Wednesday, July 15, 2009

Planning Checklist for 5 To 10 Years before Retirement

On the earlier planning stages, the retirement planning process has been intentionally oversimplified so that you don't get distracted by unnecessary information that might divert or delay accomplishing the most important tasks. Your responsibility so far has been to build a solid foundation of good financial habits so that you can grow your assets and grow your financial intelligence. Now it is time to up the ante because retirement is within site. You have a limited number of years remaining to adjust for any errors or shortfalls.

It's time to take retirement planning seriously and dig into the details. You're getting close enough that time is running short and any critical adjustments must be made now while there is still sufficient time to change course. In order to know what adjustments to make you will have to get more detailed.

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Below are some actions steps to consider now that you can see light at the end of the retirement tunnel:
*       Build Your Dream: Grab a favorite bottle of wine, relax with your spouse and share your dreams for retirement. You want to answer the "what, where, and when" questions. Where do you want to live? What do you want to do? When do you want to do it? Answering these questions is essential because they determine "how much" your retirement will cost. You must know the "what", "where" and "when" of retirement planning to go to the next step and figure out "how much". Think in stages because the early period of retirement when you are active and traveling will be very different from late stage retirement. Build a vision that both of you are excited to live.
*       Create A More Accurate Ballpark Estimate: Once your dream for retirement starts taking shape you can then sharpen your pencil when estimating "how much" assets and income you will need to retire securely. Your dream for retirement determines the cost. Five-star travel is more expensive than camping, and playing golf costs more than playing bridge. Where you live and what you choose to do will determine your financial needs. It is time to tighten up your budget estimate and determine if your assets are on track or lagging behind. With just a few years to go you have precious little time to make significant adjustments.
*       Consider Paying Down The Mortgage: If your savings is on track and there is still more money than month then consider paying down your mortgage. There are many advantages to living mortgage free in retirement: not only does it lower your monthly income needs but your home is a uniquely protected asset against certain debts and financial obligations. Many retirees feel more secure and sleep better at night when they own their home free and clear.
*       No More Consumer Debt: Consumer debt including auto loans and credit card debt are a no-no at this stage of the retirement planning game. Debt is antithetical to wealth building and financial security. You should only spend what you can afford because retirees need to earn interest - not pay it. Learn to live within your means now before it is too late.
*       Take Care of Your Health: There's not a lot of value in spending your working years building a robust nest egg only to die of a heart attack before you get to enjoy it. As youth fades your body becomes less tolerant of poor health habits. It may be a cliché but now is the time to build the habit of exercising and eating right so that you can add more years to your life and more life to your years. Get regular checkups and screenings so that any problems can get caught early enough to do something about them. Take care of your health now so that you can live a long, full retirement.
*       Encourage Independence For Dependents: You may be at a tough stage in life where aging parents need help and adult children are just getting started. When you get squeezed at both ends like this it is hard to take care of your own retirement planning needs at the same time. If your kids are out of school and not disabled encourage their independence. Empower instead of enable. It is important to respect your financial needs as much as everyone else's. 
*       Review Your Insurance Coverage: Life insurance that was appropriate when your savings and kids were both small may be a wasteful expense now. Alternatively, it may be appropriate to raise the liability limits on your home and auto insurance policies and consider an umbrella policy as your assets grow. You should also understand long-term care insurance and how it fits into your overall financial plan. You're entering a different phase of life and your insurance needs should change to mirror life's changes.
*       Get Defined Benefit Plan Estimates: Contact Social Security and your company's human resource department to get a benefits estimate based on possible retirement dates. How are your benefits affected by your expected retirement age? Are any special severance packages being offered? What career changes can increase or decrease benefits? What about health care insurance? Learn the arcane rules and intricacies for both the public and private pension systems so that you can plot a strategy to maximize the benefits you will receive. This knowledge can make a significant difference.
Consolidate Retirement Plans
If you've worked for several employers through the years and you've got a number of "smaller" plans with each employer, it might be time to consolidate your retirement plans.  The benefit of consolidating plans is that it allows you to gain a better picture of what's happening with your total retirement portfolio and makes managing the portfolio itself much easier. Whether it's an IRA, or a 401k plan, it's a fairly common request to transfer one retirement account into another.  Your plan administrators should be able to supply you up with all the required paperwork.  Be careful about taking personal ownership of the money or it could be viewed by the IRS as an early withdrawal.
Play Catch Up
If you find yourself in the situation where you need to play catch up with your retirement savings, keep in mind that the IRS has some catch-up limits that apply to individuals 50 and older:
  • 401k Plans - In 2009, you can contribute up to $22,000 to a 401k plan - which includes a $5,500 catch-up limit. 
  • IRA (including Traditional IRAs and Roth IRAs) - In 2008 and 2009, you can contribute up to $6,000 - which includes a catch-up limit of $1,000 - to a traditional or Roth IRA.  
Finally, make sure you stay informed of the retirement planning options your company offers.  Many companies are beginning to offer Roth 403b plans and Roth 401k plans that provide employees planning for retirement with the combined benefits of each of these plans.
*       Get Health Insurance Estimates: It's time to determine what Medicare supplemental insurance will cost and get estimates for self-insuring the time period between when you retire and when you qualify for Medicare. Fidelity Investments estimates that a couple retiring at age 65 with no employer health coverage will need close to $200,000 just to fund out of pocket medical expenses in retirement. These numbers are significant and must be built into your budget.
*       Get A Second And Third Opinion: Get referrals for at least two fee-only financial planners who specialize in retirement planning. Have them look over your portfolio, budget, and investment allocations and provide additional opinions. You want to make sure you haven't overlooked something important or completely misjudged the situation.
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The multiple available financial planners, both free and fee-based, can help you sort out some of the more technical questions like taking Social Security early or waiting until later for bigger benefits. Should you take a lump-sum retirement plan distribution or monthly payments? What is the best order of liquidating assets to support spending in retirement? What is their recommended asset allocation and investment structure? These questions are complicated and vary with individual circumstances. The fee charged for the personal advice is cheap insurance for the value provided by having an educated, second set of eyes look over your retirement plan. Just don't let them sell you any investments or insurance. You want impartial advice - not a sales pitch. I would be remiss if I didn't mention that a retirement planning coach can be very valuable as well.

If you and your hired experts agree that you are on track for a secure retirement then congratulations: you are a retirement planning genius. On the other hand, if it looks like you are lagging behind then now it is the time to do something about it.

Also, because this stage of retirement planning is about detail it is important to understand the limits to what can realistically be accomplished here. The scientific appearance of the retirement planning process paints a deceptively detailed picture about what is essentially an artistic and inherently imprecise process. Don't be deceived by the apparent accuracy of it all. Retirement planning deals with the vagaries of life - not the precision of science.

The problem with retirement planning is the necessity of making a bet on an unknowable future. You must make assumptions about the future to build your plan, but the assumptions could be wrong. Inflation might be higher than expected, you might live longer than expected, or your assets might grow slower than expected. Worst of all, you could experience catastrophic and expensive health problems. Each of these risk factors is potentially large enough to undermine the best planned retirements.

For these reasons it is wise to use a range of assumptions from pessimistic to optimistic to determine how secure your retirement plan is. Try inflation at 7% rather than the customary 3% and watch the impact. Throw a bear market, cancer, and Parkinson's disease at your plan and see how it holds up. Ultimately, no retirement plan is ever complete no matter how accurate it appears today. This is just the unfortunate reality of making a long-term bet on an unknowable and unpredictable future. Do the best you can and build a safety cushion just in case one of your assumptions proves to be too optimistic.

This may not be a pleasant or comforting way to approach retirement planning, but reality is reality whether we like it or not.

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