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Timing is everything — wise words that are as true in relationships and golf swings as they are in retirement planning.
Indeed, while many pre-retirees have a target retirement date in mind based on their age, few appreciate that when they call it quits during the calendar year can potentially give their savings a shot in the arm.
If retirement day is imminent, it pays to review your employer’s benefit policies so that you don’t leave free money on the table, said Sidney Warrenbrand, a financial professional with Baystate Financial in Boston, Massachusetts.
“You want to figure out those key dates on your benefits calendar and plan your retirement to maximize those payouts,” he said.
Here’s a look at what may be at stake:
As you consider the timing of your future retirement within the year, you may also wish to consult a financial professional for greater clarity on the best age to retire.
Vesting
Regardless of how old you are when you retire, it is important to consider your vesting schedule, especially if you are relatively new to your current job.
Vesting refers to the percentage of stock options, matching contributions to a retirement plan, or profit sharing an employee actually owns. Employers typically use vesting schedules to incentivize workers to stay, doling out ownership of employer-provided benefits over time.
For example, some use a cliff vesting schedule, in which workers become 100 percent vested in their 401(k) employer match after, say, three years. They would receive nothing if they leave sooner. Others might allow their employees to vest at 25 percent per year, so their employees would be fully vested after four years.
Note that the contributions you make to your workplace retirement plan through payroll deductions are always yours to keep.
“If you join your company two years before you retire and you’re not yet fully vested in any stock options you received or employer-matched contributions to your 401(k), you can boost your nest egg in retirement by waiting until you are fully vested,” said Warrenbrand, noting that some company benefits vest according to work anniversaries and others are structured to vest annually in, say, January or June.
Retire early in the year if…
The best time of year to retire is a moving target that depends on a number of factors unique to you. There may be a compelling reason to begin your retirement early in the year if:
- You have a pension plan that provides an additional year of service credit on January 1, credits that are used to calculate the size of your pension payout. By waiting until the new year to retire, you might also receive a cost-of-living increase. Just be sure you understand your pension plan rules, as some employers award service credits based on your work anniversary and not the calendar year. Your human resources or benefits department can help answer questions. “A lot of state pension plans give service credits that are tied to the employee's start date,” said Warrenbrand.
- Your company waits until the first quarter of the year to distribute year-end bonuses. “We often recommend that pre-retirees who receive an annual bonus plan their retirement to coincide with that bonus,” said Warrenbrand. “We do see some companies giving out their bonus in the early months of the following year, which certainly helps pre-retirees build up their cash buffer for a smooth transition into retirement. It’s a nice little payout.”
- You plan to begin claiming Social Security right away. Waiting until the new year to claim Social Security typically results in an extra year of service credit, which would increase the size of your benefit. The Social Security Administration offers an online benefits calculator where you can compare your benefit estimates based on a selected date or age. (Learn more: When should I file for Social Security?)
Retire midyear if…
Tax management may be one reason to retire earlier in the year, or at least before the third quarter, as your total annual compensation would be less than prior years, which could potentially lower your tax bracket considerably.
A lower tax bracket is especially helpful if you plan to do a Roth IRA conversion in the year you retire. Remember, you’ll owe income tax on the entire amount you convert to a Roth IRA from a traditional IRA. And the amount you pay is based on your federal income tax bracket for that year, which ranges from 10 percent to 37 percent.1
“There is merit in showing people the benefit of retiring midyear, when they haven’t yet collected their full annual income,” said Will Pfeifer, a financial professional with GoldBook Financial in Scottsdale, Arizona. “That way they can do a Roth conversion and it might not push them into a higher tax bracket. Some people hang around for an extra 8 hours of paid sick leave, and that’s OK, but it doesn’t statistically impact their chance of retirement success. A lower tax bracket, however, might help them significantly.”
Pre-retirees who are considering a Roth IRA conversion should perhaps consult a financial professional for guidance first as those who convert after they retire may be subject to income-related monthly adjustment penalties, which could increase their Medicare premiums substantially.
Retire later in the year if…
In other cases, you may benefit by retiring later in the year if:
- You need the extra savings. Remember that maxing out your pretax retirement account by even one extra year can have a disproportionately positive impact on your financial security thanks to compounded growth. For example, a contribution of $22,500, the annual limit for 2023, would grow to $87,000 over 20 years, assuming a 7 percent annual return, according to Nerdwallet’s compound interest calculator.
- Your bonus is paid out at year-end. If you receive an annual bonus, don’t separate from your employer before the award date.
- You expect to reach the Social Security tax wage limit ($160,200 in 2023) and you have a sizable payout coming for unused paid leave. By waiting until after you hit that Social Security tax limit, your annual leave payout would be exempt from the 6.2 percent Social Security tax. To avoid the Social Security tax, however, you would have to collect your leave payout by December 31. As a result, you may need to push your actual retirement back to, say, late November to give your payroll department time to settle up. Here again, your human resources team can offer guidance on timing. (Learn more: What is the Social Security bonus and how to use it)
- You can cover your immediate living expenses without having to withdraw savings from your traditional IRA or 401(k) right away. After age 59½, withdrawals from pretax retirement accounts are taxed as ordinary income. When combined with your taxable earnings for the year, those withdrawals could potentially push you into a higher marginal tax rate.
Health insurance coverage
Depending on your age, health insurance may be another important factor for pre-retirees.
Many employers provide health care coverage on a monthly basis. In that case, it could potentially make sense to retire on the first of the month to eke out an extra full month of benefits. That’s especially true if you are younger than 65 and not yet eligible for Medicare. (Learn more: Retiring early? A guide to understanding your health insurance options)
The Consolidated Omnibus Budget Reconciliation Act (COBRA) gives certain workers and their families who lose their group health insurance benefits due to voluntary or involuntary job loss the right to continue their coverage for a limited period of time. Continued health insurance coverage under COBRA is often more expensive than you would pay while employed, because you would typically be paying for both your own share of the costs and also the portion that your employer previously paid through your benefits package.
Warrenbrand said some states offer private medical insurance to eligible residents for about the same cost as Medicare.
“It varies state by state,” he said. “We recommend that folks who are within five to 10 years of retirement drill down and do the math on what those health insurance costs will look like for them pre-Medicare.”
Other timing issues to consider
Your own retirement timeline may also depend on when your benefit checks kick in.
For example, you may choose to retire at the end of the month to eliminate any gaps between your last official paycheck and the start of your pension benefits, some of which are distributed at the beginning of the month.
Retiring at the end of the month might also allow you to cash in on extra hours of accrued sick leave or paid time off.
It may make sense to plan your departure date after a holiday, so you don’t forfeit any paid days off.
Lastly, if you plan to leave the workforce before the traditional age of retirement, be sure you wait to begin withdrawals from your pretax retirement accounts (including your 401(k) and traditional IRA) until you are at least age 59½ to avoid a 10 percent early withdrawal penalty. All distributions from a pretax retirement account are always taxed as ordinary income.
Conclusion
If you’re in your 50s or early 60s, you’ve no doubt given thought to the age you’d like to be when you call it quits. To maximize your financial security, however, your exit strategy should also factor in your bonus and pension payouts, vesting schedule, taxes, need for immediate withdrawals from your pretax accounts, and unpaid vacation time.
Armed with information, you can make the best decision for you about whether to retire in January, December, or mid-way through the year.
Discover more from MassMutual…
A checklist for early retirement
Beware retirement’s overlooked risk: Sequence of returns
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