Working in retirement, is it worth it?

Written by Gillian McCarthy, CFP®

Retirement is changing; the trend of working in retirement is on the rise for many reasons. We all know retirement income must be planned for and planned out accordingly. However, what if retirement happens in stages? The increasing trend of working in retirement raises the stakes of the answer to this question. Continuing to work while collecting Social Security may alter your benefit and affect your tax consequences. Understanding the impact will help you decide if continuing to work is truly worth it.

Coordination is key in retirement

In retirement, your income will come from multiple sources. Social Security is a crucial source and must be supplemented, whether it be with investment income, pension income, or distributions from retirement accounts. Coordinating these streams is vital to maximizing the longevity of your accounts. The question of when you should tap into Social Security is one of the first questions you’ll need to address. To begin answering the timing question, start here.

If you are phasing into retirement, things get a bit more complicated. Let’s start with defining what matters. Your age plays a role in when you hit your ‘full retirement age.’ Full retirement age (FRA) refers to the age you will receive 100% of your Social Security benefit. If you collect before that age, you will be penalized. If you collect later, you will be rewarded. If you are born between 1943 and 1954, your full retirement age is 66. For every year after 1954, your full retirement age is increased by two months. If you were born anytime in 1960 or later, your full retirement age is 67.

Age is just one of many numbers

Timing your retirement with your full retirement age matters because you will be penalized if you begin to collect Social Security early but continue to work. If you decide to retire from your career early, later taking on some part-time work, watch out! Your Social Security benefit will come with an earnings cap of $22,230 (2024) when you begin to collect Social Security before your full retirement age. If you earn more than $22,230 in a year, then your Social Security benefit is reduced by $1 for every $2 you earn over that limit.

To complicate the situation, in the year you reach your full retirement age, you will have a higher cap on your earnings. The cap is $59,520 for those entering their full retirement age in 2024. This cap tends to increase each year. Before your birthday month in the year you reach your full retirement age, your benefit will be reduced by $1 for every $3 you earn over that limit. This year is unique, to allow flexibility and encourage those who are able, to continue to work right up to their full retirement age.

What counts?

The Social Security Administration considers your salary or wages from an employer as your ‘earnings.’ Other income such as pension income or investment earnings does not come into play. Again, timing is crucial; these earnings are counted when you earn them, not when they are paid out. For instance, if you receive five vacation days and three sick days in 2022 that are then to be paid out to you in the following January of 2024, they count in the year they are earned 2023, not the year they are paid out. Keep track of ancillary pay that could put you over the earnings limit before you realize.

Spoiler alert ahead

Causing your Social Security benefits to reduce by working seems to be a clear-cut deterrent on continuing to work in retirement. Well, you actually can have your cake and eat it too, sort of. Yes, it is true that collecting Social Security before your full retirement age and continuing to work will reduce your benefits, but this is temporary. Spoiler alert, once you hit your full retirement age, your benefits will be increased, offsetting your previously reduced benefits.

How does that happen?

At your full retirement age, your Social Security benefit will be recalculated. The recalculation will look at the months you worked, and your benefits that were reduced while you were working. Your 35 highest paying years will come into account in the recalculation as well. If you were experiencing some of your highest paying years while collecting Social Security before your full retirement age, your benefit would automatically be adjusted to include those years; the result will very likely be an increased benefit.

Don’t forget the taxes while working in retirement

There is one more limit to watch out for if you are working and collecting Social Security retirement benefits. Your Social Security benefits will become taxable depending on your level of income in addition to your benefits. As a couple, married filing jointly, if your combined income falls between $32,000 and $44,000 then you will be looking at a tax bill on up to 50% of your Social Security retirement benefits. Up to 85% of your Social Security retirement benefits will be taxable if you are making more than $44,000 while working.

What if….

Let’s take a look at an example. Joe retires at 62 (his FRA is 66) due to minor health issues. He begins to collect Social Security at age 62, before his FRA. He intends to obtain a less physically intensive job a few years into retirement to supplement his income and plans to earn $50,000 annually. Let’s look at the impact year by year.

The first, second, and third year of retirement, (ages 62 through 64) Joe is fully retired and has no earnings. He is collecting his reduced Social Security benefit because he is collecting before his full retirement age.

The fourth year of retirement, age 65, Joe begins to earn a salary of $50,000. His new earnings decrease his Social Security benefit by $13,880. This is because the Social Security administration deducts $1 from Joe’s benefit payment for every $2 he is earning over the yearly limit, which is $22,240 (2024). Joe is earning $27,760 over the annual threshold. From a tax perspective, 85% of Joe’s Social Security benefit will be taxed, assuming he is married filing jointly. For more on how to reduce taxes in retirement, please take a look at our blog post on the topic.

In Joe’s 5th year of retirement (age 66, year turning FRA) he again earned $50,000. His earnings this year will not cause a reduction in his Social Security benefit. Remember the earnings limit on the year turning your full retirement age increases to $59,520 (2024). Again, 85% of Joe’s Social Security benefit will be taxable.

At age 66 (Joe’s full retirement age) his benefit is recalculated to credit him the benefits that were deferred while working. Joe’s second career certainly complicated his tax situation and Social Security benefit planning. In his simplified case, the benefits of working in retirement outweighed the negatives. Joe was able to earn a salary that allowed him to reduce his withdraws from his retirement accounts during those years. All of the reduced benefits will be returned to him as soon as he reaches his full retirement age.

In summary

This decision can become complicated, very quickly. There is no golden rule to follow in all scenarios. In most cases, if you are earning some of your highest wages between ages 62 and your full retirement age, it would not be in your best interest to collect Social Security early. If you are considering a part-time gig during these years, do not be afraid to weigh your options, the decision may not be a clear cut answer.