Retirement Guide: 6 Things to Avoid When You’re 5-10 Years From Retiring

 

I’ve probably been told more than a hundred times over the course of my career that,

“Troy, I wish I would have met you about 10 years sooner.”

What they usually mean by that is, “If I would have taken these actions or understood these concepts 10 years ago, 5 years ago, I could have made better decisions to prepare for retirement more intelligently.” That’s what I want to do with this video. These are not necessarily the top six most critical and important things that you should avoid or attempt to accomplish. They’re just simply six things that are important.

If you understand the concepts and can start to apply them to your retirement, these should put you into a more strategic position when you do ultimately call it quits, because remember, you have the accumulation phase, which is when you’re building, earning, and saving a nest egg. Then once you get to that pre-retirement phase, which is 5 to 10 years away, that’s leading into retirement.

You’re still building, still saving, and still growing, but you’re starting to realize that there is light at the end of the tunnel, and you are going to retire. Then, of course, the retirement phase. That’s when you start spending and distributing all those assets that you’ve accumulated over the years. These are tips and suggestions that you can apply in the accumulation phase, but definitely should be thinking about in the pre-retirement phase.

All of this is to help you, when you get to the retirement phase, to have better choices, more options, and hopefully more money, pay less tax, and put you on a better path to retirement.

Mistake 1: Not Contributing to an HSA, a Health Savings Account

The first one is not contributing to an HSA, a health savings account. I think this is the most powerful account in the entire world, simply because it’s the only account where you can put money in and get a tax deduction, it grows tax-free, and then you can take it all out tax-free, of course, for qualified medical expenses.

The caveat here is you must have a high-deductible health plan. Again, this may not apply to everyone, but if you don’t go to the doctor often and you only need catastrophic medical insurance or coverage, and you can afford the higher deductibles and the smaller monthly premium payments, what this does for you when you get to retirement is it allows you to have the sum of money that has been growing tax-free.

You had tax deductions in the accumulation phase when you contributed to it, but now, especially if you retire prior to 65 and you have to purchase health insurance in the open marketplace, this can do one of two things. One, it can help you pay for those health insurance premiums, but because the income comes out tax-free, it doesn’t increase your adjusted gross income or modified adjusted gross income, which could also help you to qualify for a subsidy on the exchange, and your health insurance premiums possibly could go down to zero.

Now, with that said, it depends where else you’re getting your income from in those early years of retirement. This is step four of the Retirement Success Plan, health planning, and as far as the HSA is concerned, it has more benefits than just the account itself. It helps with income and tax planning once you do get to retirement, especially if you retire prior to 65. I just wanted to briefly go through what does this mean.

Example of Potential Results: Tax Deductions and Money Coming Out Tax-Free

You get a tax deduction, I want to show you, and then the money coming out tax-free, because financial planners and CPAs, we throw out these terms and just assume everyone clearly understands what that means. I want to show you. You put money into an HSA. Let’s say you have $100,000 income. If you have a family, you can put $9,550 in if you’re over the age of 55. If you’re single, you can put $4,300 into the HSA. If you’re less than 55 with a family, you can put $8,550 into an HSA.

Now, it’s important to note here that each spouse cannot do the maximum. That’s the total amount for the family that can go into that health savings account. This is essentially what it does. It reduces your income. Now, this would be your gross income. If you have other deductions or the standard deduction, it would reduce your income further. That would leave you with what we call taxable income, and then you pay tax on that amount of income.

It reduces your income, so you pay less tax on the amount of income that you receive while you’re working. Then the goal here is to put as much money into this over a series of years, and you get to invest the money. Let’s just say you buy an S&P 500 index fund, and it grows, it compounds at 7%, 10%, whatever. Hopefully, we can get $50,000 to $100,000 a year in here.

Then when you get to retirement, especially prior to 65, when Medicare kicks in, because you have to go into the marketplace to buy your own health insurance, you can take this money out to pay for your health insurance premiums or your other qualified medical expenses, and not pay any taxes. This is income in growth that you never pay taxes on, not going in, and not coming out.

More importantly, from an income and tax planning standpoint, when you take this money out, it doesn’t go on your tax return, so that can help keep your income down in retirement, to hopefully help you qualify for a subsidy and even have lower health insurance premiums. If you can afford the high deductible health plan, you’re not going to the doctor all the time, it does give you lower monthly premiums, but you have a higher deductible. Check with your health insurance broker, check with your company benefits, whatever options you have to look at. This is a strong consideration for someone leading up to retirement.

Mistake 2: Retirement Portfolio is Misallocated

One of the big mistakes we see when we talk with someone for the very first time and we’re going through what we call step one of the retirement success plan, which is understanding your willingness to take risks and then seeing if your portfolio is congruent with that willingness. It’s extremely important, not just in the accumulation phase, but especially in the retirement phase.

 

We often see that people are misallocated, meaning they’re either too conservative or too aggressive. I wanted to point out this– it’s like a bell curve. Theoretically, when we’re younger, we should really be 100% stocks in all of our investments. Now, I’m not advising you to go 100% stocks, but theoretically, because when we have a long time to let that money grow and we don’t have to take money out, because with your retirement account, you can’t take it out without penalties prior to 59 and a half in most instances.

Really, we want to be more aggressive throughout this timeframe, theoretically. Then there’s really this three years pre-retirement and three years post-retirement that we should be aware of. This is where we’re most vulnerable to what’s called sequence of returns risk. That’s the combination of losing money in your accounts combined with taking money out. If you lose 10% and you take 5%, your life savings has went down by 15%.

Now, if that happens for a second year in a row, you take money out, you lose money, now you’re starting to negatively compound your life savings, and that can destroy it really quick. The three years prior to retirement and the three years post-retirement, if we’re going to be more conservative, that’s the window where you really want to consider it, because you don’t want to jeopardize your ability to retire by losing 30%, 40% of your life savings in the three years prior to retirement.

Then in the three years post-retirement, that’s when your money has to last the longest that it ever will. We don’t want to fall victim to sequence of returns risk here.

Why 3 Years Pre- and Post-Retirement is Most Vulnerable

To clarify why three years pre and post-retirement, it’s because the stock market has never been down for more than three consecutive years. The Great Depression, World War II, and then the financial crisis from 07 to 09.

Now, from 07 to 09, it took about five years for the market to regain its prior levels, but the S&P 500, when I talk about the market, that’s what we’re referring to, was down for three consecutive years. World War II, it took even longer than that for the market to actually regain its previous levels, but it’s those down years. It’s when the portfolio is losing money because it’s going down and you’re taking money out.

That’s the sequence of returns risk. Once it starts to come back up, even though the market has not quite yet attained the levels it was previously, you’re having positive returns while you’re taking money out. You’re preserving, hopefully, more of that account balance, and then when things do finally get going in the right direction, you’re seeing your wealth hopefully continuing to grow. That’s why three years, because it’s unprecedented to see the stock market down for more than three consecutive years.

It’s like a bell curve, and just understanding if you are more aggressive or if you’re conservative, maybe you should consider being a little bit more aggressive in the accumulation phase, but really, it’s this three-year window, pre and post-retirement, six years total. You could extend that out to maybe seven or eight, but understanding that during this period, it probably makes a little bit more sense to be more conservative, because you don’t want something bad to jeopardize your retirement, and you don’t want to fall victim to sequence of returns risk in that first three years.

Mistake 3: Not Diversifying Your Tax Buckets

The third one here is not diversifying your tax buckets. We’ve all heard to diversify your portfolio, and if you’re an avid follower of this channel, you’ve heard me talk about this numerous times, but many of you may be watching this for the very first time, so very, very important concept here. We want to diversify our savings, our tax buckets, with all of our savings. I just wrote savings in this account here, because this is like your bank, this is your emergency fund, 50,000, 75, whatever that number is for you.

Then your pre-tax, this could be inside your 401k, this could be individual retirement accounts, but it’s money that you’ve put in, you’ve got a tax deduction for it going in, it’s growing tax-deferred, but when you take it out in retirement, you have to pay income taxes at that time, and at whatever rates are in the future. Of course, you have the Roth, which is the money you pay taxes on your income today. You put it into your Roth, and it grows tax-free.

There’s a five-year rule you have to qualify for, but for the most part, this is going to be a tax-free account forever. A lot of people are not aware of the 401k after-tax part. You have a choice. Once you max out, usually in your higher-earning years, again, the 5 years, 10 years before retirement, usually your highest-earning years, when you’ve maxed out your pre-tax contributions to your 401K, most people, they put their excess savings into what we call a non-qualified account.

Your savings account, your investment account outside the tax-protected shelter of your retirement accounts. Well, you have– you should have, you need to ask your HR department, or whoever custodies your 401K,

“Do I have an after-tax component inside my 401K?”

Of course, you want to build enough liquidity and savings, and also investment accounts outside of all of these, that matches your lifestyle, right?

If you’re planning on buying a boat or if you spend a lot of income, whatever it might be, you need enough over here, but for money you’re saving for retirement, once you’ve maxed out the pre-tax, once you’ve maxed out the Roth, you can put money into the after-tax part of your 401K. What’s so special about this is, all the money you contribute, when you retire, you can roll those contributions into the Roth IRA.

Why Diversify?

The reason why you want to diversify your tax buckets is so you have choices, when you retire, of where you withdraw your income from. Then you can control what goes on your tax return and what your taxable income is. Remember back to the HSA and the health insurance premiums. If all of your money in retirement is just in the 401K, IRA, and the pre-tax, and you want to spend $70,000 a year, well, you have to take it all from there, 70,000 goes on your tax return.

If you’ve diversified your tax buckets, maybe we can take 25,000 from here. We can take 25,000 from here. We can take money from here. Now, the only thing that goes on your tax return is the withdrawal you made from here. Now your taxable income is 25,000. You now can qualify, potentially, for a subsidy. Your health insurance premiums may go down to 200 a month from 2,000 a month. Of course, every state’s a little bit different there, but there are other elements of the tax code.

It’s like a net. Whenever you pull money from here, this always goes on your tax return as taxable income. The IRS, the Internal Revenue Code is like a net. The more taxable income you have, the more gross income that’s subject to tax, it starts to pull in other potential sources of income and also can put you into a state of taxation with other elements of your retirement. I have a lot of videos on this channel here. Just understand, by diversifying your tax buckets, you have flexibility, you have choice.

You can really manage what goes on to your tax return, which can have numerous benefits when you do retire.

Mistake 4: Not Mentally Preparing for the Shift from Accumulation to Spending for Retirement

Number four is more psychological, this is important, it’s something that we don’t often see, and this can really determine if you have more successful early years in retirement or you’re living in more fear, and uncertain about actually spending money. A lot of it, I found, from my experience, comes from the fact that we have not mentally adjusted to the seismic shift that happens in retirement.

You spend your entire life in the accumulation phase. You’re saving money, you’re putting it into all these accounts, you’re hoping it grows, grows, grows, you’re raising kids, most likely, you have so many things going on with work, maybe with church, and Little League, and life is hectic, it’s chaotic. That’s the accumulation phase. You don’t really pay as much attention to the money, you save it, you invest it, and hopefully, it grows. When you get to retirement, all that is over, for the most part.

Now it’s time to actually spend money, okay? This is the big psychological shift. Here, we’re saving, saving, saving, saving. We get to retirement, we’re no longer saving, because we don’t have all these sources of income coming in anymore. Now we’re actually spending all of that money. What happens then? Do we have enough? Will I run out? How much do I spend? This is why we create plans, so you have visibility into how your decisions today are impacting your future security.

The psychological shift that takes place is, you go from the accumulation phase to the retirement phase. You go from savings to distributing. This can be quite fearful for many people. The more you start to acclimate your mind and understand that, “Okay, once I get to retirement, it’s really time to start distributing,” and you need a plan, of course. Some accounts, they may spend down entirely, while other ones are growing.

Many different ways to look at this, but most importantly, understand that you are shifting. This is a massive change in mindset, and it can be the difference between retiring more comfortably, from a psychological standpoint, and being in a lot more fear, stress, and anxiety.

How Retirement Can Impact Your Relationship With Your Spouse

As a little bonus here to this one, if you’re married, a lot of times, one of the big psychological shifts that take place as well is you and your spouse, if you’re both retired, now you have all this free time, and you’re going to be spending it together.

Of course, you may have your own interests, hobbies, and friends, but maybe you two worked for most of the past 40 or 50 years, and you only saw each other in the evenings, or one spouse was working, the other was taking care of the kids, and you really only saw each other in the evenings. Now, the kids are typically out of the house, you’re retired, maybe you’re both retired, whatever that looks like for your family, now, all of a sudden, it’s 24 hours a day.

Psychologically, sometimes you have to learn how to fall in love again, you have to learn how to relate, you have to learn how to enjoy spending time with each other. We’ve seen this play out over the years, of course, and it’s just a little bonus thing, from a psychological standpoint, that really is important to really start to prepare for, and start to talk about with your spouse, because it can really make a big difference.

I don’t know if this is– I think they’re calling it “The Grey Divorce,” but one of the fastest-rising demographics for getting a divorce in this country is people around retirement age and pre-retirement. That could be contributing to it, I don’t know for sure, but I do know we’ve experienced this firsthand with clients. Starting to think about, “What does life look like with my spouse,” and understanding you’re going to have all this time together, can help to start talking about that and at least thinking about it.

Mistake 5: Predetermining When to Take Social Security

Number five is, I don’t want you to predetermine when you’re going to take Social Security. Social Security is a tremendously critical element of your retirement. For many of you, it’s going to be well over a million dollars of retirement income and if both spouses worked and you have some longevity, it could be two to three million dollars. I’m not exaggerating, two to three million dollars of retirement income, depending on when you take it, how long you live. It’s a massive decision.

Too often, we’ve seen people come in, and they say, “Troy, I’m going to take it at 62, I’m retiring at 62, it’s my money, they’ve been taking it out of my paycheck and this is when I’m going to take it.” Look, it’s your money. If that’s what you want to do, go for it. What I would recommend is, let’s look at Social Security as just simply another source, of course, to provide income in retirement, just like your retirement account, just like your investment accounts, just like all of your other tools that you have at your disposal.

We want to optimize when you take money from Social Security with respect to your other investments, with respect to your longevity, your health, how much risk you’re willing to take in your portfolio. If you’re a super-conservative investor, you should probably defer Social Security longer as a general rule of thumb. If you’re a more aggressive investor and you have enough assets to withstand market volatility and downturns, maybe you want to take Social Security sooner, because you don’t need it for longevity purposes.

It’s also a preferentially taxed item, and you have this other tax-infested retirement account, that there’s a balance between when you take Social Security and the amount of dealing you can do with the tax-infested retirement account through Roth IRAs, because when you take Social Security and then you do Roth conversions, you lose the preferential treatment that Social Security provides, like that net.

It brings all of Social Security into a state of taxation, and now you’re probably paying more than you otherwise have to, or will receive less over time, after taxes. Just like you have to decide 62, 67, or 70, these are the trigger points.

How to manage Social Security and Required Minimum Distributions (RMDs) to avoid Tax Surprises

Full retirement age is 67. For most of you watching this, if you’ve not taken Social Security yet, of course, you can defer it as long as age 70, but you can also take it any time in between there.

When you don’t predetermine when you take it, you can have that flexibility. If the market’s down, you’re 66, and you were going to take it at 67, well, let’s possibly consider taking it at 66. If you’re going to defer until 70, again, market’s down or something comes up, unexpected expenses, as long as you have a plan, it makes sense, and it’s not jeopardizing your long-term security, maybe you take it at 67, 68, or 69.

For some of you, it may make sense to take it at 62 or 63. All I’m saying is, don’t predetermine when you’re going to take it. Let’s make a strategic decision about what makes the most sense for you in your retirement, because you also have to decide, when am I going to start taking money from your IRA, because at 73 or 75, depending on how old you are now, you are required to start taking money out of these accounts. You have no more choices. Just like at 70, you don’t have a choice.

You automatically start receiving Social Security at 70. 73 and 75, RMDs, Required Minimum Distributions start. This is the government’s plan, right? You have to take money out of the IRAs, but for a lot of you, if you’ve saved a decent amount of money inside your 401k or IRA, these required distributions, later in life, they can be really, really large, which can bring more Social Security into tax, can bring dividends, long-term capital gains. All of these sources of income can bring them into higher states of taxation.

You need a plan. Just don’t predetermine when you’re going to take Social Security. Make a coordinated decision with your other sources of income, your longevity, all of these things working together. Of course, that’s what a retirement income plan is.

Mistake 6: Why Fear Holds So Many People Back From Retiring When They’re Financially Ready

The last one, and maybe the most important, depending on your situation, is don’t be afraid to retire. I can’t tell you how many times someone has come in and they say, “Troy, I wanted to retire two years ago, or three years ago, and I just kept working, because I was afraid. I was afraid.”

We run through the analysis on the first and the second visit, and we put it all into the software, we go through it, and they’re going to end up passing away based on how much they want to spend. Somewhere between $2 million and maybe $5 million. What that means is, either we need to spend a lot more, which is unlikely to happen because they were already living in fear up to this point, but they could have retired one, two, three, maybe four years ago.

By not creating visibility, by having a plan, by talking to someone, by understanding what your choices are, many people live in fear and then they prolong the retirement decision. A lot of times, your identity gets tied up with who you are at work as well. Just start thinking about retirement, start envisioning what are you going to do with your time, who do you want to be with, where are you at, what are you doing.

This can start to acclimate you to what retirement can be, and then, of course, you need to understand the money side of it. How long will it last? Do you have enough? How much can you spend? How do you pay less tax? For us, this is what the Retirement Success Plan is all about, but I don’t want you to be in fear and push retirement away, away, away, because we don’t know how long we have.

You’ve worked hard, you deserve to retire, you deserve to do so in a way that you can comfortably spend without living in anxiety and fear. Have a plan, but most importantly, don’t put it off because you’re afraid to retire. Reach out, talk to someone. If there’s someone in your neighborhood that is a certified financial planner professional, or somebody in your local area, of course, if you want to reach out to us, feel free to.

Most importantly, have the conversation, start to create some visibility of what retirement could look like to you, and then decide, can you retire?

➡️ Do you need a Retirement Success Plan that goes beyond allocating funds to truly fit your needs? We can help you create a retirement life plan customized for your retirement vision and legacy. Call us at (877) 404-0177 or fill out this form for a free consultation: https://click2retire.com/6-Things-To-Avoid