reposted from MarketWatch.com
by: Andrea Coombes
December 19, 2012
If your retirement date is just a few years away, it’s time to start fine-tuning your 401(k) and your overall savings strategy. Retirement experts offered these nine tips for savers who are nearing retirement.
1. Stash some savings outside of retirement accounts
Many savers keep all of their retirement savings in a 401(k) or similar tax-qualified account. But consider putting some money in an account that’s not tax-advantaged, said Mackey McNeill, founder and president of Mackey Advisors in Bellevue, Ky.
That way if you need a lump sum—and newly retired folks often come up with a few big expenditures, she said—you’re not bumping yourself into a higher tax bracket.
“Every time it comes out of the 401(k) or IRA, it’s taxable,” McNeill said. Having a separate account “allows you to be more tax-efficient.”
Say you decide to downsize to a condo and you find one you want to buy—but your home hasn’t sold yet, so you need to pull the down payment from your retirement savings. That’s a taxable distribution and, combined with your regular distributions for living expenses, could push you into a higher bracket.
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“Something like that gets to be pricey because it’s not just the down payment—it’s the taxes, too,” McNeill said. “If you could take a little bit now and a little bit later or have some money outside the IRA, you can manage your tax hit.”
2. Make a provision for cash flow
To make sure you’re not forced to sell stocks in a down market, consider investing some savings in short-term bonds and cash. Retirees should have “at least two to five years of cash flow in their portfolio, preferably five,” McNeill said.
“The first four or five years of retirement, those are the periods that are most likely to send you back to work,” she said. “It’s when those first few years have intense negative performance—that’s when the portfolio is going to fail,” McNeill said. “If you have to sell stocks when they’re down, [your portfolio] doesn’t have enough oomph in it to recover because you’re withdrawing too fast.”
You can hold this money inside your tax-qualified account, such as an IRA, she said. “This is money we can use in a market correction,” McNeill said.
Some clients, McNeill said, like having two IRAs, with one invested in short-term bonds and cash and the other in equities. That second account “has more volatility but I don’t have to worry about that because I’m not going to tap into that for five years,” she said. The first account acts as your paycheck. “If you physically separate them, people feel better about it.”
3. Assess your bond portfolio
Maybe you’ve been shifting more money toward bonds as you get closer to retirement. The question is: what type of bonds?
Dan Goldie, president of Dan Goldie Financial Services LLC, in Menlo Park, Calif., suggests sticking to short-term, high-quality bonds.
“The purpose of fixed income in the overall portfolio is to provide stability,” said Goldie, who is also co-author, with Gordon Murray, of “The Investment Answer.” “The two things in the bond market that affect risk and return are credit quality and maturity length. I use high-credit-quality, short-maturity bonds,” he said.
In other words, he avoids longer-term and high-yield bonds, because they “are more highly correlated with stocks,” he said. “If stocks go down, chances are your long-term bond fund and your high-yield bonds will go down at the same time.”
Goldie said that, in general, a portfolio that’s 70% stocks and 30% short-term bonds has about the same volatility—but higher returns—than a 60% stock, 40% bond portfolio that uses long-term and high-yield bonds. “You get more bang for your buck” with the first portfolio, he said.
4. Get more conservative, but don’t overdo it
People often assume they need to overhaul their investing approach as they near retirement. For people in reasonably good health, that’s not necessarily true.
“I often have people tell me, ‘Well, I’m coming up on retirement so I need to make a major change,’” Goldie said. “Retirement is an important date because it is the end of your earned income or a reduction in your earned income, but it’s not the end of your life. You still need to keep investing as long as you’re alive.”
Others agreed. “You’ll most likely be getting more conservative, but it’s more conservative based on who you are, not necessarily a conservative portfolio,” said Scott Holsopple, chief executive of Smart401k, an Overland Park, Kan., firm that offers plan advice to savers.
If you’re healthy you might have 20 or 30 years in retirement. Even if inflation is low, it will eat away at your purchasing power over that time, Goldie said.
“It’s reasonable to reduce your equity exposure as you enter retirement, but by no means should it be eliminated,” Goldie said. “And for most people it’s a joint lifetime—a husband and wife—which is even longer than a single life expectancy.”
5. Ensure that your portfolio is diversified
You know that diversification is important. But how closely have you looked at your investments? McNeill said one new client came to her with a portfolio that looked to be diversified, but on closer inspection it turned out that 70% of the holdings could be traced back to one company—thanks to investments in company stock, plus bond and mutual-fund investments that all linked back to that firm.
“You could easily retire and find yourself ‘not retired’ again with this portfolio,” McNeill said.
Before you retire, “Get out that magnifying glass and look a little closer,” she said.
6. Understand target-date funds
Take a close look at any target-date funds in which you might be invested. These set-it-and-forget-it investments—an increasingly popular 401(k) option—promise to handle the hard work of asset allocation and rebalancing for you. The idea is you need just one target-date fund that’s named with your retirement year.
But target-date funds with the same name can vary widely in how they invest. Some funds assume investors will withdraw their money on the day they retire; others assume investors will stay invested throughout retirement. Each strategy suggests a different approach to asset allocation, so check to make sure the target-date fund isn’t taking on more risk than you can handle.
“If you’re going to retire in 2030, don’t just buy the retirement 2030 fund. Actually look and see what allocation that 2030 fund has and try to get a sense of whether that is right for you,” Goldie said.
7. Trim fees
Ideally, you’ve been investing in low-cost investments since you started putting money aside for retirement. But if you haven’t, now’s the time to start. The less you pay in investment expenses, the more money you’ll have to spend in retirement.
Look for low-cost, widely diversified index funds so that you increase your expected return, Goldie said. That, in turn, means “more potential income in retirement,” he said.
8. Ask key questions
Often, soon-to-be retirees focus on their planned date of retirement—perhaps because it’s easier than focusing on the complex question of how much money you’ll need. But those money questions are more important, Holsopple said.
“Rather than saying, ‘I want to retire at 65’ or ‘in 10 years,’ take a step back,” Holsopple said. Ask “How do I want to live in retirement? What is that going to take in terms of savings, and where am I right now?” he said.
“You can control your savings rate and you can control your expectations. Those are a big driver on whether you’re able to live the retirement you desire,” Holsopple said.
9. Save more
Ramping up your savings in the years leading up to retirement is a good idea for two reasons. Obviously, you’re growing the pot of money you’re going live on in retirement.
But saving more now also means you’re learning to live on less. That’s a useful practice for those who haven’t saved enough. And that would appear to be many of us. Read related column: Retirement fears rise among older workers .
Some estimates suggest a 67-year-old should save eight times his salary if he wants to enjoy 85% of his preretirement income in retirement. Read related column: Retirement savings: How much is enough?
Andrea Coombes is a personal-finance writer and editor in San Francisco. She’s on Twitter @andreacoombes.