This section of CCOERA's Distribution Decisions Guide provides information on some of the issues you will need to consider before you begin your retirement. A person's plans to spend their retirement years will vary widely based upon their age, health, ambitions, and available resources to fund retirement. In addition to creating a budget for retirement, you will also need to consider how you will use retirement benefits provided by the federal government, such as Social Security and Medicare.
Advances in health care have significantly increased the average life expectancy among Americans (see chart), however, we continue to look at age 65 as a preferred retirement age. This means most retirees will enjoy a much longer retirement than their parents did. It also means that it will take more money to pay for it. Many retirees choose to continue working part-time, or in a less stressful capacity during the early years of retirement, because their health condition is much better than retirees twenty or thirty years ago. Some are forced to work during retirement due to poor planning or other circumstances that prevented them from accumulating sufficient assets to fund their retirement. Fortunately, greater life expectancies and continuing advances in health care work in their favor to enable continued employment in later years.
Social Security: Since 1935, when the Social Security Act was signed into law by President Franklin D. Roosevelt, Americans have become increasingly dependent on the retirement benefits provided by the program. Initially, the program was intended only to aid old-age Americans as our nation transformed from a workforce dominated by agriculture to one where industry and commerce were more prominent. The new national welfare program included a federal system of old-age retirement benefits for retired workers, many whom had lost their savings during the Depression, and a federal-state unemployment insurance program. Although retirement benefits are a significant portion of the Social Security program, benefits received from Social Security were never intended to fund a persons entire retirement. Generally, Social Security benefits represent less than half of a retired person's income.
Perhaps one of the most important decisions you’ll make about Social Security, is when you should begin receiving the benefits. Some of the more recent changes to the program have increased the normal retirement age in order to address the effects of Americans’ greater life expectancies. Even though everyone eligible for benefits can still begin receiving payments as early as age 62, the age at which you can receive full retirement benefits has been increased from 65 to as high as 67, depending on the year of your birth.
Working While Receiving Social Security Benefits
Many retirees continue to work, either full or part-time, while they're receiving Social Security retirement benefits. Depending on the amount of income you earn, it could increase future benefits for you and your survivors. However, if you receive "earned income" from a job, and you receive benefits before you reach your full retirement age, your benefit amount may be reduced. Earned income is any income derived through gainful employment. Income received from retirement plan/IRA/deferred compensation plan withdrawals, pensions, rental income, interest, dividends, and capital gains are not wages. These other forms of income will likely be taxable, however, they are not subject to the Social Security Earnings Test.
Social Security Earnings Test
In January 2000 new rules were implemented regarding which group of retirees would be affected by the Social Security Earnings Test. Under the new law, working retirees that have reached their full retirement age (currently 65) are not subject to the earnings test and will not have their benefits reduced as a result of earning income from wages. Under the previous law any retirees under age 70 were subject to earnings testing, and potentially reduced benefits. If you are under your full retirement age when you begin receiving benefits and you are earning income from wages, then your Social Security payments will be reduced by $1 for every $2 you earn above the annual limit, which is indexed with inflation. The annual limit in 2001 was $10,680, and was increased to $11,280 for 2002. Of course there is a point at which you could lose all of your benefits, if your wages exceed certain levels. For example, if the average annual retirement benefit for an individual is $10,488 (in 2002), and you have wage earnings of greater than $32,256 ($10,488 x 2 + $11,280) you would lose all of your benefit for that year. Also, wages (excluding income from self-employment) are subject to these tests for the year in which they are earned, not when they are received. There are also special rules regarding income earned from wages during the year you reach your full retirement age.
Additionally, if you are self-employed, the Social Security Administration considers whether you perform substantial services in your business. Essentially, you must work less than 45 hours per month to be partially exempt from the earnings testing, or less than 15 hours to be entirely exempt. Finally, if you are working outside the U.S. a different set of rules apply. So it's best to contact the Social Security Administration for assistance if you are self-employed or working abroad.
Taxation of Social Security Benefits
The last consequence you will want to consider before you decide when to begin receiving payments from CCOERA is the potential taxation of your Social Security benefits. To determine whether or not any of your benefits are taxable you will have to perform a somewhat complicated calculation. This compares a base amount, which is not indexed for inflation, to one-half of your benefits, plus all of your other income, including tax-exempt interest. If you are married and file a joint return, you and your spouse must combine your incomes and your benefits to figure whether any of your combined benefits are taxable. Even if your spouse does not receive any Social Security benefits, you must add your spouse's income to yours to determine how much, if any, of your benefits are taxable. Yes, these procedures were designed by the Internal Revenue Service. Use the worksheet and Base Amount Table shown below to estimate potential tax liabilities on your Social Security benefits.
Medicare is our country's national health insurance program for people age 65 or older, certain people with disabilities who are under age 65 and people of any age who have permanent kidney failure. It provides basic protection against the cost of health care, but it doesn't cover all medical expenses or the cost of most long-term care. Medicare is financed by payroll taxes from employees and employers (currently 1.45% each), and monthly premiums paid by some of its beneficiaries. Even though Medicare operates separately from Social Security, you will obtain general information and enroll through the Social Security Administration.
Two Parts to Medicare
Medicare has two different types of coverage, referred to as Medicare Part A - Hospital Insurance, and Medicare Part B - Medical Insurance. Neither of these should be confused with Medicaid, which is a medical assistance program for those with low income and little or no resources to pay for healthcare. Although Medicaid is partially funded by the federal government, it is administered by your local state and county governments.
Medicare Part A – Hospital Insurance
This helps pay for hospitalization, skilled nursing facilities, home health, and hospice care. Most people age 65 or older are eligible for Medicare Part A without paying a monthly premium based on their own, or their spouse's employment. If you do not meet the requirements you can still get Medicare Hospital Insurance by paying a monthly premium ($319 in 2002). Medicare will pay for all covered inpatient services in a Medicare-participating hospital for a benefit period of up to 60 days, except for a deductible amount ($812 for each benefit period) that you must pay. For 61 through 150 days, Medicare pays for all covered services, except for a daily coinsurance amount which is $203 per day for days 61-90, and $406 per day for days 91-150, in 2002. In a Skilled Nursing Facility, Medicare will pay for covered services for up to 100 days - 100% for the first 20 days, and everything except a daily coinsurance amount (up to $101.50 per day in 2002) for the next 80 days. If you require home health care, coverage for unlimited visits is provided for under Medicare Part A. Additionally, terminally ill patients are eligible for hospice care for two 90-day periods, followed by unlimited 60-day periods.
Medicare Part B – Medical Insurance
Anyone eligible for Medicare Hospital Insurance (Part A) can enroll in Medicare Medical Insurance (Part B) by paying a monthly premium ($54 in 2002). Even if you're not eligible for free Medicare Part A, you can still buy the Part B Medical Insurance. Medicare Medical Insurance (Part B) helps pay for doctors' services and medical supplies not covered by Medicare Hospital Insurance (Part A).
In addition to the premiums there are additional out of pocket costs, such as a deductible of $100 per year (2002). After you have reached your annual deductible amount, Medicare will generally pay for 80% of approved charges. You are responsible for the remaining 20%, which is referred to as coinsurance.
Many retirees purchase Medigap insurance to pay for deductibles, coinsurance and services not covered by Medicare, such as prescription drugs. There are ten standard Medigap policies, each offering varying combinations of benefits, and are sold by private insurance companies.
There are many other considerations to ponder when deciding how you will manage post-employment health care. Therefore, we strongly suggest that you contact Medicare and your employer for information about all of your available options.
Retirement Budget Worksheets
Like any other endeavor, the key to success is a realistic and sensible plan. For additional assistance, this section contains a retirement budgeting worksheet to help you determine how your income and expenses during retirement match up. When you were saving money for retirement, the general rule of thumb was to accumulate enough to replace 70% - 80% of your annual income (including Social Security). Now that you are nearing your planned retirement age it's a good idea to calculate a more specific estimate of your retirement budget. While the heart of your plan is budgeting your expected income against expenses, first you'll need to determine what you expect to do during retirement. If you want a life of luxury during retirement, such as numerous expensive vacations, you may find that this lifestyle will require more than you were making during your peak earning years. On the other hand, if you're content with a more frugal retirement, you may find that you're able to live very comfortably on less than 70% of your pre-retirement income. You can download a Retirement Budget Worksheet in Microsoft Excel format by clicking the link below.