The True Costs of Working in Retirement
More and more people say that they plan to work in “retirement.” A growing minority say they will never retire.
I’m not opposed to that. There are good reasons to continue working after age 65 or any other age, even if it’s not full time work. Some people need the money. A few extra years working can significantly improve financial security even if you don’t “need” the money. Other people will benefit from the social interaction, structure, and feeling of achievement and purpose that can come with work.
Yet, there are a number of factors to consider, and some factors have interplays that not everyone realizes. Be sure you know all the costs and benefits of extending your career.
Costs. Work brings in additional income, but there also are likely to be costs. Commuting, clothes, meals, dry cleaning, and other expenses can mount. Calculate the net real cash benefit from working. Some people want to work part-time or at a less challenging and lower-paying job as they grow older. Then, they are surprised at how little net financial benefit they gain from working. Avoid that kind of surprise.
Social Security. Continued employment means you should consider delaying Social Security until at least full retirement age. When you receive Social Security retirement benefits before full retirement age (over 66 for people retiring now rising to 67 for many close to retirement), your earned income can reduce the retirement benefits. In 2014, Social Security retirement benefits will be reduced $1 for every $2 you earn above the earnings cap of $15,120 for earnings before the year you reach full retirement age. In the year you reach full retirement age, the benefits are reduced $1 for every $3 earn above the cap of $40,080 annually until the month you reach full retirement age. (The cap is adjusted for inflation each year.)
Once you hit full retirement age, there is no cap on the earned income you can receive while receiving benefits.
You don’t completely forfeit the benefits if you trigger the income caps. The benefits you receive once hitting full retirement age are adjusted for the benefits withheld in earlier years when you exceeded the earned income limit. (This make-up adjustment doesn’t apply to someone who received spousal benefits instead of his or her own benefits before full retirement age.)
For most people, the best approach if they’re going to continue working is not to begin Social Security retirement benefits until reaching full retirement age. You might want to delay benefits until age 70 if you’re going to continue working. An exception would be for someone who wants his or her spouse to begin receiving a spousal benefit. Then, after reaching full retirement age you can apply for benefits and suspend them immediately. Your spouse can begin to collect half your benefit, but you’ll get the higher benefit for delaying yours until later.
Of course, continuing to work without drawing benefits also might increase your eventual benefit. Your benefit is determined using your 35 highest-earning years, adjusted for wage inflation. If a few more years of working boosts that average, you’ll receive a higher benefit. On the other hand, if you take a lower-paying job for a while, that could reduce your 35-year average.
Taxes. There are several tax angles to consider.
If you stopped working, would you fall into a lower tax bracket? If so, a higher tax bracket is a cost of continuing to work. That higher rate applies to all your income, not only to the working income. You need to consider if continuing to work will impose higher taxes on investment income, IRA distributions, and any other income. A higher tax rate on that other income could be a cost of working longer and reduce the benefits of work.
Saving the salary. Most likely you would work to increase your nest egg. If so, how will you save that money? Should you put it into a 401(k) or deductible IRA, saving you tax dollars now? Or should you put it into a taxable account or Roth IRA (if you’re eligible) so that you owe lower taxes in the future when you spend the money? It’s an important decision that requires some analysis.
The key factor often is the amount of money you already have in IRAs and 401(k)s. These accounts require minimum annual distributions after age 70½ (see page four of this issue), and those distributions are taxed as ordinary income. Many people complain that as they enter their late 70s or so the RMDs accelerate, generating a lot of taxable income they don’t need. Those distributions also will increase adjusted gross income in the future, and that could trigger the stealth taxes (for examples, see page five of this issue).
The only way to limit RMDs is to limit the amount of money in IRAs and 401(k)s. Carefully consider if you are willing to pay higher taxes today by foregoing 401(k) or IRA contributions so that you might limit income taxes in the future.
Medical expenses. The biggest fear of retirees and pre-retirees is the cost of retirement medical expenses. Indeed, many people are working longer to either keep employer medical coverage or accumulate additional money to pay for retirement expenses.
When you plan to work past age 65, be sure you know how your employer coverage and Medicare are coordinated. Most employer plans require workers age 65 or older to sign up for Medicare and use Medicare as their primary insurer. The employer plan only covers gaps in Medicare. You need to know if your employer plan works that way and what the coverage gaps are in both Medicare and the employer plan.
If you don’t apply for Medicare when first eligible, you are likely to pay a penalty. You’ll pay that penalty every year for the rest of your life. Most people have to enroll at age 65, even if they are working. But there are exceptions for people covered by some employer plans. When you plan to hold a job after age 65, you need to know how that will affect your status under Medicare and your enrollment requirement. You can find more details in our November 2012 visit.
