One scenario we often encounter when financial planning for couples is when one spouse chooses to retire early while the other spouse continues to work. While the couple may have sufficient assets that allow one spouse to retire, there are still several moving parts to the financial planning equation that should be considered.
Regardless of when you retire, seniors are not eligible for Medicare until age 65; therefore, health care can be an important issue. HealthView Services estimates for a healthy 65-year-old couple retiring this year, the projected out-of-pocket costs for health care throughout retirement is estimated to be around $321,944. This figure doesn’t include deductibles, copays, dental care or long-term care. Knowing you will likely face similar costs, you may want to evaluate all available options to try to minimize your health care costs when retiring early. If the working spouse has health care coverage through an employer, the retired spouse should be able to obtain coverage through that plan. Another option to consider could be to find a part-time job that will provide health coverage benefits; however, employment could affect the amount of the Social Security benefit.
When you take Social Security benefits before your full retirement age, benefits can be reduced by up to 30%, depending on how early you begin taking your benefits. Your benefit can be even further reduced by $1 for every $2 you earn above $16,920 (in 2017). For example, let’s say your monthly Social Security benefit at full retirement age of 67 is $2,600. If you retired early at age 62, your benefit would be reduced by 30% to $1,820. Now, let’s say you decided to work part-time consulting for your old firm and earned $20,000 a year. You would be earning $3,080 over the limit. Your Social Security benefit would then be further reduced to around $1,691.
Instead of working, you may choose to withdraw needed assets from your retirement accounts. If you have an IRA or 401(k), assets in those accounts are generally tax deferred, meaning they are taxed at ordinary income tax rates when you withdraw them. IRA income will not count toward Social Security benefit forfeiture; however, it can result in some of your benefits getting taxed. Taxes on Social Security benefits are calculated using provisional income, which is calculated starting with your gross income not including your Social Security benefits. This includes Traditional IRA and 401(k) withdrawals. You then add any tax-free interest you received, such as interest from a municipal bond. Finally, you add 50% of your Social Security benefit to derive your total provisional income. If this is more than $44,000 for married couples filing jointly, up to 85% of your Social Security benefit is taxable.
Generally when one spouse retires early, it is quite difficult to avoid taxation all together. Furthermore, possible financial moves depend on your overall financial situation. If you have substantial assets in your retirement accounts, you may choose to use those assets to fund an early retirement and delay Social Security benefits until age 70. If an early retirement puts you and your spouse into a lower tax bracket, you may look to convert some of your Traditional IRA assets to a Roth IRA, opting to pay the taxes now. This could also reduce your IRA balance, thus decreasing the required minimum distributions you will have to take once you reach age 70 ½.
If an early retirement is something you want, most investors could benefit by talking to a financial planner and work through cash flow projections to see the potential effect of each scenario. If you would like to know how an early retirement will affect your situation, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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