Since the Great Recession, the number of retirees working part-time in retirement has skyrocketed.1 Faced with diminished 401(k) plans and the prospect of increasing retirement costs over expanding life spans, many retirees were left with no other choice. But, even as 401(k) plans are recovering, many retirees are simply not willing to trade in a lifetime of work for a new lifetime of leisure. Whether it is a fear of boredom or a desire to maintain their wellness, a majority of retirees are opting to continue working at least on a part-time basis. However, working in retirement can create some complications which could end up costing you more than it is worth. The decision to work in retirement needs to be considered in the context of your financial situation along with all of its ramifications.
Working in Retirement Can be Very Taxing
A big mistake many working retirees make is not understanding how the extra income will impact their tax situation. Retirees who receive pension benefits or who start taking withdrawals from a defined contribution plan could easily find themselves in a higher tax bracket once they start receiving earned income from a part-time job.
Required Minimum Distributions
Some retirees may try to get around that by delaying their withdrawals from their defined contribution plans. While it may seem like a good idea to delay withdrawals from a 401(k) or IRA, it increases the likelihood you will be forced to withdraw more than you need when the Required Minimum Distribution (RMD) rule kicks in. RMD requires that you begin taking withdrawals at a minimum rate when you turn 70 ½. If you take out less than the required amount, you will not only pay taxes on the amount not withdrawn, you will also pay a 50% penalty.
Higher Capital Gains Tax
You could also end up paying a higher capital gains tax rate. If you are in the 10% or 15% tax bracket, you pay 0% capital gains. But, if your additional income bumps you up to the 25% tax bracket, you would pay a 15% capital gains tax. That could be especially taxing if you rely on the sale of assets for any of your income.
Social Security Tax
If you are receiving Social Security benefits while you work, a portion of your benefits could be taxed. The IRS combines your income from a number of sources, including earnings, dividends, capital gains, retirement account withdrawals as well 50% of your Social Security benefits, to determine the taxable portion of your Social Security benefits. For a married couple filing jointly, a combined income from those sources of $32,000 or more, up to 85% of their benefits are subject to income tax.
Reduced Social Security Benefits
Although you are allowed to receive Social Security benefits while you are working, depending on your age and the amount you earn, you could lose some of your benefits. If you retire before your full retirement age, your benefits will be reduced by as much as 30% depending on when you were born. In addition, if you earn more than a certain amount, $1 in benefit payments will be deducted for every $2 you earn above the annual limit. In 2017, the annual earnings limit is $16,920. After your full retirement age (66 for people born between 1943 and 1954), you can earn as much as you want and your benefits will not be reduced; however, you still need to be wary of the Social Security tax.
Planning Ahead can Keep You Out of Trouble
There are a number of planning steps you can take to avoid these pitfalls. Knowing your tax situation, when to take Social Security benefits and the best time to start taking retirement plan withdrawals is key to optimizing your retirement income. Your financial planner is best positioned to help you understand the impact your part-time work will have on your retirement income so you can make informed decisions on each step of the way.
1More Older Americans are Working, and Working More. Pew Research. June 20, 2016