Here’s Why The First 5 Years Of Retirement Are The Most Dangerous
If you think the hard part of retirement is finally coming to an end, I have some bad news. It turns out that the first five years after retirement are the most treacherous.
A recent study from Nationwide found that an alarming number of young retirees are running into financial difficulties they never saw coming. We are not just talking about a few bucks here and there; we are talking about fundamental shifts in the way they live and spend money.
According to research:
“…more than half (55%) of recent retirees say they regret how they saved for retirement, while 28% wish they had started saving earlier and 13% wish to contribute to their retirement savings and investments each year. More than 1 in 4 retirees say their retirement expenses are higher than they expected.”
The truth is that retirement is not a static event. It’s a change, and if you don’t nail the first few years, you might spend the rest of your life trying to catch up. Here’s what the data says about why those early years are so difficult and how you can avoid the same pitfalls.
The shock of the “tender age”
Financial planners often call the time before and just after retirement “the lean years.” A Nationwide survey highlights why: 38% of recent retirees find their expenses are higher than they expected.
When you work, your lifestyle is often dictated by your commute and your office hours. Once those are gone, you suddenly have an extra 40+ hours a week to fill. For many, filling those hours costs money. Whether it’s travel, hobbies, or an extra trip to the grocery store, the “honeymoon” is a real thing that can ruin a long-term plan if you’re not careful.
(See 7 Uncommon Ways to Cut Living Costs in Retirement)
Repentance of the original appellant
One of the biggest takeaways from the study involves the timing of Social Security. A whopping 70% of retirees interviewed said they would change the way they manage their money if they could go back in time. One of the biggest regrets? Claiming Social Security too early.
It’s tempting to grab that check as soon as you turn 62, especially if you’re feeling a little bit of those higher-than-expected expenses. But doing so locks in lower profits forever. If you’re healthy and can find a way to close the gap, waiting even a few years can make a big difference in your monthly income over the next three decades.
How to protect your portfolio
The reason those first five years are so important is something called “return sequence risk.” If the stock market takes a dive just as you start withdrawing money from your 401(k), it becomes more difficult for your portfolio to recover. You are effectively selling stocks at a discount while eliminating your principal.
To combat this, you need a strategy that doesn’t rely entirely on the whims of the S&P 500. Here’s what the experts say:
1. Build a cash cushion: You should have enough money to cover living expenses for at least one to two years in a high-yield savings account or money market fund. This way, if the market crashes in the second year of your retirement, you don’t have to sell your investments at a loss to pay off your loan.
2. Be flexible in the way you spend money: A national study found that the most successful retirees are those who are able to adapt over time. If it’s a bad year for the markets, maybe skip the big European ship and stay closer to home.
3. Reconsider your withdrawal rate: The old “4%” rule is not a law of nature. If you find that your expenses are higher than you thought, you may need to work part-time for a year or two to avoid draining your accounts too quickly.
(See $1 Million Will Last 26 Years to Retire in This Big City)
Ignore the tax collector
Many retirees are shocked to learn how much “income” is owed to the IRS. If all of your money is in a traditional IRA or 401(k), every dollar you withdraw is taxed as ordinary income.
The study found that most people did not report the tax bite on their distributions or the fact that their Social Security benefits may be subject to taxes. It’s a good idea to talk to a professional about “tax loss harvesting” or doing a Roth conversion before you officially retire it.
The important thing is that retirement is not a “set it and forget it” situation. It’s a job in itself, especially in those first 60 months. If you can get into that window without blowing your budget or claiming your benefits early, you’re in a much better position to enjoy the next few decades.
