How to prepare for retirement: A retirement readiness checklist

As retirement nears—especially as your number of remaining working years drops into the single digits—it's time to evaluate your retirement readiness.

Up to now, retirement planning may have been vague, with only broad ideas about what you might do and what things might cost. You've been saving for retirement most of your life, but you don't really know if it's enough.

As you approach retirement age, it's crucial to go through a retirement checklist to determine where you stand.

Here are four steps to help you get organized and prepared for retirement.

Having a vision of your post-work life gives you a goal that can drive your financial decisions. It can shape how long you need to save, how much you need to save and how you'll spend what you've saved. Start by answering these retirement planning questions to set a strong foundation:

Some people have an age, a number of working years or a milestone they're aiming to reach before starting retirement. There aren't any retirement rules that say when you have to stop working. However, age does dictate when you:

• Have access to your tax-advantaged retirement accounts, like a 401(k) or traditional IRA without penalty (at least age 59½).
• Can claim Social Security retirement benefits. (Claiming as early as age 62 means a reduced amount while holding off until age 70 means a maximum amount.)
• Have to take required minimum distributions (RMDs) from tax-deferred retirement accounts, such as 401(k)s or 403(b)s (age 73 for those born before 1960, and age 75 for those born in 1960 or later).

When to retire is entirely up to you. You may consider:

• What feels like the right age to stop working?
• Do any retirement benefits depend on a number of years of service at your job?
• Is early retirement your plan, or do you want to delay as long as possible?
• How does your health and life expectancy factor in?
• Does your family situation affect when you start retirement?

Even if you don't know for sure, an approximation can give you a working timeline so you can set milestones. Make sure to discuss these questions with your partner, too.

Retirement can be a chance to settle down or change things up. Personal and financial reasons will influence your options, but it's important to narrow it down so you can plan for what you want. Think through the possibilities:

• Keeping your home. Particularly if you've already paid off your mortgage, you may want to stay where you are for as long as possible. You also could consider turning your home into a rental property for retirement income.

• Downsizing your home. Relocating to a smaller or less expensive home could save you time, effort and money in your retirement years. Especially if your plan is to age in place, your home should be a manageable size for upkeep and repairs.

• Moving for a lower cost of living. In retirement, your priorities shift. Living close to your work or residing in a certain school district may not be important now. Lower taxes, affordable housing and public transportation could draw you elsewhere and make your retirement dollars last longer.

• Moving where you want, even if it costs more. You want a retirement that you'll enjoy, so don't neglect the nonfinancial reasons for a retirement location. Living near family, having certain amenities, being near the water or the mountains—many things can influence your retirement dream.

When you're not working a full-time job, you have plenty of time for other things. Think about how you want to spend your days so you'll know what expenses or income may be involved:

• How will you remain active and engaged?
• What passions and hobbies do you want to pursue?
• Are there clubs, church groups or special-interest organizations you'd like to join?
• Will you want to keep working or start a business?
• Do you have plans to volunteer or take on a nonprofit project?

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Eliminating debt before retirement is a common goal for many aspirational retirees. And while it certainly has its benefits, it may not be necessary based on your financial resources and personal goals.

Ask yourself:

A common question is whether or not to pay off your mortgage before retiring or if you should keep other good debt going, especially if interest rates are advantageous. If making a house payment or taking on a family member's student loans is factored into your retirement finances and it works, then it's OK. But if debt payments will overstretch your limited income, then it's better to pay it off before you retire, even if it means delaying retirement, or not take on more debt at all.

Even if you can afford to carry some debt, you may not want to. Debt can strain your budget and cause you stress. If paying off all your loans and bills before you stop working will make you feel more relaxed, then it's a smart use of your money and may mean you enjoy your retirement more.

It's also essential to have a plan to avoid accumulating debt in retirement.

• If you expect your debt to grow in retirement, you may not have a sound budget.
• Unexpected expenses can happen at any time, so build an emergency fund to help avoid further debt and protect your financial picture.

Creating a retirement budget involves thinking about how you'll spend your money and the needs within your retirement vision so far.

Review the income and expenses you have now and consider the following:

• What work-related costs (i.e., lunch, commuting, clothing) will go down? What discretionary spending (think travel, entertainment and leisure) may go up?
• If you're planning to move—regardless of whether you're downsizing locally or relocating to a new city, state or country—how will that affect your expenses?
• What else might change from your current budget? Will your income be more or less? Will your expenses, spending and charitable giving be more or less?

Get help with retirement budgeting

Our personal cash flow worksheet helps you take inventory of the money you have coming in and tracking what goes to saving, sharing and spending. You can fill out one for the present day and one for your retired future and compare.

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Once you know your retirement budget, you can better plan for how you'll support it. Lining up the details of what you want your retirement to look like with what you've accumulated in your savings—or expect to—is essential for gauging your retirement readiness. At the end of this step, you'll know if you have realistic expectations or if you need to go back and adjust some of the parts in Step 1.

Everyone's answer is different, but a general guideline is building up retirement savings that's about seven to eight times your annual income. Since you've already worked up a budget in Step 1, you're already on the way to finding an answer that's more personal to you:

• Estimate. Gauge if you have enough money to retire by taking your projected retirement expenses, anticipating how long your retirement will last and comparing it to what your projected savings and retirement income will be.

• Calculate. With workable numbers for your planned sources of income, annual savings rates and your spending in retirement, you can find out how long your money might last. Using a retirement income calculator makes it easy.

• Double up. If you're married, consider how much money a couple needs to retire. Consider the expenses you share as well as the savings opportunities you have and how you can take advantage of them. For example, if you both work and have workplace retirement plans, you can each save to the maximum individual limit but plan to spend it together.

Based on those projections, if you find you don't have enough savings to meet your retirement goals comfortably, it's crucial you use the time you have to get back on track. Consider all the tax-advantaged retirement savings opportunities available to you:

• Get the most out of your 401(k). Make sure you're taking full advantage of employer matching contributions. If you're already saving enough to receive the full match, consider maxing out your 401(k) or other employer plan. These accounts have much higher annual contribution limits than IRAs.

• Look for ways to catch up. Once you reach age 50, retirement accounts like 401(k)s, 403(b)s and IRAs allow you to put in extra money. Catch-up contributions on top of contributing the usual maximum limits let you reduce savings gaps.

• Go beyond your employer's plan. You can open an IRA on your own even if you contribute to a workplace retirement plan. Deductible traditional IRAs let you defer taxes until you withdraw money later while Roth IRAs are funded with after-tax contributions but allow the opportunity for tax-free withdrawals in retirement. (With an IRA and a Roth, verify that you don't exceed the income limit before contributing to one.)

Contributing to a tax-advantaged retirement account is only one piece of the saving process. You'll also need to decide how to invest your money for retirement and the risk tolerance you're comfortable with.

• Aggressive approach. When you're working and saving for a retirement date that's still many years away, investing for growth might be your primary goal. A portfolio tilted toward more aggressive equity investments may be a good fit.

• Moderate approach. As you get closer to retirement, you may want your investment focus to shift away from growth and toward stability to support your withdrawals.

• Finding balance. Your retirement is likely to last several decades. Be sure to maintain a balance of investments that will allow your portfolio to outpace inflation and provide the return you need to ensure your money lasts while also allowing you to take withdrawals when you need them.

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After evaluating whether you've saved enough for a comfortable retirement, it's essential to make a plan for how you'll turn your savings and other sources of money into a regular stream of income that can support you for the long haul. Taking a structured approach can give you more confidence your money will last throughout your retirement. Here's how to form your strategy:

Your savings account doesn't have to be your only source of income in retirement. Before you decide how much you're going to take from your balance, identify everywhere your retirement money will be coming from.

It's possible to have multiple employer and individual retirement accounts. Make sure you've accounted for them all and that you know what you can do with them:

• Did you have another job with an employer-based retirement account that you let sit? Now's the time to think about rolling it into an IRA for easy access.
• Are you in your 50s but not yet 59½ and facing the possibility of quitting, getting laid off or retiring extra early? If so, the rule of 55 may help you access your current employer retirement savings account penalty-free.
• Consider all of the options for your 401(k) when you retire. You may want to leave it in the plan, roll it into an IRA or take a distribution and invest it elsewhere if it's to your advantage.

Social Security is a guaranteed, inflation-adjusted source of income that can provide a secure base of income in retirement. Two considerations that can affect your income from this source are:

• Age. Choose the age you want to claim your Social Security benefit carefully. Taking it before your full retirement age means you permanently receive a lower monthly payout. Delaying (up to age 70) means you get a higher monthly payout for the rest of your life.
• Marital status. If you're married, coordinate your Social Security benefits with your spouse. You may want to both claim at the same time, or you may want the higher-earning spouse to wait longer to optimize benefits. This often is called a staggered or split strategy.
  

Pension plans can provide a firm foundation for your retirement, but some factors surrounding pension payout options—typically a single lump sum or ongoing monthly payments—can influence your pension's ultimate value.

• Consider a lump sum if:
  
  • You need the money now.
  • You fear the pension plan could go bankrupt.
  • You want to ensure you can pass it on to your heirs.
• Consider monthly payments if:
  
  • The amount will adjust for inflation.
  • Your spouse would continue to receive a benefit if you die.
  • You think you will live a long time and don't want to run out of money.

An annuity can provide you with an income stream that lasts throughout your life, potentially boosting your guaranteed sources of income if your Social Security and pension benefits fall short of what you need. Keep in mind the different types:

• Immediate annuities. Turn a lump sum of money into a fixed income stream, taking some of the uncertainty out of your distribution plan.
• Deferred annuities. Begin your payouts at a later date, which can allow you to spend from your other retirement savings without worrying as much about making it last, knowing that this additional income stream will be coming.

While the main point of life insurance is to provide for a loved one if you die, your cash value life insurance also may give you a source of income to tap in retirement. Review your contract to find out if you can withdraw the cash balance or take tax-free loans and decide if you want to count it as part of your retirement income stream.

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The foundational retirement income you can count on includes Social Security, pension and annuity income, plus any life insurance cash value you intend to draw. Aside from setting these in motion, you won't have to do much calculating or maintenance to know what you're getting on a regular basis.

For the rest of your savings and investment accounts, it's crucial to calculate and plan your retirement withdrawals so you don't take out too much money too early and run out. Consider these key decisions when it comes to withdrawals:

A systematic withdrawal strategy helps you strike a balance between covering your living expenses throughout retirement and avoiding the risk of longevity and outliving your savings.

Among the approaches to take, a common starting point is the 4% rule. This method involves withdrawing no more than 4% of your account balance per year during retirement. The idea is that the balance you leave invested can gain enough interest and earnings to rebuild and endure through your retirement, potentially as much as 30 years.

This rule may not be the best retirement withdrawal strategy for you, and there are variations that may fit better. Some retirees start at 4% the first year and then adjust future withdrawals for inflation each year after, while others determine a range they need to stay within over time.

Pay attention to RMDs. With tax-deferred retirement accounts like 401(k)s and traditional IRAs, you only can accumulate savings and earnings up to a certain age. Once you turn 73, or 75 if you were born in 1960 or later, you're required to take out a certain portion of your account, as calculated by the IRS based on life expectancy. RMD worksheets can help you determine this annual amount.

You'll have to decide how to handle your RMDs:

• Factor them into your spending plan.
• If you don't immediately need this money, put it somewhere where it has the potential to grow, like a certificate of deposit (CD) or brokerage account.
• Consider a qualified charitable distribution (QCD) with unneeded IRA funds to help reduce your tax bill.

Being fully retirement ready means you've also prepared for key retirement risks. Even with a solid plan in place, unexpected events can threaten to drain your savings. Incorporate these risks into your plan so they don't derail you.

It's no secret that the average cost of health care rises the older you get. Plan ahead so you can navigate these expenses without sacrificing your financial security.

Most seniors will have long-term care needs during their lifetime. It could be a matter of a few months while you recuperate or several years if you develop a condition. Have a plan to pay for it. Use a long-term care calculator to estimate how much it may cost. Add the expected cost to your expense projection to make sure you have adequate savings.

If you're at least age 65, you can sign up for Medicare. It likely will be your primary health insurance, and the premiums are based on your income. In addition to standard Medicare, evaluate the Medicare supplements to see which coverage suits your needs the best. Keep in mind that your Medicare premiums are affected by your income. If you retire before you're eligible for Medicare, consider other health insurance options for early retirees.

Prices usually increase over time due to inflation. Your expenses will go up, but that doesn't have to mean disaster if you account for it. Take steps to offset inflation's impact on your retirement savings.

• Add it in your budget. Use an inflation estimate of 4% to adjust your budget going forward. You don't have to (and frankly, can't) know an exact future inflation rate for this. But it pays to factor for it in some capacity.

• Invest with inflation in mind. If you're too conservative with your investments, you could miss out on growth opportunities. Maintaining an allocation to stocks can help your portfolio keep pace with inflation but comes with a risk of loss. Consider hedging against inflation by keeping a portion in inflation-protected investments, such as TIPS or I bonds, to provide a fixed real rate of return.

Strategically navigating taxes in retirement can help you recognize certain tax liabilities and plan to take withdrawals from retirement accounts in a tax-efficient way. Specific considerations as you prepare for retirement include:

• Know how your retirement income sources will be taxed. Consider your current and future tax filing status. What you pay in taxes now may be different when you shift to your retirement income. It's crucial to watch your income—and if you're married, your combined income—so you can create a tax-smart plan around your lifetime savings.
  
  • Taxed upon withdrawal at ordinary tax rate: Traditional IRAs, traditional 401(k)s or other employer plans, pensions, annuities, HSA withdrawals for nonmedical expenses after age 65
  • Taxed annually between 0%–20%: Qualified dividends and capital gains from nonretirement investment accounts
  • Not taxed annually or upon withdrawal: Qualified Roth IRA and Roth 401(k) or other Roth employer plan withdrawals, HSA withdrawals for qualified medical expenses
• Understand how Social Security is taxed. Depending on your income, up to 85% of your Social Security benefit may be subject to federal taxes.

• Weigh if a Roth conversion makes sense. If you're in a lower tax bracket now than you will be once Social Security, pensions and RMDs kick in, you may consider converting from a traditional to a Roth IRA. While you may incur expenses upfront for this conversion, you'll allow your money to grow tax-free and be able to take tax-free withdrawals of earnings (after the account has been in place five years) for the rest of your life.

• Be prepared for tax changes with a spouse's death. Tax brackets favor couples in terms of both rates and deductions. When a spouse dies, the surviving spouse may move to a higher tax bracket and have a lower standard deduction.

If you run into volatile markets early in your retirement, it can impact your financial security. This is called sequence of returns risk. Consider the following ways to protect yourself:

• Keep some cash in reserve. Holding enough cash or fixed investments to get you through the first few years of expenses can shield you from the effects of a poor sequence of stock market returns. It's not for everyone, so consider if it's realistic for you and how much short-term savings you can afford to maintain.

• Be financially and emotionally ready. Your own emotions can be the biggest source of investment risk. Panicking and abandoning your investment plan when things get bumpy can cause losses.

Living a long life is something a lot of people strive for. But if you live longer than you plan for, you may deplete your savings too soon. You need to safeguard against longevity risk.

• Account for longevity risk in your withdrawal plan. Don't underestimate your life expectancy and risk running out of money too early.

• Maximize your Social Security and pension income. This ensures you have a firm base of inflation-adjusted, guaranteed income that won't run out.

• Consider that annuities can provide lifetime income. Whether you use an immediate annuity with payouts that start right away or a deferred annuity that starts payments later, having annuities in your mix can provide protection from longevity risk. You even can purchase annuities inside tax-deferred retirement accounts. Qualified longevity annuity contracts (QLACS) allow you to purchase income annuities without violating RMD rules.