Many people would consider Margaret Haapoja's post-retirement career ideal. At 71, she has continued her longtime career of writing gardening articles published in newspapers and magazines. What's not to love about getting paid for a hobby you enjoy, covering a topic on which you are an expert?
The weed of tax complications, for one. Haapoja built her retirement savings on her writing income, and now her writing income is a factor that she and her husband must take into consideration as they calculate how much they can withdraw from her individual retirement account. They also have to look at how her income affects their net take from Social Security. "It doesn't discourage me from taking work," Haapoja says, but the situation is more complicated than she had anticipated.
More Americans than ever expect to continue working past the traditional retirement age. The 2013 Wells Fargo Middle Class Retirement study, which surveyed 1,000 middle-class Americans, found that 34 percent of this group thinks they will have to work until age 80.
But when Social Security benefits are added to your income stream, you need to factor in a fresh set of tax considerations, as Haapoja has learned. After a certain point, new earnings can push you into a tax bracket that effectively erodes some of your Social Security income, which means you might not capture the net gain from working that you had hoped. If you're close to retirement, you need to bear this in mind as you tee up an encore career.
The first step to understanding how your post-retirement earnings might pan out is to find out exactly when the Social Security Administration lets you call yourself retired. The full retirement age has been gradually rising, so even for younger baby boomers, it is no longer 65. Before your "full retirement age," any Social Security benefits you draw might be offset by an "earnings test."
Every year past your full retirement age, you are no longer subject to the annual earnings test, explains Kia Anderson, a Social Security Administration spokesperson. That is because Social Security benefits are based on your earnings history, not on your total retirement income.
The whole point of working in retirement is to add to your total income, says David Littell, who teaches retirement planning to financial professionals at The American College of Financial Services. But depending on how much you earn and related taxes, "You might not benefit tremendously from the combination of work and Social Security benefits," he says.
If you have a healthy income by Social Security standards, and also from earnings and investments, you will cross a threshold and will have to pay taxes on part of your Social Security benefits, Littell explains. How much income is too much? That is a moving target called "provisional income." Too much provisional income and up to 85 percent of your Social Security benefits are taxable. "You earn a dollar more, and that costs a dollar of your Social Security," up to a point, Littell says.
The tax fun doesn't stop there. Here are additional tax factors that affect working retirees, according to financial planners:
-- Social Security taxes will continue to be deducted from your income, regardless of the Social Security benefits you are also drawing.
-- If you are self-employed, you must pay both the employer and employee portion of FICA. Although the employer portion is tax-deductible, that only eases the pain.
-- Some states tax Social Security benefits and some do not. Where you live affects your net take from the benefits.
Fortunately, there's a way to sidestep some of this. You can work until age 70 to maximize your earnings history (thus boosting the basis for your Social Security benefits) and saving more for retirement. If you can, you can also front-load encore career income by moonlighting while still drawing a salary. Then you can see how your post-retirement career will actually work out. This strategy is recommended by both Littell and Christine Fahlund, a senior financial planner with T. Rowe Price.
By taking your Social Security benefits at the last possible point - age 70 - you will capture 8 percent more annually, Fahlund says. That extra amount can help cushion market fluctuations that might affect the value of your other retirement accounts, she points out. "Social Security is not subject to the market. The amount you get is predictable and is determined by formulas. If you retire at age 70, it's a higher baseline," she says.
Essentially, you work a few years longer and get much more. That means you will have to earn that much less from your encore career, which would mean you have to be open to the possibility of working more for personal satisfaction than for cash flow.
"Then, working becomes more of a value judgment: Is this a hobby business, or can you charge less for your work?" Fahlund says. "You have the chance to downshift."
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