Retiring is a huge achievement. It's the culmination of decades of hard work and planning. But it's also a dangerous time financially, because missteps when you're about to retire can cause regrets that will last the rest of your life. Before you retire, it's essential to make sure you understand all the financial implications of retirement so that you can be sure that your future will be secure and prosperous. Here are some things that you'll definitely want to keep in mind.
Taking Social Security
One key decision that you'll have to make when you retire -- or in some cases, even before you retire -- is when to start taking Social Security. The government allows eligible workers to take their Social Security benefits as early as their 62nd birthday, even though full retirement age is currently four years later at age 66. The trade-off, though, is that the earlier you take your retirement benefits, the smaller those payments are. If you're claiming benefits on you own work record, waiting until 70 to start getting Social Security checks will make your monthly payout more than 75% higher than if you start getting them at 62.
Once you retire, you don't have to worry about the impact of work income on your Social Security benefits. But if you're considering taking Social Security even before you retire, keep in mind that earnings above certain amounts -- $15,720 for 2016 -- can trigger the partial or total forfeiture of Social Security benefits. There's a silver lining in such cases in that the Social Security Administration gives you credit for missed months of benefits by boosting the payout amount in the future, but the short-term impact of benefit forfeiture is something you absolutely need to consider to make sure that cash flows come in the way you expect.
Planning for healthcare costs
The other key government program that helps retirees is Medicare, and most people become eligible for Medicare at 65. That can present a challenge if you're planning to retire earlier. Currently, retiring workers have some options, including signing up for coverage from healthcare exchanges under the Affordable Care Act or taking advantage of continuing COBRA coverage under your former employer's group plan. But both can be expensive options for retirees suddenly trying to live on a fixed income.
Even after Medicare kicks in, planning for healthcare costs takes some effort. Traditional Medicare covers only about 80% of eligible expenses, and some key healthcare needs aren't covered at all. Turning to Medicare Advantage plans, Medicare supplemental insurance, and prescription drug coverage under Medicare Part D are all options that you can pursue, as well as looking into whether you can stay covered under a spouse's group health plan at work. It's worth taking a close look at all your options to figure out which is best for you.
Dealing with taxes
Finally, many retirees never really understand the tax implications of their retirement finances. The implicit assumption is that once your income from work goes away, so too will your tax liability. That's true for many retirees with extremely limited financial resources, but those who've done a good job of setting aside money for their retirement will have to do some tax planning as well.
For example, withdrawals from traditional retirement accounts like IRAs and 401(k) plan accounts are generally subject to federal income tax, so if you're tapping those accounts to sustain your spending at levels similar to what you spent when you were working, then your taxable income could be a fairly high percentage of your pre-retirement taxable income. That can cause a savings shortfall, because if you've saved $1 million but end up paying $250,000 in taxes on withdrawals, then the remaining $750,000 might not give you the lifestyle you expected from the initial $1 million amount.
In addition, some taxable items have collateral impacts elsewhere. One example involves taxation of Social Security benefits. For most people, Social Security isn't taxable, because they don't have enough other income to trigger taxation. However, those who take out too much money in taxable distributions from retirement accounts or have other sources of income can trigger the taxation of their Social Security benefits, adding to their tax bill.
If you're about to retire imminently, then the key is to know about all of these issues and to look to plan around them as best you can. If you still have a few years to go before you plan to retire, then you can take the additional steps of making changes to your overall investing and financial planning to avoid any potential pitfalls and make the most of your financial resources in retirement.
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