5 financial steps you should take before you retire

Secrets of a dream retirement
Secrets of a dream retirement

You've worked hard for your money throughout your career, and once you retire, it'll be time for your money to start taking care of you.

But before you call it quits, set aside some time to take these five financial steps. They'll help you make the transition from employee to retiree and set you on the path to a financially successful retirement.

1. Make a Social Security plan

It's important to know how much you're going to get each month from Social Security, and with a "My Social Security" account or a paper copy of your statement, you can get a great estimate of that number. Your specific benefit will be based on your (or your spouse's) earnings history and the age at which you start collecting.

Key things to consider when it comes to Social Security are that you can start collecting at any age between 62 and 70, and the longer you wait in that window, the higher your monthly benefit will be. In addition, know that you'll likely face a penalty if you're still working and start collecting benefits before your full retirement age.

2. Get on top of the coming changes to your health insurance

If you're 65 or older, you'll likely qualify for Medicare. If you're retiring under age 65, your employer may offer you a chance to stay on its plan as a retiree in good standing. If it doesn't, you might still be able to stay on the company plan for 18 months through COBRA benefits. Beyond those options, you qualify for guaranteed-issue health insurance through the Obamacare program, and may receive a subsidy for it, depending on your income level.

Regardless of what health insurance path you take, know that your coverage, available provider network, and costs are likely to change once you're no longer an active employee. To give yourself the best chance of a healthy, happy retirement, know what's coming down the pike and have a plan to assure you get the care you need despite those changes.

3. Adjust your budget to fit your new circumstances

While your healthcare costs are likely to rise in retirement, many of your other expenses will fall, notably those associated with working. In addition, if your kids are grown and independent, and your mortgage is paid off, your regular outlays will be significantly lower than they once were.

Particularly since your income will likely drop in retirement too, and a portion of your cash will come from spending down your assets, it's incredibly important to keep your spending rate sustainable. A general rule of thumb for retirees is "The 4% Rule." Under that guideline, to give yourself a great chance of having your money last at least as long as your retirement, you need to:

  • Start with a diversified portfolio;
  • Keep that portfolio diversified throughout your retirement,
  • Withdraw 4% of the value of your portfolio to cover your first year's expenses, and;
  • In each succeeding year, withdraw an amount based on that first number, but adjusted upward for the rate of inflation.

With that rule guiding your investment drawdown, as long as your total costs are covered by your Social Security benefit, your 4% rule withdrawals, and any pension you may get, you should be on track.

4. Put together a cash and bonds structure for your near-term needs

While stocks are a great way to build wealth, once you start relying on your portfolio to cover your costs of living, the volatility of stocks makes them unreliable as a source of spending money. Indeed, money you need to spend within the next five or so years does not belong in stocks, though even as a retiree, you'll likely have longer-term financial goals where stocks can still play a role.

One way to structure your finances in retirement is via something called a bond ladder. With that structure in your portfolio, you have:

  • Cash to meet your current needs over the next few months to a year;
  • Bonds that mature on a regular schedule over the next few years to replenish that cash, and;
  • Stocks to continue to provide growth to your portfolio and replenish those bonds as they age.

5. Think about the legacy you want to leave behind

If you're following the 4% rule of retirement withdrawals, chances are good (though there are no guarantees) that you'll leave some assets behind once your retirement draws to a close. These can be used to help your children, their children and/or charitable endeavors of your choice. If you plan well, you may even be able to make choices that mean you'll be around to see them benefit from your generosity.

Consider things like lifetime gifts to your children. You and your spouse can each give up to $14,000 to each of your children and their spouses each year with no gift tax consequences. That allows for a maximum transfer of $56,000 from one married couple to another, each year.

Additionally, there are no limits on money you send to eligible education institutions for tuition or health care providers for qualified medical care for others. If you exceed the annual limits, you can take a credit against your lifetime exemption ($5.49 million for singles, $10.98 million for married couples) and still not pay a gift tax.

If you choose to support a charity, a charitable remainder trust is a tool that can help you get funds to it while you're still alive. With that setup, you will still receive an income stream from that donated money to help cover your costs. In many respects, it's a win-win: You get to see the benefits of your goodwill, but you still get the income from your assets. And of course, you can always leave a portion of your estate to a charity of your choice in your will.

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Plan today for a more fulfilling retirement

By taking these five financial steps, you set yourself up on a firm foundation for your retirement. With your money set up to work well on your behalf, you can fill more of your time in retirement with your higher priorities in life. And that's a great reward for a lifetime of hard work.