Clients’ 5-Year Countdown to Retirement is Critical

It’s the prime time to help them grow assets, right-size risk and tie up loose ends.

By DJ Hunt

Financial planning is a never-ending pursuit, with each stage of life bringing its own unique set of considerations and strategies. The five years prior to retirement are among the most critical, so here are some areas we must make sure our clients have buttoned up during those important years.

Growing the Asset Base

There are many aspects that affect our client’s ability to live the retirement they envision, but none is more important than the amount of investment capital they have to draw from when the paychecks stop coming. For many of our clients, the final five years of work will be the highest earning years of their career. We must help them make sure they are setting aside as much of this income as possible into their retirement and investment accounts.

Before and After-Tax Savings

For 2022, workers over 50 can contribute up to $27,000 to their 401(k). Helping our clients ensure they are “maxing out” their contribution limit is an important aspect of the planning we provide. If a bit of belt tightening to make room for larger retirement contributions is in order, we can help them streamline their cash-flow planning by working with them on their budget.

Many workers have done a good job packing money into their 401(k) but have neglected to put money into after-tax investments. These “401(k) millionaires” are sitting on an asset base of which every dollar will be taxed when withdrawn. The last five years of work are a perfect time to make sure your clients are funding after-tax accounts. Having an investment pool that is not subject to ordinary income taxes can be a powerful tool in your client’s tax-minimization strategy.

This can be especially important for early retirees who will be on an Affordable Care Act healthcare plan between work and Medicare. Keeping taxable income as low as possible will enable early retirees to maximize their ACA subsidies, as well as avoid the income-related monthly adjustment amount (IRMAA) breakpoints on the two-year look-back for calculating Medicare premiums.

Don’t Forget HSAs

An often overlooked, but very valuable account to head into retirement with is a health savings account, or HSA. Many people simply look at an HSA as a tool used for paying medical expenses with pre-tax dollars. But for clients whose employers offer high-deductible health plans, the HSA has other features that are too good to pass up.  For starters, it is the only account that is triple-tax free: The employee’s contributions are tax deductible in the year they are made (up to $9,300 for a married couple over 55 in 2022,) the funds in the account can be put to work in an investment portfolio that grows tax deferred, and withdrawals for qualified medical expenses are distributed tax free.

If HSA funds are withdrawn for non-medical purposes, the amount withdrawn is taxed as ordinary income plus a 10% penalty. But what some planners fail to consider is that when the retiree turns 65, that 10% penalty goes away. What the client is left with is essentially an extra IRA that is not subject to RMD rules.

Getting the Risk Right

Most advisors would agree that a worker with 25 years to go until retirement can afford to take more portfolio risk than a worker that’s just five years out. But the decision on the exact stock/bond mix for each investor will always involve more inputs that just age and time to retirement. So five years before retirement is a good time to revisit your client’s risk profile.

A client with just five more working years should be in a portfolio that they can sleep well with at night no matter what’s going on in the stock market. The worst thing an investor can do is to panic sell after experiencing a heavy downturn. And the second worst thing is to begin taking retirement withdrawals during such a downturn. This “sequence of returns” risk is mitigated by having enough bond exposure in the portfolio to cushion equity volatility as retirement approaches. Again, this will be a different mix for each investor, but it should be a less aggressive portfolio than what they had during the bulk of their working years.

Cash-Flow Analysis – Tying Up Loose Ends

By the time clients are five years from retirement, they should be well accustomed to maneuvering within their budget. Now is the time to focus on the process of ensuring that early retirement cash-flow projections are within the realm of reality. Consumer debts should be paid off or well on the way to being paid off. We want to ensure that cash flow — especially pre-tax retirement account distributions — is going to fund lifestyle, not debt service. Ideally, the house will be paid off by the time the clients stop working, freeing up a potentially significant line item in the budget.

Additional Reading: The Most Critical Question for Retirement: Why?

If your clients plan on “living it up” for the first few years of retirement, ensure that those extra expenses have found their way into your projections, and that there is a plan in place to fund the fun.

The first few years of retirement are also a great time to consider doing Roth conversions. Roth conversions and extra travel/vacation expenses at the same time might be tricky from a tax perspective. So, making sure that after-tax account discussed above has a meaningful balance is extra important for these clients.

The last five working years have some important considerations to focus on, but the good news is that clients who may have some catching up to do have plenty of time to course-correct and still be very prepared to hit their retirement date goal.

DJ Hunt, CFP is a fee-only financial advisor with Moisand Fitzgerald Tamayo, LLC. in Melbourne, Florida. His clients include working professionals, business owners and retirees. DJ can be reached at [email protected].


Latest news

Losing a Spouse Hits Most Women Hard Financially: Thrivent

Many widowed women had no financial conversations or plans in place before their spouse died, Thrivent's new survey finds.

Schwab Survey Finds Increased Opportunities for Advisors

Americans are most likely to seek financial guidance from an advisor, and three-quarters avoid social media influencers, the survey reveals.

The Sky’s the Limit for CEO Pay

Companies now must disclose how much CEO stock holdings increase when the market rises.

Advisors Boost Allocation to Private Markets as Client Interest Grows

Over half the investment advisors surveyed by Hamilton Lane plan to allocate 10%+ of clients’ portfolios to private markets this year.

Virginia Leads in Personal income, West Virginia is Last: WalletHub

A new WalletHub report lets you see how your state ranks in personal income for the top 5%, bottom 20%, and total population.

FPA: Financial Planners Still Prefer ETFs in Client Portfolios

The FPA and Journal of Financial Planning's annual trends survey also finds advisors are bullish on the economy, but only in the short term.