For individuals hurtling toward retirement, conventional personal finance wisdom dictates continuing to fund retirement accounts as aggressively as possible, including leveraging catch-up contributions. While these additional contributions can accumulate into a tidy sum, after age 60 they have fewer years to compound, and the tax deferral becomes less valuable. If your retirement numbers are in relatively good shape, however, consider these four spending strategies that offer a positive psychological payoff.
Strategy 1: Get Ahead of Big-Ticket Transactions
As retirement approaches, it is beneficial to forecast major outlays over the next two to five years—such as home repairs, improvements, or vehicle replacements. If you are still working, you can fund these expenses from cash flows rather than funneling additional funds into retirement accounts. Pushing these big-ticket purchases into your working years has a psychological benefit: withdrawing money from investment accounts can be fraught, especially in early retirement when you are still adjusting to the new financial landscape. This challenge is particularly acute for those planning to delay Social Security, as they will be drawing all cash flow needs from their portfolios during those years. Spending from working income tends to be psychologically more palatable. As you consider what to spend on, lean into your vision of retirement. If you plan to pursue a passion for cooking, splurging on new counters might be money well spent. If more road trips are in your future, securing a safe, reliable vehicle should be a priority.
Strategy 2: Pay Down Debt
The decision to prepay a mortgage typically boils down to which choice provides a better return: debt paydown (and relief from interest payments) or investing in something with a similarly safe return. It often depends on the prevailing interest rate environment. Today, many mortgage holders could reasonably earn more on safe investments than they pay to service their debt. However, liquidity and spending needs must also be considered. If paying off your mortgage would require tapping into retirement accounts and triggering a large tax bill, or leave you cash-strapped and less flexible in retirement, you should think twice. Nevertheless, mortgage paydown is the ultimate 'sleep at night' allocation, especially as retirement nears, because it reduces fixed expenses and allows for a flexible approach to discretionary spending. This flexibility can boost lifetime retirement spending. Few people regret paying off a mortgage.
Strategy 3: Build Up Liquid Reserves in a Taxable Account
You can contribute as much as you wish to a taxable account and withdraw funds without restrictions. Being able to spend from taxable accounts with minimal tax implications provides the leeway to pursue other worthwhile strategies in early retirement, such as converting traditional IRA assets to Roth. However, do not overallocate to safer assets in your taxable account. Cash offers a low return relative to other assets, regardless of where it is held, and may not even outpace inflation. A prudent approach is to hold no more than two years' worth of liquid reserves—such as CDs, money market mutual funds, and similar instruments—across both taxable and tax-sheltered accounts.
Strategy 4: Splurge
If you are in your 60s, you likely know loved ones who were struck down in the prime of their lives before fully enjoying retirement. Why not embrace the big, fun experiences you have been saving for retirement while you are still working and healthy? As Jamie Hopkins notes in the book How to Retire, the greater good is that by continuing to work and earn income, you forestall portfolio withdrawals. If taking a few amazing trips a year or buying a vacation home now makes working more palatable and helps you feel comfortable with splurges, those allocations are well worth considering—even if they mean pulling back on savings.
This article was provided to The Associated Press by Morningstar. Christine Benz is director of personal finance and retirement planning for Morningstar and co-host of The Long View podcast.
