According to a recent AARP survey of baby boomers, four out of five members of that generation plan on working after they retire from their “real” jobs. Some will do so out of necessity — to make up a shortfall in savings, for instance, or to patch together some health insurance coverage until they turn 65. Others will do so for more intangible reasons: to bolster their self-esteem, to learn a new skill, to continue to feel vital.
No matter what their motives, sexa- and septuagenarian clients have more to consider than whether the free coffee makes up for the heavy lifting required by that job at Wal-Mart. Here's how you can help them realize the tax, Social Security and financial benefits of their labor, while avoiding the pitfalls.
Get A Job
Waiting is the hardest part
If earning a few extra bucks helps a 60-something-year old delay taking Social Security, it can boost the amount he gets per month when he does finally begin receiving a check. That's because the benefit is based on an average of the highest 35 years of an individual's work life. So adding more high-paying years can help. According to the Social Security Web site, today a 62-year old's prospective monthly stipend grows by 8 percent for each year past the full retirement age he puts off initiating the payment stream (you can find a client's full retirement age at www.ssa.gov/pubs/ageincrease.htm). In other words, if he were to get $1,000 per month today, he will get $1,440 by waiting until he turns 67 — and over $1,800 if he can hold off until he hits 70.
Gimme shelter — from taxes
A dollar saved is a dollar earned — and a dollar earned will let some clients hide two saved dollars from future taxation. Let's say you have a client with money sitting in a checking account, and he earns $4,000 this year: He can transfer $4,000 from the taxable checking account to a Roth IRA for himself, plus another $4,000 to a spousal Roth IRA if he's married. This move will shelter $8,000 from generating any taxable income in the future. But the savings don't stop there: His low income allows him to qualify for the Saver's Credit — a reduction in his income tax bill of up to 50 cents for every dollar he and his wife put into any retirement plan (maxing out at $2,000).
A tax-free Roth IRA conversion?
The Saver's Credit can also give IRA owners a big reduction in income taxes today and tomorrow. Let's say the hypothetical client above also has a good sum in an IRA: Now he can convert several thousand dollars from his IRA into a Roth IRA and use the credit to offset the income tax that would normally be due on such a conversion. Keep in mind the Saver's Credit is scheduled to expire after 2006 — so clients wishing to “work and convert” should act fast.
Or Stay at Home
But rejecting the golf course for the office is not without its drawbacks. In addition to enduring the normal problems of a working stiff, your employed clients could be in for a nasty surprise from the government — especially if they've already put in for Social Security benefits.
More work, less money
Watch out if your clients supplement their Social Security checks with part-time work, at least while they are under their full retirement age. If the clients are under the full retirement age and earn more than $12,000 — the amount at which benefits begin to be cut back — they will lose $1 for every $2 over the maximum. If they are at their full retirement age, they'll still lose $1 for every $3 over the limit they earn. Say a man turns 63 this month and is collecting $1,500 per month in Social Security: If he earns just $20,000 this year from employment, his monthly check will be reduced by over $300; if he earns $40,000, the $1,500 will be reduced to a little over $300.
Funny, I don't feel rich
Even pensioners of moderate means who work after reaching full retirement age can be put into a tax bracket that was once reserved for CEOs and NBA power forwards. The Center for Retirement Research at Boston College estimates that the implicit tax rate of typical working 70-year olds will approach 50 percent if they are also collecting Social Security. How can this be, you ask, when the current top tax bracket at the federal level is 35 percent applies to income over $326,450? Because in 1983 the government made half of Social Security benefits subject to income tax if the individual's modified adjusted gross income (MAGI) exceeded $25,000 ($32,000 for couples). Then in 1993 Congress deemed 85 percent of the Social Security checks subject to tax if the retiree's MAGI was over $34,000 ($44,000 for couples). So let's say a married couple has an income of $60,000 and is getting another $18,000 in Social Security benefits: Since they are in the 25 percent tax bracket, earning another $1,000 would normally cost them $250 in federal taxes. But since 85 percent of their Social Security payments are now also subject to taxes, the real tax bill is $462.50 — the original $250 plus 85 percent of the same $1,000 taxed at 25 percent ($1,000 × .85 × .25 = $212.50). One thousand dollars of earnings is taxed at 46.25 percent — and that doesn't include state or local income taxes. To add insult to injury, the government has conveniently forgotten to raise these limits up for inflation, so each year millions of unsuspecting middle-income grandmas and grandpas are ensnared in an upward-spiraling tax web. You can help your clients calculate how close they are to the “danger zone” by looking up Publication 915 at www.irs.gov.
The facts, then, boil down to this: If a client is already receiving Social Security, he should think long and hard about going back to work.
As with many things financial, a little bit of planning goes a long way.
Writer's BIO: Kevin McKinley is a CFP and vice president of investments at a regional brokerage and author of Make Your Kid a Millionaire — 11 Easy Ways Anyone Can Secure a Child's Financial Future.