The 4 Things to Do Before Retirement

Some crucial maneuvers will help soon-to-retire people avoid trouble

The size of your nest egg isn’t the only thing you should be focused on as you close in on retirement.

So say financial planners and experts, who point to several financial moves investors can make in the years before they leave work that might help them preserve their savings, reduce their tax bills and provide for loved ones and heirs.

The decisions made during these critical years, experts say, can play a key role in determining whether an investor has a regret-free retirement or not (at least financially).

“Thirty or 40 years ago, there was nothing to regret. There were fewer 401(k) plans, no Roth options, etc.,” says Lee Martin, a certified financial plannerwith Bellevue, Wash.-based TRUEretirement, whose clients tend to be in retirement or within 10 years of it. “But chances for regret have skyrocketed with all the choices out there.”

Here, then, are some of the biggest financial-planning issues that advisers say investors nearing retirement should consider:

1. Understand revocable versus irrevocable choices

It doesn’t get any more basic, or important, than this: Spend the most brainpower on the financial choices that can’t be reversed.

Mr. Martin coaches his clients to distinguish between choices that are revocable (or changeable) and those that aren’t. Starting Social Security withdrawals is mostly irrevocable, as are certain decisions about how to draw pension income.

On the pension front, employers will ask workers before they retire to elect whether to take pension funds in a lump sum or in the form of monthly payments. Once they choose, workers can’t revert to the other option.

Depending on the role the pension assets play in a retiree’s income mix, different choices make different sense, Mr. Martin says. Those concerned about outliving their assets might like the reliable monthly payment for life, whereas those who want to place the assets in a different part of their portfolio often elect the lump sum.

“The question [investors have] to ask themselves in this instance is, ‘Can I do a better job managing the pension funds myself?’ ” he says. “Those who take the lump sum often move it into an IRA.”

Also irrevocable: some housing decisions. Choosing to live in certain senior living environments, such as continuing-care retirement communities, can also lead to irrevocable financial outlays, in the form of typically six-figure nonrefundable down payments for entry.

2. Spend some of it now, and stay liquid

Spend some extra money right before you retire?

That might sound like bad advice to some, but experts say it makes sense for many preretirees.
Cash flow in retirement takes the form of “spending down” saved assets, rather than accumulating and increasing income. Planners and clients can’t foretell life expectancy or the future cost of health problems or inflation, so income preservation and cash flow must be managed carefully.

With that in mind, preretirees should consider springing for needed repairs or purchases while they are still earning money, says Timothy Gagnon, a certified public accountant and tax lawyer who is a professor at Northeastern University.

“People need to look at their home, their roof, their car, and replace or repair anything that needs attention before they retire, preferably during the three to five years prior to retiring,” says Mr. Gagnon. “You don’t want big hits to cash flow once retirement begins.”

During the early years of retirement, many people follow the conventional wisdom of dipping just a small toe into their resources, while waiting to tap income streams such as Social Security or retirement-account withdrawals in the hopes that their payouts or portfolios will grow.

That isn’t a bad idea, but near-retirees-even if they’ve pared back their stock exposure-also need to consider what might happen in the market around the time they retire. Many adults will enter retirement during a bear market, says Christine Benz, director of personal finance at investment-research firm Morningstar Inc.

“The risk is that you might wind up pulling out a larger percentage payment of your portfolio while making withdrawals in a market where prices are down,” she says. “You don’t want to do that at the bottom of the market.”

To safeguard against that scenario, she recommends what is known as a “bucket strategy,” where investors keep a layer of liquid reserves so they don’t have to sell shares in a down market.

Advisers interpret and implement bucket strategies in several ways, but the general idea, she says, is that you maintain a level of cash reserves so that you can “stay flexible if income from distributions is low,” tapping reserves rather than eating into equities to get needed income.

3. The taxman looms, so be sure to diversify

For those with traditional retirement accounts (a 401(k), non-Roth IRA, etc.), Uncle Sam will make sure you start taking some of your winnings off the table. But you and your adviser have to keep on top of the tax implications-and it’s best to do this before you start taking so-called required minimum distributions (RMDs, for short) at age 70½.

RMDs are taxed as ordinary income. Retirees should understand what their total income and tax bracket will be both before and after RMDs commence, and that they are responsible for setting aside funds to pay taxes.

‘Thirty or 40 years ago, there was nothing to regret [in retirement choices]…. But chances for regret have skyrocketed with all the choices out there.’

-Financial planner Lee Martin

At the same time RMDs kick in, retirees also lose beloved maneuvers-such as making pretax contributions to retirement accounts-commonly used to lower taxable income.

Those who own their homes outright have already lost their mortgage-interest tax deduction, while those who no longer work may lose deductions such as a home office.

“Tax diversification isn’t brought up as much as it should be. If you wait until you start drawing income, it’s too late,” says Joe Sicchitano, a senior vice president and head of wealth planning at SunTrust Bank, which in 2014 began offering clients a retirement tool, called SummitView, to look at all their assets in one place and model retirement scenarios. “You don’t necessarily need to change underlying investments, just the vehicle [containing them].”

Ms. Benz says adults between 63 and 70½ “still have a lot of control over their income,” whether or not they’ve retired, and can take steps to offset a looming tax hit.

These include a Roth conversion (which will also have tax consequences, albeit different ones) or moving some funds into brokerage accounts, so they remain in the market but in a vehicle where withdrawals are taxed at capital-gains rates versus ordinary income-tax rates.

4. Know your benefits and how choices affect heirs

One of the wisest things preretirees can do is double-check the fine print in their employers’ 401(k), pension or other benefit plans, as well as the fine print connected to any annuity choices they are considering.

For example, higher earners often find that their employers offer not only a 401(k) plan but also a “nonqualified deferred compensation,” or NQDC, package. Since the dollar amount against which an employer can make a 401(k) match is currently capped at $265,000 (under compensation limitations announced each year by the Internal Revenue Service), some employers paying higher earners north of this amount recognize a match on the overage through an NQDC plan.

“I’ve seen these plans crop up at a lot of the local drug companies,” says Ann Minnium, a fee-only adviser with Concierge Financial Planning in Scotch Plains, N.J. “Most people think that this is part of their 401(k), but it isn’t.”

Ms. Minnium says NQDC plans often begin paying employees at age 55, at retirement, or within a five- to 10-year window past age 55. Employees need to vet how their plan works to put the money to work in the most sensible way.

Preretirees also should consider choices for using annuity and pension plans. The plans often require a choice between withdrawals in the form of a “straight life” income stream or over a multiyear term (10 years, 20 years, etc.), says Mr. Martin.

In the straight-life scenario, people get the maximum allowable monthly payment for the rest of their lives-so they can’t outlive income from the annuity. When they die, however, their spouse and heirs get nothing, which turns this into a bad bet if the investor dies soon after payments begin.

In a multiyear term, investors receive the annuity payments monthly for the duration of the term they choose-but if they die before the term ends, their heirs get the payments for the duration of the term.

The overall lesson: All retirement planning  strives to provide a mix of resources for enjoying life, alongside resources that can cover unforeseen costs and events, plus expectations about inflation.

Mr. Martin puts it this way: “There are a lot of levers you can control.”

JANE HODGES, The Wall Street Journals