Should You Work in Retirement?

Thinking of working a bit longer and delaying your retirement? Mind the pitfalls. True, postponing retirement can have its advantages -- you can delay tapping your 401(k) nest egg and may even add to it while you're working.

But you can run into problems if you begin collecting Social Security checks or taking withdrawals from some tax-deferred retirement plans while you earn a paycheck. Generally speaking, overstaying your welcome at work could have some serious health care, Social Security and pension ramifications. Consider these four factors before signing on for another year.

Income Tax

One of the most common caveats would-be retirees frequently fail to consider is that staying on the job an extra year might bump them into a higher tax bracket.

"People forget that any extra distributions or benefits they receive on top of their salary also count as income," says Kevin Seibert, managing director of the Lubbock, Texas-based think tank, the International Foundation for Retirement Education. "It's taxable, just like their regular salaries."

Working seniors can find themselves in a higher tax bracket in one of two ways -- by taking pension distributions on top of a regular salary or by taking Social Security benefits while they continue working, Siebert says.

Employees can easily sidestep the first pitfall by educating themselves on how close their current income is to the next tax bracket, and if their retirement plan has a mandatory distribution date. While employees who use a 401(k) plan as their primary retirement vehicle have the freedom to delay their distributions until after they officially leave the company, those enrolled in traditional IRA plans must start taking distributions no later than age 70½, whether or not they're still drawing an annual salary.

"In that case, it might make sense to plan ahead a little and start taking smaller distributions earlier to avoid being thrown into a higher tax bracket," Seibert says. "It doesn't make sense to start taking your retirement if you're going to pay it back in taxes."

A new law gives retirees a break from having to take a required minimum distribution from their IRAs in 2009. Many seniors experienced big losses in their IRA accounts in the recent stock market downturn, prompting lawmakers to waive distributions for this year only.

Taking Social Security benefits before you leave the company can have the same effect, says Yolanda M. York, a spokeswoman for the Social Security Administration. While single filers with total adjusted gross incomes of under $25,000 per year ($32,000 for married couples filing jointly) for the 2009 tax year won't have to pay income tax on their Social Security benefits, those earning more can lose up to 85 percent of their benefits to income tax alone.

"A lot of people don't realize Social Security benefits are taxable," York says. "That's important when deciding whether to delay retirement."

Social Security Benefits

Ken Steele, a Metlife senior financial planner based in Waltham, Mass., says that income tax isn't the only place where working seniors can lose money. Those who sign up for Social Security before the government-designated full retirement age will probably have their benefits withheld if they're also earning salaries.

"With Social Security, you're only allowed to earn about $14,160 (in 2009) before you start giving back $1 of Social Security for every $2 you earn," says Steele. "If people aren't mindful of that, they're going to lose a lot of money."

That means that workers who are eligible for Social Security benefits (beginning at age 62), but under full retirement age (65, 66 or 67 depending on the year of birth) who draw, say, $1,000 per month in Social Security benefits, will have their entire benefits package withheld for a year if their annual salaries exceed $38,160. While it's not a permanent loss -- the Social Security Department will repay all withheld benefits in monthly increments after you officially leave the working world -- those relying on a fat check from the government may have to work with a significantly reduced one while they stay on the job.

Those who attain full retirement age in 2009 (but not until later in the year) have a much higher income threshold before benefits are withheld. According to the Social Security Administration Web site, these workers can earn $37,680 in 2009 ($3,140 per month) without penalty, after which $1 of Social Security will be subtracted for every $3 of extra income until the month they reach retirement age. Workers who don't collect Social Security until after the government-designated retirement age won't be subject to income restrictions at all, and "passive income" gained from sources such as investments or rental properties don't count in the formula either.

To avoid losing Social Security to either income tax or through withheld benefits, York advises those planning to stay on the job past the prescribed retirement age to delay taking their Social Security for as long as possible. The longer you wait, the higher the monthly payout because it's based on your projected life span, which of course gets shorter as you get older.

"Your benefits will increase automatically each year until the age of 70," York says. "If you continue working, you can get the most out of your benefits by waiting until then." At age 70, the payment to which you're entitled is maxed out, so it makes no sense to delay beyond then.

To figure out exactly how much your income will impact your Social Security benefits, check out the SSA's online Retirement estimator.

Pension Benefits

Stick around long enough and you might be rewarded with a stagnant or even reduced pension plan, says Richard Johnson, principal research associate for the Urban Institute, a Washington D.C.-based nonprofit that studies social and economic issues.

"In a lot of pension plans, especially defined-benefit plans, your benefits are computed based on a set number of years of service," Johnson says. "If your plan maxes out at 30 years and you work past that number, you're not going to get any additional pension benefits for that last year."

While an extra year's worth of salary will benefit potential retirees far more than losing a year of pension benefits, Johnson adds that in some cases, workers who stay past their prescribed retirement age risk lowering their overall pension benefits.

"In some plans, the benefit is a percentage of earnings during the last years of service, so if you reduce your hours or have lower earnings during your last few years, you could actually reduce your pension benefits," Johnson says. "Before you stay an extra year, you want to make sure your benefits aren't going to go down."

Rather than sticking with a job that will freeze or lower pension benefits, a smarter move may be to max out years of service with one company, get a fiscally comparable job with another company, and then start drawing your pension benefits as well as a new salary, (though be mindful that the new salary and pension benefits may bump you into a higher tax bracket).

Before deciding to stay an extra year, workers should go over their pension plans with a knowledgeable human resources representative and tax adviser to carefully evaluate whether staying on could cost them retirement cash.

Health Care Options

So you're finally old enough for government-subsidized health care. Congratulations! Those who continue working past the age of 65 have the option of Medicare, their company-sponsored health care plan, or a combination of both. While more health care options (and two monthly health care premiums) should translate to fewer out-of-pocket medical expenses, MetLife's Steele says that workers who enroll in Medicare and a company-sponsored plan can actually wind up paying more.

"As soon as you turn 65, your health insurance company is going to try to make Medicare your primary provider," says Steele. "You have to be careful of that. Whereas certain treatments or office visits were covered in full with your corporate plan, they may not be covered under Medicare. You could also have higher deductibles and co-pays."

Many workers over 65 opt for two health care policies -- Medicare combined with a supplemental company-sponsored insurance plan. Yet the company-sponsored plan alone might be better. For example, workers who enroll in Medicare Part D, the prescription drug plan, can get up to $2,700 worth of prescription drugs covered before a "coverage gap" starts, requiring plan holders to pay for prescriptions out of pocket until the end of the year or until "catastrophic coverage" kicks in -- when costs reach $4,350 or more. Workers who stay enrolled in the regular company-sponsored health care plan without Medicare might have those costs covered, but those who switch to Medicare plus a supplemental insurance plan could wind up paying out of pocket.

"It's very possible that two health care plans can give you less coverage than one," Steele says. "Workers eligible for Medicare need to figure out which health care insurance option works best before staying in the job."

The trick to finding the right time to step out of the work force is to weigh the trade-offs of tax, pension and insurance pitfalls against the benefits of an extra year of income, Seibert says. "Most people are going to benefit from staying in the work force longer, but it's crucial to make as informed a decision as possible," he says. "They only have one chance to get retirement right."