For many Americans, retirement won't mean giving up work entirely. And that's not necessarily a bad thing, as continuing to hold a job in your later years can allow you to hopefully do something you enjoy while also increasing your financial stability.
The issue, though, is that working in retirement can affect your Social Security checks. In some cases, you could see your benefits actually go up if you continue earning as a retiree. But in other circumstances, you could find yourself losing some of your benefits if you've claimed them while still holding down a job. And you need to be prepared for that so it doesn't derail your finances.
To make sure you fully understand how your decision to work could affect your retirement benefits, here are three key things you need to know.
1. Your Social Security benefits could go up if you give your average wages a boost
First, the good news -- if you continue working in retirement, you could end up raising the average wages your benefits are based on. And that could mean higher monthly Social Security checks.
See, the amount of your Social Security checks equals a percentage of your average indexed monthly earnings (AIME). AIME is calculated by adjusting the wages earned throughout your lifetime for inflation, then determining your average wage in the 35 years when your adjusted earnings were highest.
If you're still working, you're still logging wages that could be factored into your AIME. If you earn more now than you did in some past years, you could push out those low-earning years in your AIME calculation. Or if you didn't put in a full 35 years on the job yet, you could replace some years of $0 wages that would otherwise be included in the calculation with the wages you're earning now.
If your continued work raises your AIME, you'll see higher Social Security checks because of it.
2. You could temporarily forfeit some of your benefits due to the RET
Unfortunately, the news isn't all good. If you're under full retirement age (FRA) and you're hoping to work and collect Social Security benefits at the same time, you could run into a problem in the form of the retirement earnings test (RET).
Under the RET, if you work when you're under full retirement age for the whole year, you'll temporarily forfeit $1 in Social Security benefits for every $2 earned above $18,240 in 2020 (or above $18,960 in 2021). If you're under FRA for part of the year when you're working, you'll forfeit $1 in Social Security benefits for every $3 earned above $48,600 in 2020 (or $50,520 in 2021). Once you've hit FRA, though, you can work as much as you want without worry.
The loss of benefits isn't necessarily permanent. When you've reached your full retirement age, the Social Security Administration will calculate the number of months of missed benefits and credit you back any early filing penalties for those months. Since early filing penalties reduce your standard Social Security benefit amount by 5/9 of 1% per month for each of the first 36 months you claimed Social Security before FRA and an additional 5/12 of 1% for each month prior, getting credited back the penalties will raise your check amount slightly. And over time, you'll get back the money you missed out on -- if you live long enough.
Still, the fact that working can lead to the loss of Social Security checks in the short term is a big problem if you were hoping to have both a paycheck and benefits to live on as a retiree.
3. You could cause more of your Social Security to be subject to tax
There's another issue as well, and it applies to everyone regardless of their age. If you work and your paychecks push your "provisional income" above $25,000 as a single tax filer or $32,000 as a married tax filer, part of your Social Security benefits will be subject to federal tax when they otherwise wouldn't be.
Provisional income is adjusted gross income plus nontaxable interest income and 1/2 your Social Security benefits. Once it goes above $25,000 for singles or $32,000 for married filers, you're taxed on up to 50% of benefits. And once it exceeds $34,000 for single filers or $44,000 for married joint filers, you could be taxed on up to 85% of your Social Security.
When you're taxed on your benefits, that's money you don't get back. Of course, owing a bigger bill to the IRS isn't reason enough to give up working if you like the job or need the money -- nor is the fact you may end up forfeiting some Social Security money under the RET.
But you do need to know that working could have these effects so you can be prepared for the loss of funds when setting your retirement budget. Otherwise, you may anticipate a higher household income than you end up with -- and that could get you into financial trouble.