How to Structure Your Finances 1 Year Before Retirement

For the last 40 years, our firm has been helping people manage their money for retirement, and the last year before retirement is one of the most crucial time periods to really get things organized. And there are several steps that we take when we’re helping people determine if they can retire and meet their goals. And I’m going to share with you today the steps that we use to do that.

Step 1: Organize All Your Data​

The first step is making sure that you have all of your data organized. So this would include making sure that you thoroughly understand all sources of income that you’ll have in retirement. For many people, this means Social Security. For many people, this means collecting pension income from a current or previous employer. And then of course, many people will have their nest egg as well, and making sure that they have enough money in that nest egg to support their lifestyle.

And having all of that organized is important. Making sure that you have an inventory of all assets is hugely important, because frequently those assets will dictate different strategies, even though it’s not income, it’s just as important to make sure that is organized as well. Making sure you understand your health insurance strategy prior to Medicare and post Medicare, which we’ll be going over in more detail in a little bit, making sure that all your other insurances are organized and making sure that your estate plan is up to date.

And again, we’ll be expanding on that.

But take an inventory of all the different resources that are going to be important for helping you retire. And again, this is how we do it, but this is how I would recommend you do it if you’re a do it yourselfer.

Step 2: Run an Income Projection​

The next step is making sure that you do an income projection to help you understand if you have enough money to reach your retirement goals and to do an income projection effectively, you have to have an idea on how much income you’re going to need in retirement, and or you have to live within the means of the income that you find is the maximum amount that you can take for income in retirement.

So two popular options to do this that we do at our firm and you can do on your own, you can use online financial calculators to do this. Option number one is essentially look at the take home income that you have now and make adjustments to how that will change in retirement. So for some of you, there might be certain additions that you have and certain things that you will subtract from what your current take home pay is when compared with during your working years versus your retirement years.

So an example of that is sometimes people will have their mortgage going away around the time that they retire. And obviously that’s not an expense that would carry on into retirement if you’re paying that mortgage off.

Sometimes people don’t need to continue to carry life insurance in retirement, which is a premium that would go away. Many people’s health insurance premiums will change, either for the better or for the worse.

But looking at what your current take home pay is today, and making adjustments to how that will change in retirement can give you a good idea on how much money you’re going to need in retirement. So that’s option number one.

If you don’t want to go through all of that, option number two, when you’re running an income projection, is to basically run the income projection to show you the maximum amount that you can withdraw from your nest egg without having to worry about depleting that nest egg during the life expectancy you have set for your income projection.

And then this will give you the maximum amount of money that you can take home on an annual basis, and you just have to live within those means. Those are two popular options when you’re running your own income projection. And again, if you want to work with a financial advisor, your financial advisor will do this, or should do this.

And if you do this on your own, there are many financial calculators online that you can use to do this.

Step 3: Develop Your Tax Strategy​

The next step is figuring out your tax strategy. And this is, in my opinion, one of the most important pieces of the puzzle to increase your take home pay that you have during retirement. So in order to be able to have an effective tax strategy, it’s important to understand the different types of retirement nest eggs that people have and how they’re classified from a tax perspective, so many people will have money that fits into one of these three different buckets that you see in front of you on the screen. The first bucket is what we call the tax deferred bucket, which would include things like IRAs, 401(k)s. Some of you might have 403(b) plan or a 457(b) deferred compensation plan.

From a tax perspective, all of these investments work very similarly from the perspective of when you put money into this bucket, it goes in on a tax deductible or pretax basis. It grows tax deferred. But when you take money out of this investment for retirement purposes, the income that you take out is subject to taxation at that time.

And for most states, it’s subject to federal and state income tax.

Tax Deferred, Tax Free, and Non-Qualified Buckets​

The second bucket is what we call the tax free bucket, which can include things like Roth IRAs, Roth 401(k)s, Roth 403(b)s, and Roth 457(b) plans. When you put money into this bucket, you usually don’t get a tax break up front, but the money grows tax free, and when it’s taken out for qualified reasons, it comes out entirely income tax free as well.

The third bucket is what we call the non-qualified bucket. And this one’s a little more confusing because you don’t get a, you usually don’t get the tax break up front when you put your money into a non retirement account or a non-qualified account.

And depending on the type of investment that you own in this bucket, that will dictate the tax liability of the investment.

Tax Inefficient Investments to Avoid​

So generally speaking, we want to avoid highly taxed investments in this bucket. Things like corporate bonds are very tax inefficient. Government bonds are fully subject to federal income tax on all the interest that you make each year. So they’re also what I would consider not very tax efficient. Stocks can be tax efficient depending on how big the dividend is.

The higher the dividend, the higher the taxes. And mutual funds can also range from very tax efficient to very tax inefficient. Avoiding the tax inefficient investments in this bucket can make a big difference in retirement. And organizing your investments effectively in the different buckets can make a big difference. As we’ll go over here on the next slide, which is allocating the proper investments in the proper buckets.

Asset Location Strategy Across Buckets​

So if you have a tax deferred bucket that’s going to be taxed at the highest rates when you take it out, wouldn’t it make sense to put more conservative investments in that bucket so that when you go and you have to take that money out, there’s not as big of a tax deferred bucket there to take money out of? And then on the flip side of that, if you have a tax free bucket that’s never going to be taxed, well, wouldn’t it make sense to put the investments we don’t expect to grow as much in the bucket we do not want as big and put more of the growth assets in the tax free bucket, so that that bucket ultimately grows to a larger amount over time?

All things being equal, the answer to that is usually yes. There are circumstances that dictate using a different strategy, but generally speaking, we want a bigger tax free bucket, smaller tax deferred bucket. And we want tax efficient investments in the non-qualified bucket. So if your goal is to have a portfolio that’s invested 60% in stocks and 40% in bonds collectively with all three of those buckets, you don’t have to have each bucket have a 60/40 allocation.

One bucket can be much more growth oriented. Another one can be much more bond oriented. And you can still hit your 60/40 goal for an overall portfolio for risk tolerance.

Step 4: Plan Health Insurance Pre- and Post-Medicare​

The next step is making sure that you have your health insurance strategy figured out pre Medicare and post Medicare.

Many people who are retiring from an employer that doesn’t provide health insurance to get them to Medicare age at 65 will need to go and buy their insurance either through COBRA which can be expensive.

And it’s only a temporary solution because it will run out at a point in time in the future. Or what we find many of our clients will do is go on the exchange or get Affordable Care Act insurance, also known as ACA insurance, also known as Obamacare. It’s all one of the same, but the cost of that type of insurance, whether your state has ACA insurance or a state sponsored version of ACA insurance, which a handful of states have, the cost of that is generally determined by your modified adjusted gross income.

And if you have your nest eggs organized in a way that will be able to reduce your modified adjusted gross income before 65, it can save you a lot of money on Affordable Care Act insurance or the state sponsored version of Affordable Care Act insurance, but you have to make sure you have those buckets organized correctly to reduce that cost.

Additionally, after you hit Medicare age and you can get on Medicare at 65, there’s different variables that can affect the cost of your Medicare insurance. You might have heard people talk about IRMAA, which is I-R-M-A-A and basically what IRMAA means is once your income exceeds a certain level, you have to pay a higher amount for your Medicare insurance.

And avoiding that can be an effective strategy for putting more money in your pocket over the long term and having less money go towards Medicare. So figure out what your health insurance strategy is going to be pre Medicare and post Medicare. It’s another important step.

Step 5: Evaluate Other Insurance Needs​

In addition to that, figuring out what your other insurance needs are. As I had mentioned earlier, some people needed life insurance when they’re younger, but they might not need that life insurance later in life if their assets are big enough to support husband and wife or couples, they don’t need as much.

They don’t need as much life insurance in retirement in many circumstances. So evaluating, do I need that life insurance anymore? It’s a good time to evaluate that one year before you retire.

Do you need long term disability or short term disability insurance? Once you have a large enough nest egg to support your lifestyle? Probably not. And in many cases, you can’t even have it.

Home, auto and umbrella insurance. I think one year out from retirement, it’s a good time to evaluate that too, because that’s when many people have the largest net worth that they may ever have. And having an umbrella policy that’s frequently inexpensive and will protect you to a much higher degree is an important thing to evaluate. And like I said, it’s relatively inexpensive to protect yourself on a much larger scale.

So talking with your insurance agent on that, it’s a good time to evaluate. And then of course, there’s other insurance needs that may or may not be important when you go into retirement as well.

Step 6: Update Your Estate Plan​

Another step that I think is extremely important is making sure that your estate plan is put together effectively, making sure that if one spouse passes away the other spouse is taken care of, and making sure if both spouses pass away, that the assets transfer efficiently to the children is extremely important.

And it’s a good time to reevaluate that, because many times when people get their estate plan done originally or most recently, that’s just done at one snapshot in time following the completion of the last time you had your estate plan updated. Things change. Your asset levels change. You may have an estate tax situation that you weren’t aware of.

Laws change, tax laws change. All of these changes require you to take a more proactive role in making sure that your estate plan is moving with the motion picture of your life, as opposed to one snapshot in time.

Common Estate Planning Documents​

Common documents that people will have when they retire include a will, potentially a trust, depending on their circumstances.

The most common type of trust out there is a living trust or revocable trust. But there are also times where people should have irrevocable trust set up, especially if you have a situation where you live, maybe in a marital property state, and you want to make sure your assets stay with your children if you and your spouse pass away, if you have a child that’s a spendthrift and you want to make sure that the amount of money they can get on a monthly basis or an annual basis is limited so they don’t blow through their entire inheritance.

That’s something else that we frequently see people take care of at this time. So there’s a variety of circumstances. Estate taxes sometimes will require the establishment of an irrevocable trust at some point in the future as well. So take a look at everything. Make sure you have a durable power of attorney in place. Health care directive beneficiary designations are all set up according to the estate plan that your attorney set up for you, making sure that you tighten all of that up before you retire is one of the final steps that we like to make sure is in place.

Next Steps and CFP Consultation​

So I’ve talked a lot about things that you can do if you’re a do it yourselfer. But if you like to get a second opinion from somebody that does this on a full time, educated basis, our certified financial planners here do this all day, every day, and you can schedule a quick 15 minute call to see if you’re on the right track and to kick the tires with somebody that does this all the time.

We work with people all over the United States, and I’d encourage you to take advantage of this. We have a link you can click on to get that set up. Or you can go to Bernicke.com to get your 15 minute phone call with a CFP from our office to take advantage of this. I hope you learned a few things today, and thank you very much for your time.