When is the right time to retire?
We spend decades saving for a financially secure retirement, so when the time comes, it can be exciting, emotional, and a little bit scary. It’s a big decision to decide when to retire, because all of these emotions in addition to some serious financial considerations are at play. And in addition to carefully planning when you will retire, it’s also important to determine the best time of the year for quitting work.
The specific date on which you start your retirement could impact several different factors that affect your retirement finances. These include benefits from your former employer, Social Security distributions, and taxes to name a few.
Here are 7 factors to consider as you plan the best time of the year to start your retirement.
1. Do you have a pension?
If you work for the government or an employer that offers a defined benefit pension plan, it might be smart to retire on the day that follows the anniversary of your first day working there. This way, you’ll receive an extra year of service credit toward the calculation of your pension benefits.
2. Have you saved up any cash reserves?
Some advisors recommend saving enough money in a liquid cash account to cover the first few years of living expenses after you retire. Then you won’t have to tap into your retirement accounts if the market is down at the time when you begin your retirement.
However, if you don’t have any cash savings and will need to start withdrawing money from your retirement account as soon as you retire, you might consider retiring either very early or very late in the year. This could allow you to avoid making retirement account withdrawals in a year when you might have earned income that would push you into a higher tax bracket.
3. Are you retiring early?
The age of 65 has long been considered the unofficial retirement age, but many people are deciding to retire sooner than this. If you plan to retire early, remember that you will be assessed a 10 percent penalty on withdrawals you make from a traditional IRA or 401k before you reach age 59½.
So if you will turn 59½ at any time during the year you plan to retire, you should wait until after your birthday to retire and begin taking distributions from these accounts in order to avoid this early withdrawal penalty.
In 2020, there are some exceptions to this due to the coronavirus stimulus, or the CARES Act. Individuals who would normally incur the IRS’ 10% penalty on early distributions are exempted for ‘coronavirus-related distributions’ of up to $100,000 of distributions in 2020. While the 10% penalty is waived, distributions may still be considered as ordinary income. This ordinary income can be spread over 3 tax years, lowering the tax impact. Individuals also have 3 years from the date of the distribution to repay all or a portion of the distribution taken if they so choose.
4. Will you have to take required minimum distributions (RMDs)?
Beginning in January of 2020, the recently passed SECURE Act will pushed the age at which individuals are required to begin withdrawing money from their retirement accounts back from 70.5 to 72. Additionally, the bill allows working individuals to continue to contribute to their traditional IRAs past the age of 70.5.
These changes will only come into play for those that will turn 70.5 on or after January 1, 2020.
Due to the CARES Act, Required Minimum Distributions may be suspended for 2020, allowing individuals to defer taking distributions from retirement accounts if desired. For those who’ve already taken Required Minimum Distributions in 2020, they may actually be able to return those funds to their IRA and push any further distributions into 2021.
5. Will you work on a part-time basis after you retire?
Many people today are choosing to work part-time or earn money as a freelancer or contractor after they retire. If you work part time and elect to start receiving Social Security benefits before you reach the full retirement age (FRA) for receiving Social Security benefits — which is between 66 and 67 years old, depending on when you were born — your Social Security benefits will be reduced if you earn more than $1,470 per month in 2020.
More specifically, $1 of your Social Security benefits will be withheld for every $2 you earn above this threshold. This calculation is known as the Social Security earnings test.
If you’re retiring before reaching FRA but expect to earn more than $1,470 a month in income, and you will reach FRA sometime during the year you plan to retire, you should probably wait until after your birthday to retire and claim Social Security benefits. This will enable you to avoid the reduction in your Social Security benefits due to the earnings test.
6. Do you have accrued vacation pay?
If you have accrued a significant amount of vacation pay at your employer, find out when they will pay you this money. Since this pay will be considered earned income and thus subject to the earnings test, you might want to wait until after you’ve received the funds to retire and apply for Social Security benefits.
7. Will you turn 70 years old during the year?
By waiting until after you reach FRA to begin collecting Social Security benefits, you can increase the amount of your monthly payment when you do eventually start claiming benefits. But this is only the case up until age 70, at which time the increases stop.
So if you will celebrate your 70th birthday at any time during the year you plan to retire, you should consider retiring and filing for Social Security after your birthday. After you reach 70 years old, you won’t receive any additional benefit by waiting longer to retire and receive Social Security.
Our Take: When is it the Right Time to Retire?
There are lots of factors that go into deciding the best time of year to retire. Talk to your financial and tax advisors for more detailed guidance in your specific situation. Personal Capital advisors can guide you in these and other important decisions when it comes to your retirement. To learn more about our wealth management services, click here.
Our Retirement Planner tool will also help you plan for various scenarios when it comes to retirement to see how it will impact your chance of success. Using the Retirement Planner, you can see how retiring at different times will impact your planning.