In the past, people’s work lives ended when they retired. Today, that’s not always the case. According to a 2018 Harris Poll study, 72 percent of today’s workers are looking forward to semi-retirement rather than leaving the workforce cold turkey.
Why is semi-retirement so appealing? For some people, it means a smoother transition into retirement. For others, it’s a chance to pursue a different career or job, and often without a need for significant income. And, working fewer hours or possibly picking and choosing your hours is another plus. So, what’s the best way to prepare?
In semi-retirement, most people work less hours or, at least, have more flexibility. This generally means less earned income. For this reason, if semi-retirement is a possibility, start planning one to two years in advance.
Where to begin? Knowing how much you will need to cover living expenses during your semi-retirement years is critical. Once this is determined, establishing an emergency fund equal to three to six months of anticipated spending is recommended.
Not only will you generally have less pay, it is also important to consider how semi-retirement may impact your typical employee benefits. You may have to forfeit benefits all together or accept a reduced version. What will this mean for your living expenses? Most likely, they will increase.
Health insurance can be a large, added expense for those going off company benefits before Medicare kicks in at age 65. You may also lose eligibility to participate in an employer retirement plan. The cost of health insurance and the lost pre-tax savings opportunity, as well as other employee benefits, may have an impact on your standard of living.
Don’t Touch those Retirement Accounts!
Semi-retirement can be an excellent opportunity to allow your retirement funds to continue growing prior to full retirement. If you’re able to meet your current living expenses with the income earned during your semi-retirement years, it may not be necessary to access money from an IRA, 401(k), or other retirement accounts.
Delaying withdrawals from retirement accounts can be helpful for several reasons. First, if you begin your semi-retirement before age 59 ½, it can be costly to withdraw funds from retirement accounts. Ordinary income tax as well as an early withdrawal penalty of 10% will be assessed in most cases to distributions from a traditional IRA, 401(k), or 403(b).
For example, let’s say you are age 56 and need $5,000 from your IRA to cover an upcoming expense. The $5,000 withdrawal from your IRA would be included as income on your tax return and taxed at federal and state tax rates. The 10 percent penalty would also apply, causing an extra $500 payable to the IRS. (Note: There are special rules that allow you to withdraw money penalty free prior to age 59 ½ if you are eligible, but should be considered only if it fits your long-term situation.)
Penalties aren’t the only reason to avoid withdrawing funds during semi-retirement. Your money enjoys pre-tax investment growth while it remains in your retirement account. This means interest, dividends, and realized capital gains are not subject to tax. The longer your funds can stay in these tax-deferred accounts, the longer they continue to grow tax-free!
Social Security & Semi-Retirement
“When should I begin taking Social Security benefits?” This is a question financial planners often hear. As a semi-retiree, that question can prove even more complicated.
The earliest you can begin taking Social Security retirement benefits is age 62. However, if you take benefits prior to your full retirement age (FRA) - the age at which you are first entitled to unreduced benefits - your Social Security payment is permanently reduced based on the number of months that you started before then.
To make matters worse, benefits are also reduced for those who start Social Security before full retirement age and still have earned income. In 2019, the limit on earned income is $17,640 per year. Your Social Security amount will be reduced if you earn more than the annual limit prior to your FRA. If this is the case for you, it may make sense to delay Social Security benefits until you are fully retired.
So, what’s the key to a successful semi-retirement? Plan ahead! Get a good grasp on your current and future expenses. Avoid tapping into retirement accounts and make informed decisions about Social Security. Don’t hesitate to include your financial advisor when developing your semi-retirement strategy. Here’s to a smoother transition into full-time retirement!