The Retirement Timing Mistake
Please quit in January, not in December!
Yesterday, a simple question likely saved one of my clients thousands and thousands of dollars.
"When exactly are you planning to retire?" I asked.
"Sometime in late December," he replied casually.
That's when I had to pump the brakes.
The Last Day Rule That Catches Clients Off Guard
Lurking in the fine print of many 401(k) plans is a requirement that trips up countless retirees every year: Your plan may require that you be employed on the last day of the plan year in order to receive any profit-sharing contribution for the entire year.
My client's plan stated it clearly under the sub-section titled ‘Are there any requirements to receive a profit sharing contribution?‘. Here’s the exact language:
‘To be eligible to receive an allocation of profit sharing contributions, you must be employed on the last day of the plan year, and complete 1,000 hours of credited service in the plan year.’
A little more digging on my part revealed: ‘Plan Year: January 1st to December 31st’.
So if he had retired on December 28th as planned he would have forfeited the entire profit-sharing contribution for his final year of employment. All those hours worked and his reward? A giant lump of coal in his stocking for the holidays!
Instead, after a quick conversation, he will now retire on January 5th of next year.
Why This Matters
Profit-sharing contributions often aren't chump change. Depending on your employer's profitability and the plan's formula, these contributions can range from several thousand to tens of thousands of dollars. For many of my clients, it represents a potential contribution of up to 5-10% of their annual compensation.
Blindly walking away from that kind of money because you picked the wrong retirement date would be a painful, and totally avoidable, lesson to learn.
Is Your Retirement Date Costing You Money?
If you're planning to retire in the next 12-24 months, here's what you need to know:
Not all plans have an end of plan year service requirement, but many do. The specific rules will vary by employer, so it’s important to review your plan documents and to ask for help from your HR department or from a quality financial advisor. Common retirement timing trip-wires may include:
Vesting schedules that claw-back unvested matching contributions if you don’t stay employed long enough to fully vest
Stock option vesting schedules that could mean leaving valuable unvested options on the table
Pension service credit rules that could unnecessarily give your pension benefits a haircut
Bonus calculations tied to employment dates that you’ll want to really understand
Health insurance coverage issues that you’ll also want to be aware of
And yes, the last day of employment requirement for any 401(k) profit-sharing contributions
Even a day can make a five-figure difference. The timing of your retirement isn't just about when you want to start your next chapter—it's a financial decision that deserves the same careful planning as all the other parts of your financial life.
For some clients retiring early in the year will make the most sense. This might be the case if you’re lucky enough to be covered by a pension and if an additional year of service credit hits your benefit record on say January 1. Early in the year could also be smart if your company pays out year-end bonuses in the first quarter of the year.
But for others, particularly those considering a partial Roth conversion of their pre-tax retirement account to an after-tax Roth account during a lower final income year, then retiring mid-year may be optimal in order to create “space” on their tax return for a meaningful Roth conversion to fill up certain tax brackets (while being mindful of the impacts of any IRMAA surcharges to Medicare).
Then again, it may pay to retire later in the year if year-end bonuses are typically paid out in that timeframe. In a final scenario, you may also want to drill down further to consider which day of the month makes the most sense. For example, it may pay to quit on the 1st of the month to get a final full month of health insurance benefits if your employer provides health care coverage on a monthly basis.
Your Summary Plan Description and other important human resource benefit and award documents hold the answers. Remember those documents you probably skimmed quickly when you were hired and promptly forgot about? Dig them out and re-read them carefully. Ask questions. Those documents will contain the exact rules that govern your benefits, and having that knowledge is key.
The Bottom Line
Retirement planning isn't just about having enough money saved, although that’s obviously important. It's about making sure you're maximizing the dollars you've earned, going into retirement with an appropriate mix of investments to weather potential market set-backs in the early years of retirement, having a plan for healthcare costs, and not making unforced errors like unnecessarily leaving tens of thousands of dollars behind because you just didn’t know…
A well-timed retirement date, informed by a thorough understanding of your employer's benefit plans, can be worth a substantial amount of money. I’ve personally seen a client couple lose multiple years’ worth of 401(k) matching contributions amounting to around $70,000, having it suddenly vanish out of their 401(k) account because they didn’t stay employed just a few months longer in order to vest in the husband’s plan. (I’ll note that this happened before they became clients of mine). That kind of thing is a very bitter pill to swallow for any client.
If you're approaching retirement, let's have this conversation before you tell your employer your last day. Poorly timed decisions, sometimes amounting to a even a few days, are a serious self-inflicted retirement wound to avoid.
Ready to ensure you're not leaving money on the table as you transition into retirement? Schedule a consultation and let's review your complete picture together.
