Uncle Sam Giveth, and Taketh Away

Returning to work after an early retirement may mean a smaller social security check, while staying on the job longer will net you more. Plus, the rules for taxing your benefits.

By Cameron Huddleston, Contributing Editor, Kiplinger.com

October 22, 2003

A decision to go back to work or stay on the job longer will affect the amount of social security benefits you receive and the taxes you pay on those benefits.

Basically, the longer you stay the job, the more you'll receive on a monthly basis. The earlier you retire, the less you'll receive. And if you return to work, your benefits will be cut even more.

More than half of retirees choose to start receiving social security benefits at 62 (the earliest age you can start collecting retirement benefits). But if you choose to go back to work between the ages of 62 and 65, you'll lose $1 in benefits for every $2 you earn above $11,520. In the year you reach full-retirement age (65 and two months in 2003), you'll lose only $1 in benefits for every $3 earned above $30,720.

But a recent change in the law enables retirees to work past full retirement age and not worry about a reduction in monthly benefit payments. And because social security benefits are based on the top 35 years of earnings, working a few years longer could mean bigger social security benefits for the rest of your life.

For each year you delay retirement until age 70, you get a credit that will increase your payments by 6.5%. So if you wait until 70 to start collecting benefits, you will earn enough credits to boost your monthly checks by 32.5%. But waiting that long to retire may not be a good idea for everyone either.

For example, if you're 61 years old in 2003 and currently earn $50,000 per year, you could get up to $1,332 per month if you take benefits at your full retirement age (65 and 10 months) or $1,865 if you wait until age 70.

Sounds great, right? It could be if you have a long life expectancy or your spouse is significantly younger than you (and likely will live long after you die). But remember, you'll miss out on more than four years of $1,332 payments, which would come to nearly $64,000. It would take at least ten years for the larger $1,865 payments to make up that difference. In other words, you'll have to live to be 80 years and four months old to break even.

For most people the best option is taking benefits at the full-retirement age. You could continue to work and invest your current social security payments to help supplement benefits later on. The better your investments do, the more likely you are to come out ahead by getting a jump-start on benefits.

Calculators on the Social Security Administration Web site can help you crunch your own numbers and devise a plan that's right for you.

Watch out for the tax bite

Whether you pay taxes on social security benefits depends, in large part, on the other income you receive. Working in retirement could make your benefits more vulnerable to taxes.

Taxes on social security benefits are based on your combined income -- your adjusted gross income plus any tax-exempt interest plus half of your social security benefits.

If your combined income exceeds $34,000 ($44,000 married filing jointly), up to 85% of your benefits will be taxed. See the table below:

For more information on taxing your social security benefits, as well as a worksheet to help you figure your tax, see IRS Publication 915, "Social Security and Equivalent Railroad Retirement Benefits."

Your prime goal in retirement shouldn't be avoiding taxes on social security benefits, says Nancy Flint-Budde, a financial planner in Clifton Park, N.Y. Your goal should be to have enough money, she says. Nonetheless, there are strategies that might help you avoid some of the tax bite on benefits.

Flint-Budde says she encourages clients not to put all of their retirement savings into qualified plans such as 401(k)s and IRAs. Money withdrawn from these accounts is considered income, on which taxes on social security benefits are based. Instead, she recommends investing directly in mutual funds and dividend-paying stocks. Capital gains on these assets aren't figured into combined income and, thus, don't increase the chance your social security benefits will be taxed.

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