Today, many people choose to work part-time once they retire. Doing so provides a number of benefits: it can be a social outlet, a chance to pursue a new interest, and a way to earn extra money each month. In a recent survey conducted by the AARP, nearly 40 percent of respondents indicated that they plan to work at least part-time during retirement. Many of these people expect that this income will cover their essential expenses, pay for healthcare costs, or even add to their savings.
However, there are a number of things to keep in mind about working during retirement, such as the effects on Social Security benefits and the tax liability that it can create.
The Effect of Post-Retirement Employment on Social Security
One of the biggest impacts of working during retirement is a temporary reduction in Social Security benefits. People can start claiming Social Security income once they reach 62 years of age. Once people start to claim Social Security, they are subject to a benefit reduction if they continue to work, at least until they reach full retirement age, which is either 66 or 67. Earned income in excess of $17,640 will incur a benefit reduction of 50 percent the amount earned after this limit. The limit may change from year to year. In this context, earned income includes not just wages, but also any earnings from self-employment, vacation pay, commission, and bonuses. However, this number does not include investment income or pension payments.
During the year people reach full retirement age, the cap on earned income increases to $46,920 and the reduction decreases to 33 percent of earnings above this cap. After that point, there is no reduction in benefits for working. However, this is not the end of the effect on Social Security benefits. When people reach full retirement age, the Social Security Administration will calculate the number of months of benefits that were reduced due to these earnings and then add that number of months to the age when benefits were first received. The result is a later retirement age in official records, which in turn yields a higher benefit for the future.
The Tax Implications of Working During Retirement
The other consideration when it comes to working during retirement has to do with federal tax liability. Social Security benefits are subject to federal income taxes if individuals go above a combined income threshold. This combined income may also be called modified adjusted gross income or provisional income, and it consists of adjusted gross income, nontaxable interest, and 50 percent of Social Security benefits. Individual filers get taxed on Social Security once their combined income grows beyond $25,000. Between $25,000 and $34,000, 50 percent of Social Security benefits are subject to tax. Beyond $34,000, up to 85 percent of the benefits could be taxed. For joint filers, the upper limit is $32,000 before the 50-percent rule takes effect and $44,000 before the 85-percent rule applies. No more than 85 percent of Social Security benefits can be taxed.
It may also be necessary to do some research about state taxes. Beyond federal taxes, 13 states have taxes on Social Security benefits. However, the rules and exemptions for retirees vary widely between these states. Individuals should first figure out if they currently live in one of the 13 states or plan to retire in one, and then consult with a tax professional to learn about strategies for minimizing tax liability.
It’s also important to keep in mind that people pay Social Security and Medicare taxes on any wages they earn in retirement. These taxes do not apply to pensions benefits, investment income, or money from an individual retirement account (IRA) or 401(k). No age limit exists on these withholdings, nor are there any exemptions for individuals who are already claiming Social Security benefits. However, these earnings could end up increasing a benefit. The Social Security Administration keeps track of earnings and will increase benefits, if appropriate, based on this additional income.
The Decision of When to Claim Social Security Benefits
When people plan to continue working once they retire, the big question is when to begin claiming Social Security benefits. This decision has an incredible impact on ultimate income in retirement and is just as important as a strategy for withdrawing from various retirement accounts. Often, it makes the most sense to wait as long as possible to claim Social Security benefits, especially if a job in retirement provides enough income to cover expenses. Delaying until the upper limit of payments is reached will ultimately result in the highest monthly payment and allow people to avoid some of the penalties for continuing to work while drawing on Social Security income. Maximizing Social Security payments is crucial, considering that these benefits last for a person’s entire life and are protected from inflation.