financial planner Stephen Zelcer

IS RETIREMENT BETTER AT END OR BEGINNING OF YEAR?

October 9, 2016 3:30 am Published by Stephen Zelcer

I often hear people say “I’d rather retire sooner than later.”  But when the choice of retirement dates is just a matter of a few months, then people often assume there’s not much difference between sooner or later.  What difference does a few months make?  Here are some important differences to consider.

Advantage of end-of-year retirement:

  1. Jump start on COLAs:  COLAs are payable on January 1stfor those who were effectively retired December 1st of the prior year.  In order to be effectively retired on December 1st, you must have your date of final separation before December 1st – i.e. by November 30th.

To illustrate:  If two people are retiring in 2017 – one’s date of final separation will be on November 30th, the other on December 1st – the one who retires November 30th will have his COLAs start January 1st, 2018, while the other who retired December 1st will have his COLA start January 1st, 2019!

This December 1st cutoff date should not apply to CSRS employees.  CSRS employees can be deemed retired in December even if they retire on the 1st, 2nd, or 3rd day of December, therefore they should receive a pension check in January which should include the COLA.

The COLA for the November 30th retiree will not be the full year’s COLA, but will be only 1/12 of the full year’s COLA (since they were only retired in December which is only 1 month of the prior year).  Still, that’s not too shabby, and all future COLAs will be compounding upon this fractional COLA, so it’ll add up over time.

  1. Avoid/minimize Social Security taxation of Annual Leave: Social security tax needs to be paid on “earned income” and annual leave is considered “earned income,” so SS tax will be due.  However, SS tax is only applied to the first $118k of income (2016).  This means that for someone who retires toward the end of the year, their income may have already surpassed $118k for that year, thus the annual leave payout will avoid Social Security taxation.

Advantage of beginning-of-year retirement:

  1. Annual leave paid out in year of lower income:  Annual leave is taxed in the year it is paid out.  Retirement income is commonly lower than the salary made in the year prior to retirement.  If the retirement income is low enough, it may reduce the marginal tax rate of the earner (e.g. they may drop from the 28% tax bracket to the 25% tax bracket).  By retiring at the beginning of a year you will receive your leave payout in a year of potentially less income, thus minimizing the taxation of the payout.  (practically though, taxes are withheld the same way they were while you were at work, so the true tax benefit won’t even be realized until you file taxes the subsequent year.)

Although I list this as a beginning-of-year retirement benefit, you can also achieve this benefit with an end-of-year retirement.  Remember, the taxation of the annual leave is determined by the year the money is paid out.  If you retire super-close to the last day of a year (December 31st) you will not receive your annual leave payout until the following year.

  1. Possible Annual leave payout at higher hourly rate:  Unused annual leave is paid out in lump sum.  The payout is actually a pre-payment of what you would’ve received had you stayed employed for all those leave hours (or days or months).  Thus, the lump sum would forecast any changes in pay that you were scheduled to receive had you continued to work for all those leave hours.

For example: Federal salaries often increase each year.  That increase usually becomes effective at the beginning of the first pay period after January 1st.  For 2017, the first pay period begins January 8, 2017.  If you retire before January 8th and have enough leave hours to forecast your projected employment beyond January 8th, your annual leave payout will reflect a higher hourly rate for those hours that project your employment beyond January 8th.

Although this, too, is a beginning-of-year retirement benefit, you can also achieve this benefit with an end-of-year retirement, but the difference is that, with a beginning-of-the-year retirement you’ll likely have more annual leave hours that get compensated at the higher hourly rate.

  1. Avoid possible RMDs if you were 70.5 in prior year:  The IRS requires TSP distributions to begin in the year you turn age 70.5.  These are Required Minimum Distributions (RMDs), and they are taxable income.  However, a not-so-well-known rule is that TSP RMDs are not required if you are still an active federal employee (still on the rolls) during the calendar year you turn 70.5.  If you are 70.5 (or older), you need to be on the rolls thru December 31stin order to avoid RMDs that calendar year.  If your date of final separation is December 30th or earlier, you will trigger an RMD for that year.

Please get in touch if you have any more questions, and or you would like to work with me.

stephen@stephenzelcer.com

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