Mom and Dad told us working was a good thing. It may not have seemed like it as kids when they were trying to turn us into fully functioning, responsible adults. But later in life, we discovered it was true.
Working gives a sense of pride and accomplishment. It makes us independent. Many older Americans continue to work during retirement for those reasons, as well as being able to contribute from a lifetime of experience, having social interaction with other people, or just having something to do. But without advance knowledge and planning, that paycheck may create some unpleasant consequences.
Taxes on Social Security
There is a long-standing myth that Social Security benefits are not taxed. And that’s what it is—a myth. If you work during retirement and the amount you earn along with other sources of income pushes you past income thresholds set by the Social Security Administration you will be taxed on your Social Security payout. For 2021 you will be taxed:
- If you’re single and your combined income is between $25,000-$34,000 you’ll have to pay income tax on up to 50% of your benefit.
- If you’re single and your combined income is more than $34,000, you’ll pay income tax on 85% of your benefit.
- If you’re married filing a joint return and combined income is between $32,000-$44,000 you’ll pay income tax on up to 50% of your benefits.
- If you’re married filing jointly and combined income is above $44,000, you’ll pay income tax on 85% of your benefit.
Social Security defines combined income as adjusted gross income plus nontaxable interest plus one-half of your Social Security benefits.
Having some Social Security benefits taken back
Who thought working and earning money could be hazardous to your financial health? The Social Security Administration doesn’t mind you earning some money, they just don’t want you to earn too much.
If you started taking Social Security before your Full Retirement Age (FRA), which for most people today is between 66-67, you’re allowed to earn a specified amount. Go over that amount and the SSA starts taking back part of your Social Security benefit. In 2021 you can earn $18,960. Go over that threshold and SSA takes back $1 for every $2 you earn over the limit.
The good news—once you reach your Full Retirement Age (FRA) you can earn as much as you can or as much as you want and there is no reduction of your Social Security benefit.
Higher taxes on retirement plan distributions
One question to ask is whether the extra income from your retirement job will push you into a higher tax bracket. If so, you’ll be paying more taxes on distributions from Traditional IRAs and on retirement plans like 401(k)s and 403(b)s. Distributions from all three are taxed as ordinary income, not the lower capital gains rate.
That doesn’t apply to distributions from Roth IRAs. Once you hit 59 ½, those distributions come out tax-free and are not subject to income tax.
Maybe the reason to work in retirement, besides the paycheck, is to have continued health insurance. If the employer has a qualified health plan, no problem. Once you leave that employer, you have eight months to sign up for Medicare without any penalties.
But if the employer health plan is nonqualified, meaning a plan that covers less than 20 employees, and you don’t enroll in Medicare when you’re 65, you will be accessed penalties that last the rest of your life.
For example, if you didn’t sign up for Medicare Part B when you were 65, you’ll pay a 10% penalty on the Part B premium for every 12-month period you were eligible for Part B but were not enrolled.
If you didn’t enroll in Part D prescription drug coverage at 65 and later do sign up, you’ll be charged a 1% late enrollment penalty for every month you could have had Part D but did not.
There is a seven-month window to enroll in Medicare Parts B & D—3 months before the month you turn 65, the month you turn 65, and three months after the month you turn 65.
Working in retirement can be a good thing for lots of reasons besides the income. Make sure the income really is a benefit and not a hindrance.