If you think the hardest part of retirement is finally reaching the finish line, I have some bad news. It turns out that the first five years after you stop working are actually the most treacherous.
A recent survey from Nationwide discovered that a staggering number of new retirees are hitting financial walls they didn’t see coming. We’re not just talking about a few dollars here and there; we’re talking about fundamental shifts in the way they live and spend.
According to the research:
“…more than half (55%) of recent retirees say they regret the way they saved for retirement, with 28% wishing they had started saving sooner and 13% wishing they were contributing more to their retirement savings and investments each year. More than 1 in 4 retirees say the cost of living in retirement is much higher than they expected.”
The reality is that retirement is not a static event. It’s a transition, and if you don’t succeed in the first few years, you can spend the rest of your life trying to catch up. Here’s what the data says about why those early years are so tough and how you can avoid the same pitfalls.
The shock of the ‘fragile years’
Financial planners often call the period just before and just after your retirement the ‘fragile years’. The Nationwide survey highlights why: 38% of recent retirees found their expenses were higher than they expected.
When you work, your lifestyle is often determined by your commute and your office hours. When those run out, you suddenly have 40+ extra hours per week to fill. For many, filling in those hours costs money. Whether it’s travel, hobbies, or just more trips to the grocery store, the “honeymoon period” is a very real phenomenon that can derail a long-term plan if you’re not careful.
(See 7 Unusual Ways to Reduce the Cost of Living in Retirement)
Early claimant’s regret
One of the biggest insights from the study concerns the timing of Social Security benefits. As many as 70% of retirees surveyed said they would change the way they manage their finances if they could go back in time. One of your biggest regrets? Relying on social security too early.
It’s tempting to grab that check as soon as you become eligible at age 62, especially if those higher-than-expected expenses bother you. But if you do, you will permanently receive a lower benefit. If you’re healthy and can find a way to bridge the gap, even waiting a few years can make a huge difference in your monthly income for the next three decades.
How to protect your wallet
The reason that the first five years are so important is the so-called ‘sequence of return risk’. If the stock market takes a dip just as you start taking money out of your 401(k), it will be much harder for your portfolio to recover. You’re effectively selling shares at a discount while simultaneously depleting your principal.
To combat this, you need a plan that isn’t completely dependent on the whims of the S&P 500. Here’s what the experts suggest:
1. Build a cash buffer: You should have enough money to cover at least one to two years of living expenses in a high-yield savings account or money market fund. This way, if the market crashes in your second year of retirement, you won’t have to sell your investments at a loss to pay your mortgage.
2. Be flexible with your expenses: The Nationwide survey shows that the most successful retirees are those who can adapt on the fly. If it’s a bad year for the markets, you might skip the big European cruise and stay closer to home.
3. Rethink 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 keep your accounts from draining too quickly.
(See $1 Million Will Last Retirees 26 Years in This Big City)
Don’t ignore the tax man
Many retirees are shocked to discover how much of their “income” actually accrues to the IRS. If all your money is in a traditional IRA or 401(k), every dollar you take out is taxed as ordinary income.
The survey found that many people did not consider the tax burden on their benefits or the fact that their Social Security benefits might be taxable. It’s a good idea to talk to a professional about tax-loss harvesting or doing Roth conversions before officially calling it quits.
The bottom line is that retirement is not a “set it and forget it” situation. It is a job in itself, especially during those first 60 months. If you can get through that window without blowing your budget or claiming your benefits too early, you’ll be in a much better position to enjoy the decades that follow.
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