Best Dates to Retire: Tax Considerations

By Tammy Flanagan

August 8, 2008

"You only retire once," the saying goes -- although I've met some people who are on their second or third retirement. Still, it makes sense to be careful about picking just when to leave.

As I expected, the Best Dates to Retire 2009 column I wrote last week generated some concern among readers about choosing the absolute best date. During the past week, I've consulted with Bob Leins, my colleague at the National Institute of Transition Planning, who is a tax specialist. He provided some tips on choosing the best time of the year to plan your retirement from a tax perspective.

Such considerations further clarify the dates I selected as best on the calendar published last week, so it's worth spending a little time thinking about how leaving during different seasons of the year might affect your retirement.

In the Spring If you are not trying to cash in 448 hours of unused annual leave before the end of the leave year, then you might consider March 31, 2009, if you're in the Federal Employees Retirement System, or April 3 if you're under the Civil Service Retirement System. Why?

Late Spring/Early Summer

Retiring on June 30 (FERS) or July 3 (CSRS) provides many of the same benefits as an early spring retirement. There is an almost even split between half a year as an employee at full salary (allowing retirement contributions to continue and IRA participation) and half as a retiree (or someone who has begun a second career).

An added bonus next year for CSRS employees is that if they choose July 3 as their retirement date, their last day on the job actually would be July 2; July 3 is a federal holiday and it comes the end of a leave period. A day of pay for enjoying a holiday and a earning your final leave accrual isn't exactly a golden parachute, but it's still a nice way to go out.

Late Summer/Early Fall

Sept. 30 (FERS) or Oct. 2 (CSRS) provides the same benefits as a spring or summer retirement. In addition, you'll have only three months of retired pay in 2009, which is less devastating to your taxes if you are beginning a second career. Usually, new retirees are placed in an interim status while the Office of Personnel Management finalizes their claims. During this time, only a partial retirement payment is made. A retroactive payment to provide full retirement benefits might not be paid until the following year, and this might shift some taxable income to 2010.

Note that I'm deliberately using "might" instead of "will" in this situation, because it's possible you won't go into interim status. Some claims are finalized within days of receipt and the full annuity payment is reflected in the first retirement check.

If you are earning a high salary in your last year of employment, you may have maxed out on Social Security tax. (In 2008, the maximum taxable wage subject to 6.2 percent FICA withholding is $102,000). If a lump-sum annual leave payment or income from a second career received in 2009 pushes you over the maximum taxable limit, it won't be subject to FICA tax.

Here's another tip for high-income earners: If you are facing the alternative minimum tax, you may be able to reduce state tax withholding for your final salary payment and your lump-sum annual leave check to reduce the amount of state income tax that you have to pay.

End of the Year

If you're considering departing in the final days of a year, remember one thing: receiving a big lump-sum payout the following year for your unused annual leave along with 12 months of retirement income could push you into a higher tax bracket in your first year of retirement. This is especially true for those who are retiring from their federal career on a Friday and starting a new career on a Monday, adding additional earned income to retirement benefits.

But the impact of a change in tax brackets can be slight and if you're income is high enough that the alternative minimum tax is applicable without consideration of the lump-sum leave payout, then getting all of the money in one year actually could be a good thing. Also, the accumulated leave and the final salary qualifies for an IRA contribution.

Next week, I'll handle some individual questions from readers about the best dates to retire.

Tammy Flanagan is the senior benefits director for the National Institute of Transition Planning Inc., which conducts federal retirement planning workshops and seminars. She has spent 25 years helping federal employees take charge of their retirement by understanding their benefits.

By Tammy Flanagan

August 8, 2008