, nothing less and adjust that amount with inflation. Chances are the money ought to last.
Here's where I would change that. Perhaps you should rethink how much you will spend in the first 2-5 years of retirement. Consider taking out less than you planned the first two years of retirement. This will help you maintain a base to live from and give you a higher probability of having an income you won't outlive even at year 30. If the markets are performing like they are today, consider taking out less money, perhaps 3% or even less. In a bad market, you need to scale back and use your emergency funds.
Here's the deal. If you are retiring in the next 5 years, planning your moves between now and the time you walk out the door will save you headaches and heartaches. Be open to continue working. During the planning stage, you may find that your savings have fallen short of your goal or that your income goal could lead to the portfolio running out before it's time. Also, a scaled down spending plan the first 5 years in retirement gives you a better probability that you will have an income you won't outlive. Through retirement, if the market is significantly higher, feel free to spend or draw out more, in a down market, scale back and use emergency funds, and be open to alternative investing strategies. Work with your advisor on this.
Jonas Zamora is a Certified Financial PlannerTM professional. You may contact him at email@example.com