If you've been a diligent saver and prudent investor throughout your career, you may wake up one day and realize that you've got enough saved up to retire. If you've been particularly fortunate with your investing decisions, you could even reach that point well before you're ready to retire.
That raises a key question: Now what? What should you do when you've saved up enough to retire, particularly if you plan to keep working for quite some time? There's no one-size-fits-all answer, but here are four key guidelines you should consider to assure your ultimate retirement success.
1. Protect your financial position
Once you've reached financial freedom, you no longer need to take quite as aggressive risks with your money. It's perfectly reasonable to shift some of your investments from stocks to investments that have a higher degree of certainty like bonds, even if your total potential returns will likely be lower.
A good rule of thumb is to not have money in stocks if you expect to spend that money within the next five or so years. Even if you plan to work for more than five years, there's nothing wrong with creating a five-year bond ladder that covers the first five years' of costs you expect your portfolio to cover in retirement. That way, if you choose to retire sooner -- or are forced to, by downsizing, health, or family concerns -- you are not forced to rely on a strong stock market to cover your near-term costs.
2. Consider whether you want to keep contributing to your 401(k)
Technically speaking, once you've saved enough, you no longer need to keep contributing to your 401(k) or similar employer-sponsored retirement plan. That said, there are some pretty good reasons to consider continuing anyway.
For one, if your employer offers a contribution match, it's tough to turn down the free money. All the extra money from your own contributions plus your employer contributions means that you can either retire sooner or fund a more expensive lifestyle in retirement.
For another, if your kids are planning to go to college, money inside your 401(k), IRA, or other qualified retirement accounts does not count toward your expected family contribution. As a result, overfunding your 401(k) can be a strategy to improve your children's financial aid packages, thus reducing your out-of-pocket costs for their educations.
Additionally, money inside your 401(k) is protected from most personal lawsuits and personal bankruptcy proceedings. While you may not plan to get sued or contract an expensive medical condition, stuff happens. If the worst comes to pass, you'll be much happier with having more of your money protected, rather than exposed to those losses.
3. Make sure you're funding your other life priorities
Chances are, if you've saved enough to fund your retirement early, you've gotten there by putting off other financial priorities. Want a nicer car? Nicer house? Better vacations? Want to fund your kids' educations without any financial aid? With your retirement taken care of, you can put the money you had been contributing toward retirement to take care of those other life priorities.
As the old saying goes, nobody lays on their deathbed wishing they had spent more time in the office. Once your retirement funds are covered, you have every right to put your money toward your other life priorities. Chances are, you'll appreciate it all that much more, too, knowing that you're able to cover those other priorities without sacrificing your own future to get them covered.
4. Consider making asset location choices
When it comes to your retirement savings, you generally have three pots of money to choose from: traditional-style retirement accounts, Roth-style retirement accounts, and after-tax accounts. Traditional-style plans are great while you're earning and saving money, as you typically get a tax deduction for contributing and your money can grow tax-deferred within those accounts.
The problem with traditional-style accounts comes in retirement. Your withdrawals are frequently treated and taxed as ordinary income. You're often required to withdraw money, even if you don't need it. Add a few decades of compounding to your already funded retirement account and your required distributions could easily increase your overhead costs in retirement. This is because your Social Security benefit can be taxed and your Medicare premiums can increase if your income is high enough.
Taking the opportunity to make Roth IRA conversions or divert your future investments to after-tax accounts instead of traditional retirement accounts can reduce that burden later in your retirement. Even if you're still working, your employer may allow "in-service distributions" that you can leverage to help with your asset location decisions. If you have money in a former employer's 401k or a rollover IRA that you set up after leaving a former job, you can leverage that money for your asset location moves.
Yes, you will pay more in current taxes by making those moves, but note two key things. First, you don't have to convert your entire balance at once. You can do it over the course of several years to keep the tax burden down. Second, if you think in terms of your total costs over your lifetime, you might find that paying a little more in tax today can save you more in taxes and costs later.
Congratulations -- you've hit an incredible milestone
Most people reach retirement age with far too little saved up for a comfortable lifestyle. That you've built a comfortable nest egg puts you in rarefied company. The tough part of building your nest egg is behind you, and you now have a great opportunity to enjoy the fruits of your labor. There's still work to be done, but you're in great shape to have the retirement you've long been planning for.