Thinking About Semi-Retirement? What You Need to Know

For those on the verge of retirement, last year’s market selloff was sobering. With stocks and bonds down sharply, you may be thinking that you need to stay on the job to rebuild your nest eggs. Fortunately, when it comes to retirement, there is a middle ground: semi-retirement. More people are embracing it as an option.

Semi-retirement allows you to keep working, but perhaps not as intensely as you did previously. It also allows you to spend more time on activities you enjoy, like volunteering or traveling.

If done right, semi-retirement can be beneficial both psychologically and financially. It gives you a chance to take a step back and ease into retirement rather than plunging in cold turkey. It also creates an opportunity to build retirement savings while putting off the need to collect from Social Security or make withdrawals from investments.

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Different Ways to Approach Semi-Retirement

Some may semi-retire by continuing their current job for fewer hours. Or, alternatively, many go off on their own as consultants or start a one-person business. For the latter group, there are a few important financial planning decisions to consider that will make the transition a smooth one:

Self-employed status comes with benefits and obligations. Self-employed individuals can deduct business expenses on their Schedule C tax form. Those expenses could include travel, phone bills, home office costs and premiums for health care and long-term care.

When it comes to tax obligations, self-employment tax rates are 12.4% for Social Security on net earnings up to $160,200 and 2.9% for Medicare on total net earnings. However, half of that self-employment tax is deductible.

Reduced income can provide a planning opportunity. For individuals who haven’t started taking Social Security or required minimum distributions (RMDs), the reduced income from a semi-retirement may ultimately put them in a lower tax bracket. This provides opportunities, such as taking some income out of a traditional individual retirement account (IRA) at a lower tax rate or doing a Roth IRA conversion.

Continued employment will affect the timing of when retirees take Social Security. Trying to collect Social Security before full retirement age is problematic if you also have earned income. The Social Security Administration will withhold $1 in benefits for every $2 you earn over the earnings cap, which is $21,240 in 2023.

If you have benefits withheld before reaching full retirement age, you will recoup them once you hit full retirement — you’re just simply limited on how much Social Security you can collect in those years.

Self-employed individuals can continue to contribute to a retirement plan. There are two types of retirement plans from which to choose: a SEP IRA and a solo 401(k). Both allow you to contribute a substantial amount toward your retirement, but there are subtle differences to note between the two. 

A SEP IRA is somewhat simpler to set up and can work if you are the only employee or if you employ others. A solo 401(k) works best if you or you and a spouse are the only employees. A solo 401k allows you to take a loan against the plan, and there is the option to contribute on an after-tax basis to a Roth; a SEP IRA does not offer these features.

Additionally, SEP IRA contributions are viewed entirely as employer contributions, and in 2023, the maximum allowable contribution amount is $66,000. Solo 401(k)s are funded with a combination of employee and employer contributions, and those over 50 can add an additional $7,500 as a catch-up contribution, for a combined total of $73,500. An adviser can help you decide which plan is a better fit.

Semi-Retirement Can Serve as a Transition to Full Retirement

For some, semi-retirement can last a long time and serve as a second leg of a career. But that is often the exception to the rule. Most use it as a transition period to connect work and retirement, as that allows you to keep working while exploring what you may want to do when you completely retire.

At first, filling up all your hours in retirement may seem daunting. But after a few years, you’ll find yourself comfortable sliding into the next phase of life. Semi-retirement can be both enjoyable and financially gratifying — a nice, rewarding combination.