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Nearing retirement? The last 5 years before you retire are critical

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Westend61/Getty Images/Westend61

Retirement is a milestone you've likely thought about and worked toward for decades. After planning and saving for so many years, you may imagine you can coast right into it.

But in the five years or so right before your retirement, your savings and investment accounts need your attention more than ever. While risk is something you always need to think about with your finances, this is the time you need to be the most vigilant about your money's security and performance.

We'll explain why the last five years before you retire are critical and explore steps you can take during this time to build and protect your nest egg.

Evaluate your retirement readiness

While you can't predict exactly how much money you'll have or spend in retirement, you'll be closer to seeing the full picture in your last few working years than ever before. As variables move from fuzzy to sharp, you'll likely be able to tell if you're on track for covering your costs as well as pursuing other goals, such as spending time with your family, traveling and living generously.

What retirement income sources can you count on?

You may have multiple sources of income to draw from once you're no longer receiving a paycheck. Take stock of your financial resources, which may include:

  • Retirement savings from IRAs and employer accounts like 401(k)s
  • Annuities
  • Balances in brokerage accounts that hold investments like stocks, bonds and mutual funds
  • Pensions
  • Your expected Social Security benefit
  • Work income from a part-time job
  • Any other assets you may have, like rental property or your financial stake in a business

You could add permanent life insurance to the list if you have a contract but no longer need the full amount of death benefit protection. You could choose to tap into the contract's cash value to supplement your retirement income.

After reviewing your income sources, add your data into a retirement income planning calculator to see how your income is shaping up. Generally, by age 60, you should have about eight to 10 times your salary saved for retirement.

Prepare for the 5 risks to your retirement savings

With five years to go before retirement, you probably have a good idea whether you want to continue your current lifestyle, what debts you'll carry into retirement and other planned changes that may affect your cost of living. But there are hard-to-predict factors you need to consider as well:

1. Outliving your money.

A long and healthy life is a blessing. But it's natural to worry that you'll run out of funds at some point, which could create a financial burden for your loved ones. Careful financial planning today can help you avoid this scenario.

2. Market volatility

Markets rise and fall, and that volatility is inevitable. Reassess your asset mix with a financial advisor and stay the course. Keeping this truism in mind is critical when investing for the short- and long-term.

3. Inflation

Rising prices can impact your future spending power, which can be especially worrying if you're living on a fixed income. You can put plans in place to protect yourself from potentially high inflation during your retirement.

4. Changing tax laws.

New legislation frequently contains tax provisions, and while some updated rules can benefit retirees, others create additional burdens. Since it's hard to predict future tax-related developments, you need to take defensive measures to safeguard your savings from the potential impact of rising taxes.

5. Health challenges that can drain your assets.

Take time now to study health insurance options for retirement, including Medicare supplemental insurance if you're eligible for Medicare. Also evaluate options for extended care, which would cover the cost of qualified daily living support if you're no longer completely self-sufficient in day-to-day tasks.

With all these possibilities in mind, you can account for the known expenses and then add some buffer room. If you expect a gap between your income and expenses, now's the time to make adjustments by reassessing your budget, making strategic moves with your investments or considering delaying retirement.

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Keep contributing to your retirement accounts

If you've been saving for years with retirement accounts like a 401(k) or IRA, you've likely built up a significant balance. Don't stop now—you're still benefiting from investment interest compounding, which is likely accelerating your gains.

Plus, if you're at least 50 years old and your retirement plan allows it, you can contribute beyond your usual annual limit with catch-up contributions.

The SECURE Act 2.0, passed in late December 2022, added a special catch-up for workers ages 60 to 63. Beginning in 2024, you can contribute either $10,000 or 150% of the standard catch-up amount, whichever is more. Beginning in 2026, the $10,000 amount will be indexed for inflation. Making these extra contributions can be an especially smart move if you're looking to decrease your taxable income now to stay in a lower tax bracket.

Reassess your investment risk tolerance

Your risk tolerance may need to change in the years leading up to retirement. After all, a shortened time horizon doesn't offer much opportunity to make up for potential investment losses due to market volatility. Also, you'll likely have a greater need for liquidity as retirement inches closer.

At the same time, your investments need to align with your retirement goals. Staying too safe with your assets can limit your ability to generate more income for retirement. One way to achieve a balance with a growth-focused portfolio is to choose short-term investments that are relatively conservative as well as longer-term assets that have a higher risk.

Diversify the tax status of your assets

Taxes can eat away at your savings, and you'll need to assess the tax liabilities you could face in retirement. These include taxes you may owe on any part-time work income, investments in a brokerage account and on withdrawals from your retirement accounts. You even may be required to pay taxes on Social Security benefits.

You can explore avenues that may help ensure you don't have to pay a chunk of taxes at the same time. For example, you might consider moving money from a tax-deferred retirement savings account like a traditional IRA or 401(k) into a Roth IRA.

You'll pay taxes on the amount you convert but won't be taxed again when you make qualified withdrawals.* One potential drawback: When you convert money to a Roth IRA, you'll see an increase in your taxable income for that year, which could propel you into a higher tax bracket.

Roth IRAs have another benefit, however. They don't have required minimum distributions (RMDs), the minimum amount you must withdraw from qualifying retirement plans like 401(k)s and traditional IRAs once you reach a specific age. RMDs are taxed as ordinary income in the year that you take them. If you miss a withdrawal, you'll face a tax penalty on the amount you didn't withdraw, in addition to the income taxes you already owed on the required amount.

However, you might have some control over the timing and amount of your withdrawals, and the strategies around RMDs are worth contemplating with a tax professional or financial advisor in pre-retirement.

Seek professional guidance for the tasks ahead

A Thrivent financial advisor can work with you and your accountant to help you set up a tax-efficient plan for your retirement assets and devise a smart withdrawal strategy.

The right expert also can advise you about other aspects of your five-year plan for retirement, including mitigating your risks, coordinating plans with a spouse or partner, helping you choose optimal investments and ensuring your income and expense assessments are on target.

*Distributions of earnings are tax-free as long as your Roth IRA is at least five years old and one of the following requirements is met: (1) you are at least age 59½; (2) you are disabled; (3) you are purchasing your first home ($10,000 lifetime maximum); or (4) the money is being paid to a beneficiary.

Thrivent and its financial advisors and professionals do not provide legal, accounting or tax advice. Consult your attorney or tax professional.

Thrivent financial advisors and professionals have general knowledge of the Social Security tenets. For complete details on your situation, contact the Social Security Administration.