5 Years From Retirement? Here's What to Start Thinking About

Why the last five years require a different mindset

For most of a career, the guiding question is how to grow savings as efficiently as possible. In the final stretch before retirement, the more important question becomes how to protect what's been built and organize it so it can reliably produce income.

This doesn't necessarily mean abandoning growth-oriented investments, but it does mean actively thinking about risk in a way that may not have mattered as much a decade earlier — because there is much less time to recover from a bad outcome right before or after leaving work.

Understanding sequence-of-returns risk

Sequence-of-returns risk refers to the danger that a portfolio experiences poor returns in the years immediately before or after retirement begins, when withdrawals (or the end of contributions) coincide with a shrinking balance. Two portfolios can have identical average annual returns over 30 years and produce very different outcomes depending on the order those returns occur in.

This is one reason many people reduce portfolio risk gradually as retirement approaches rather than making an abrupt shift on a single date, and why holding some more stable assets can help avoid selling growth investments at a loss to fund near-term spending.

Building a cash reserve for the transition

Holding one to a few years of planned withdrawals in cash or cash-equivalents is a common strategy for reducing the need to sell investments during a market downturn shortly before or after retirement. The right size of that reserve depends on your other guaranteed income, your risk tolerance and your overall portfolio size.

A cash reserve isn't meant to be a large portion of a portfolio over the long run — its purpose is to create a buffer during the specific period when sequence-of-returns risk is highest.

Healthcare coverage if you retire before 65

Medicare eligibility generally begins at 65. If you plan to retire earlier, you'll need a bridge — through a spouse's employer plan, COBRA continuation coverage, a Health Insurance Marketplace plan, or private insurance — and the cost of that bridge should be built into your spending plan well before your last day of work.

Even after Medicare eligibility begins, original Medicare doesn't cover everything; many people also evaluate Medicare Advantage or Medigap coverage and Part D prescription drug coverage during this window.

Healthcare coverage rules and costs change. Confirm current details at Medicare.gov or HealthCare.gov before making decisions.

Thinking through your Social Security claiming age

Social Security retirement benefits can be claimed as early as 62 and as late as 70, with the monthly amount permanently reduced for claiming early and increased for delaying past full retirement age. The five years before retirement is a natural time to model different claiming ages against your other income and expected longevity.

For married couples, claiming decisions can also affect survivor benefits, which is worth reviewing together rather than deciding individually.

Reviewing the tax location of your accounts

Where your money sits — a traditional 401(k) or IRA, a Roth account, or a taxable brokerage account — determines how it will be taxed when you draw it down. The years before retirement, when income may be more predictable, can be a good window to evaluate whether Roth conversions or shifting future contributions between account types make sense for your situation.

This is also the time to think about the order in which you'll draw from different account types once you retire, since that sequence affects your tax bill and how long your savings last.

Tax strategies depend on individual circumstances and current law. Review specifics with a qualified tax professional and IRS guidance.

Addressing debt before you stop working

Debt payments continuing into retirement compete directly with every other spending category, and paying them off while still earning a paycheck is generally easier than doing so on a fixed income. Mortgages, home equity loans, auto loans and credit card balances are all worth reviewing for a realistic payoff plan before your last paycheck.

Using remaining catch-up contribution room

Workers age 50 and older are generally allowed to contribute more to 401(k)s, IRAs and similar accounts than younger workers, under limits set annually by the IRS. If cash flow allows, the final working years are often the highest-leverage time to use this additional room, since there are fewer years left for the contributions to grow.

Contribution limits change annually. Check the current figures at IRS.gov before making contribution decisions.