How One More Year of Work Can Transform Your Retirement

What is retirement?

The definition of retirement is “the action or fact of leaving one’s job and ceasing to work.” While most of us intend to stop working entirely by age 65, many Americans must continue working in some capacity for the rest of their lives. The harsh reality is that most Americans don’t have enough savings to stop working. Retirement is a relatively new concept that has gained popularity in the last 100 years due to increased lifespans, employer retirement plans, and the creation of social security. Historically, the average American worked their entire life with little to no savings and had to rely on the support of their families when they got too old. The modern retirement age is 65 because this is the age of 100% social security benefits, Medicare eligibility, and pensions begin paying out. Many people wanting to retire before 60 will have to deal with the challenges of an early retirement including potential IRS penalties for retirement account withdrawals before age 59½. Time is an asset in retirement planning because the more time you have to save, the longer your retirement income will last.

 How much money do I need to retire?

Most Americans assume they will retire in their late 50’s to their early 60’s, but later realize that their retirement income doesn’t satisfy their expenses or will run out. Everyone’s ideal retirement looks different because it depends on many factors including monthly expenses, earnings on savings, age of retirement, and how long your money needs to last. First consider that the average person only needs 80% of their income as an employee because they will be able to save money on payroll taxes, savings accounts, and work-related expenses. While some of your expenses will be lower, you need to budget for new expenses such as travel, medical, and anything you want to spend money on. It’s also important to have your retirement funds invested with relatively low risk to stay liquid in a market slump. If you retire at 65, you should plan to save for 25 years of retirement to avoid running out of funds early. How much money you need to retire depends on your lifestyle, what you want to leave to descendants, and your age at retirement.

Can I retire early?

Retiring before age 65 is considered early retirement and can take some planning to achieve. While never working another day in your life might not be possible, you can plan to be financially independent enough to work on your own schedule. To determine if you can retire early you first need to figure out what your life looks like in retirement. There’s no one size fits all approach to reaching your goal, but there is some helpful advice listed in the following blog https://molentax.com/6-money-goals-to-hit-by-35-50-65/. One challenge in ending your career before you turn 65 is losing your employer healthcare and not being eligible for Medicare benefits. Reduced social security benefits can be taken as early as age 62, but don’t max out until you turn 70. As discussed earlier in the article, the IRS has penalties in place for early withdrawals from retirement accounts such as a 401k although there are exceptions. The average pension plan doesn’t begin to pay out until you turn 65, but many government employees can reach full retirement quicker. You might be able to retire early, but should you?

How much do I lose if I retire early?

If you want to retire young, Chris Hogan has an excellent blog about how to do that in 7 well thought out steps https://www.daveramsey.com/blog/how-to-retire-early. To summarize this article, you should create a retirement budget, implement lifestyle changes, invest heavily, and work with a certified financial planner like our partners at Centric. I’ve already discussed the financial challenges of early retirement, but what will it cost you? According to a study by the National Bureau of Economic Research “working three to six months longer boosts retirement income by as much as increasing retirement contributions by one percentage point over 30 years of employment.” This means that you would have to increase your yearly savings significantly over many years to compensate for each year of early retirement. The study also found that delaying retirement provides more time to save for retirement, generate earnings on your accounts, maximize employer benefits, and increase social security benefits. If your version of early retirement includes working on your own schedule, you stand to lose the education and training benefits offered by your employer. Make sure you consider all the benefits you will lose before ending your career.

How is money in my retirement accounts taxed?

Money in a taxable savings account or money market account does not have to be taxed when you pull it out, but it also does not have the tax advantages of pre-tax retirement accounts such as tax-free growth. This means that any interest and dividends you earn will be taxed as ordinary income, and any gains from stock sales will be taxable. When you take out money from tax deferred accounts such as an employer 401k, a deferred compensation account, or a traditional IRA you will have to include all pre-tax contributions and earnings in your income. On the other hand, post-tax accounts such as a Roth 401k or Roth IRA can be withdrawn tax free when you turn 59½. Both have their pros and cons, so it is important to understand the best choice for you. Learn more about the subject in the following blog https://molentax.com/401k-versus-ira/.

Is my other retirement income taxable?

People tend to think social security income is not taxable, but this is a common misconception. With no other taxable income your social security won’t be taxable, and you probably won’t be required to file a tax return. However, the more taxable income you have the more taxable your social security income becomes. Profit from self-employment is taxed at your top tax bracket plus 15% self-employment tax, but not every dollar earned is taxable. The income you earn as an entrepreneur is only taxed after your tax deductions, so you should try to be as profitable as possible while taking excellent records of your expenses. I specialize in working with small business owners to accurately report their income and expenses, as well as educating them in how to avoid paying too much income tax. I am passionate about helping my clients reach their financial goals. Contact me or one of the other skilled advisors at Molen & Associates for a free 15-minute consultation to see if we are the right tax firm for you.

Austin Long
Tax Advisor, EA

 

 

 

 

 

 

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