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Getting Ready to Make the Break – 1 Year Before Retirement

by retirebyforty on November 30, 2012 · 21 comments

in early retirement, goals and milestones, saving

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only 1 year left until retirementThis is part 3 of the nearing retirement series. It’s getting down to the wire with only one year left till retirement. Hopefully, those of us with 1 year left already read the 10 and 5 years from retirement posts and are prepared. If there is a big shortfall, it will be very difficult to catch up at this point. Let’s see what Money Magazine has to say.

Savings

Money Magazine: With one year left before retirement, savings should be 11.4x household income. Their target retirement saving is 12x your pay when you’re 65.

As I said in previous articles, I think it’s better to use your expenses as a measuring stick. Your target saving at 65 should be 25 x expenses. With only 1 year out, you should be at 25 x expenses or just a bit short.

Now Dial Back On Stocks

Money Magazine: The max you should have in stocks is 40%-50%.

This is a good idea. The stock market can be very volatile in the short term and you wouldn’t want to bank your retirement on it. I still lean toward the high end (50%) though since I’m an aggressive investor. If you don’t plan to withdraw for another 5 to 10 years then you should have more assets in stocks, especially if you are an early retiree like me. I’m still under 40 and I won’t draw down my retirement portfolio for another 20 years so our target stock allocation is currently very high at 70%-80%.

Stress-Test Your Spending

Money Magazine: You should have a good idea of your yearly expenses now. See if Social Security + pensions + part time work + 4% withdrawal from your retirement portfolio will cover your expenses. If not you will need to trim your budget. Practice living on your post retirement budget now to make sure it’s realistic.

My wife and I did this exercise for two years before I retired from my engineering career. It’s a big relief to be able to cover our expenses without having to draw down our retirement fund. Don’t count on having a big reduction in expenses once you retire. There will be other expenses like healthcare and hobbies. Trimming your budget down to a non luxurious level is the key to having a sustainable budget.

Pick Up the Pension Check

Money Magazine: Lucky enough to have a traditional pension? Find out what choices you have and figure out which is best for you. Don’t take a lump sum because it’d be tough to generate the same income the annuity version guarantees over a long retirement. Figure out if you want survivor option.

I faced the same situation with my small pension. I’m leaning toward rolling the lump sum over to my IRA. However, I’ll hold off until I see the result of the 5, 10, and 20 year projections first. I’ll have to sit down and do a more thorough calculation to see which option is the best.

Stockpile Cash

Money Magazine: Enter retirement with enough cash to fund the first 12 months of living expenses, separate from your emergency fund. With one year left, funnel money into a savings account and reduce 401(k) contribution if needed. Move a portion of an IRA into a short-term bond fund as a backstop.

Some readers questioned my $50,000 fund in my saving account because it’s only earning 1.05% interest. When you have a big change in income due to change in employment or retirement, you really need a big cushion in case something goes wrong. One year of expenses in cash is a pretty good number, although I would be a bit more comfortable with 18 months. In the event of a market crash, I can hold off on selling for a while.

Know the Medicare Windows

Money Magazine: Retiring before 65? Now is the time to figure out health insurance coverage. Retiring around 65? You can sign up for Medicare from 3 months before or up to 3 months after your birthday month. Enroll beforehand and coverage starts on the first day of your birth month. After, and it will be delayed up to six months. Retiring after 65? Sign up for Part A, which is free, pays for hospital care, and may cover gaps in your employer plan.

I’m not 65 yet so I haven’t thought about Medicare much. My mom is going to turn 65 in 2013 though, so this is a great reminder to get her signed up. Healthcare is a huge obstacle to early retirement in the United States. Luckily, Mrs. RB40 is still holding a full time job so Baby RB40 and I are covered by her employer’s plan. If she retires at 55, we will need to figure something out. Maybe we’ll need to move to another country if the healthcare cost in the US continues to spiral out of control.

Wow, with one year left, there isn’t a lot of time left for course correction. If you’re not on target, you might need to work a few years longer. Another option is to find an enjoyable part time gig so you can work much longer, which will let you delay withdrawal from your retirement saving and let it grow.  Ensure that you are prepared before you make the break.

Are you preparing for a big transition over the next year? One year is a very short time. Next week, we’ll see if Money Magazine has any advice for those of us that are 1 year into our retirement. 

Other articles in this series:

If you have 10 years before retirement.

If you have 5 years before retirement…

1 year into retirement – Enjoy it and stay on track. 

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{ 21 comments… read them below or add one }

Financial Samurai November 30, 2012 at 8:09 am

The 12X annual income in capital is a good goal imo. I have a post I wrote a couple weeks ago with some coverage ratio suggestions.

I feel kinda sad if I was 65… life is more than half over already, which is scary if you think about it!

Sam

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retirebyforty November 30, 2012 at 9:54 pm

I guess 12x is good for an average family, but I think it’s too much for frugal folks.
Yeah, my mom is talking like that too. I think I would still enjoy 65. Life is good so let’s enjoy it while we can.

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FI Fighter November 30, 2012 at 8:15 am

Great commentary. I can’t wait to be only 1 year out from retirement! In my own situation, it’ll be hard for me to dial back on stocks, since I’ll be relying on dividends to pay for my expenses.

I guess the $50k emergency fund only seems like a lot b/c with $50k, you probably have enough for a downpayment in most parts of the country. Still, better safe than sorry.

Healthcare is what scares me the most, and the biggest uncertainty when it comes to planning for early FI. I would like to believe it will always be affordable enough where I don’t have to think about relocating from the States. So, maybe a part time gig will be needed if things don’t go exactly as planned.

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retirebyforty November 30, 2012 at 9:56 pm

I don’t think we can rely solely on dividend. Lots of companies cut dividend over the Great Recession. We need to have more sources of income.
The right part time gig could include health care, but I think that will become more and more rare. Most companies seem to be heading toward freelance/part time position with no benefits.

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JayCeezy November 30, 2012 at 10:05 am

Joe, thank you for your analysis of these Money articles. One point on stocks and risk… Japan’s Nikkei was at 40,000 13 years ago. Today it is under 10,000. Inflation takes the real value to 7,000. So, it is quite possible that the U.S. is in a “value-trap” just as Japan was and is. The S&P was over 1,500 in 1999 and again in 2003.

It is quite possible for stocks to go nowhere for bear markets that last decades. If one is counting on a 4% withdrawal rate, dipping into capital becomes a requirement. Too many years of non-performance guarantees a greatly reduced nominal savings, and inflation will butcher the value even more.

I say this as someone who has watched my equity investments drop 57% in 15 months, and five years later still not recover. Even if you stay cool and do not sell, the stress and uncertainty take a huge toll. Combine that with staying at a job that also takes a huge toll, as yours did (and mine does), please consider that the ‘worst case’ is quite possible and a ‘Black Swan’ event is actually likely (i.e. a war, terror attack, natural disaster, 5 years of $1 trillion-plus deficit spending with no end in sight, motivated and competitive economic powers, etc.) Everybody believes they can withstand risk, until that risk becomes a reality. Just something to keep in mind, in an economic environment where stocks have done nothing for 13 years and interest rates are less than inflation. Keep smiling!:-)

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retirebyforty November 30, 2012 at 9:58 pm

Good point with stocks. We have been doing OK with stocks because we kept averaging in. However, once we stop contribution, we would feel the effect of a big drop much more. That’s why we need more bonds and rebalancing.
Thanks for your input.

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JC @ PassiveIncomePursuit December 1, 2012 at 11:54 am

With bonds are you investing in funds or individual bonds? I know that a lot can happen but if/when interest rates rise bond funds are going to be hit pretty bad. Just curious what your thoughts on that are and how you’re preparing for it.

I’m most worried about healthcare now but I still have around 10 years before I could think about early FI so there’s no telling what it’ll be like then.

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JayCeezy December 1, 2012 at 12:39 pm

@JC, I have divested all bond funds for the reason you mentioned; when (not if) interest rates rise, the corresponding decline in NAV (avg duration * % increase, i.e. 5 year avg. duration * 2% Fed Fund rate increase = 10% decline in fund Net Asset Value) will wipe away years of gains. If you can pick a highly rated bond and stay with it until maturity, you will be in good shape; but I am unwilling to commit money for the durations required (i.e. 10-30 years).

I have reluctantly assembled a ladder of CDs, and am not happy with the rates of return (<1% for <2 years, up to 2.8% for 7 years). After inflation and taxes (interest income is taxed the same as W-2 earned income) the buying power is less every year. But I just cannot accept the risk of another dramatic decline in my net worth. I have postponed retirement years longer than I anticipated only 5 years ago, and am not seeing good things ahead for the next 5 years. In any event, between the outsize risk of commodities like gold, uncertain tax and business outlook, continued high un/underemployment with the jobs created being of lower pay and quality than jobs lost, and a U.S. populace increasingly looking to the government for bailouts, handouts, and other comforts, my only course of action at this time is to continue saving as much as possible. Hopefully things will become clearer in the future, but I'm not holding my breath or waiting for a miracle.

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retirebyforty December 3, 2012 at 8:30 am

I’m not optimistic about bonds either. I’m thinking about increasing my allocation in P2P lending, but that’s pretty risky.

retirebyforty December 3, 2012 at 8:29 am

I stashed most of my bond allocation in Utilities for now. Bonds are just too expensive. I’ll have to keep an eye on it and move it over later.

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JayCeezy November 30, 2012 at 10:10 am

One more thing… I have a Money Magazine from 1988, with a cover story on how a 9% stock market return, and a 7% withdrawal rate on stock market holdings should insure a comfortable retirement with little risk. In 1988, that seemed like sensible and good advice. Something to keep in mind as we read a $4 magazine in 2012.

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krantcents November 30, 2012 at 2:29 pm

No, 4-5 years to go. I am ready right now, but need to wait to get a decent pension out of it. If I wait I am entitled to full benefits which means lifetime medical (medical, dental & vision). I think it is worth it. Anyway, I want to retire with my wife.

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Christa November 30, 2012 at 3:11 pm

I like your approach using 25 x annual expenses. It makes more sense to me to calculate based on plans for individual retirements rather than an average percentage.

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Elizabeth @ Broke Professionals December 1, 2012 at 6:01 pm

1.05% interest on a savings account is actually pretty good these days! I’ve always been a big proponent of having a large among of liquid assets, so I don’t think your $50,000 fund is crazy at all.

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retirebyforty December 3, 2012 at 8:31 am

If you’re self employed, I think you need a lot more liquidity than someone with a regular paycheck. We never know what next month will look like.

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Dominique Brown December 2, 2012 at 7:15 pm

Though I still have a few more years before I retire, I have been preparing for my retirement for quite some time. I like your idea of stress-testing your spendings to know your financial status and make the necessary adjustments. I also agree with you that we need to have a big financial cushion in case anything goes wrong. My wife and I are planning to save up to 18 months of our salary to make sure that we have a big enough cushion before we retire.

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Jefferson @SeeDebtRun December 3, 2012 at 5:16 am

12x annual income might be a little light for me, and how i want to retire.. i want to spend that time traveling and experiencing life’s finest.. not just sitting around the house and feeling sorry for myself.. that said, it really does depend on my expenses.. if my house and vehicles are paid off, certainly that should be more than enough..

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retirebyforty December 3, 2012 at 8:32 am

That sounds like a nice retirement. :) You’ll definitely need a lot more money though.

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Aloysa @ My Broken Coin December 4, 2012 at 6:10 pm

Can we do some math please? I am a little confused. Let’s say I am making 50K a year, and I want to retire at 65. So does it mean that I am supposed to have 600K in retirement savings? If I need 40K a year to live on, it means that I have only 15 years saved up. What happens to me if I live till 90, and need another ten years. Either this formula is too light, or my understanding of it is wrong.

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retirebyforty December 4, 2012 at 10:03 pm

Yeah, that’s why I think it’s better to use 25x expense as the saving target.
In your example, you’ll need to save 40K x 25 = 1 million. Then you can withdraw 4% (40K) and your portfolio should last over 30 years.

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Diane C December 7, 2012 at 10:01 am

Alosya, simply put, you are missing a few pieces of the puzzle. The biggest one is compound interest. The money you save and invest earns you more money. If you save in your employer’s 401K, they usually match to a certain percentage, so your money grows even faster. If you save early and invest well, you will withdraw way more money than you ever put in. Regarding living ’til 90, if you avoid converting to all cash in retirement, your investments will continue to grow.

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