One of the most common questions our financial advisors receive from clients is, “When should I start my Social Security retirement benefits?” While you’ve likely heard about some of the basics of Social Security, the decision of when to claim Social Security is unique to each individual and family. Here are a few considerations when evaluating your Social Security benefit claiming strategy:
The Social Security Administration rewards those that delay benefits past their Full Retirement Age (FRA) by increasing annual payments by approximately 8% per year, up until age 70. All else equal, it’s simple arithmetic to determine that cumulative benefits are maximized the longer they are delayed. However, all situations are not equal, particularly as it relates to life expectancy and income needs.
To better evaluate your options within this context, it can be useful to determine the respective breakeven age(s) of your various claiming options. By understanding the approximate age(s) when certain claiming strategies begin to produce the highest cumulative benefits, additional perspective can be gained on the trade-offs regarding when to claim benefits. This analysis must be customized to your situation. For example, you may have below average longevity in your family or you anticipate a much larger income needs during the earlier, more active years of retirement. An analysis of your breakeven age(s) can help to provide a framework to determine how you can maximize Social Security benefits for your retirement.
Whether you (and your spouse) are only eligible for Social Security benefits or you have other retirement income sources, it’s important to consider how the various vehicles that will fund your retirement can work together.
For example, if you are eligible for a pension and have the option of delaying and increasing such retirement benefits past your retirement age, you should request pension estimates at various start dates. By doing so, you can determine whether the annual increase of delaying your pension is larger than the increase that you’d receive for delaying Social Security. Depending on your current income needs and the assets you have to support those needs, it may make sense to first claim the retirement benefit with the smallest annual increase, allowing the benefit with the larger annual increase to continue to grow.
Regardless of your eligibility for a pension, you’ll likely need to supplement your Social Security benefits to meet your monthly income needs; most commonly supported with portfolio income and withdrawals. While your Social Security benefits will continue throughout your retirement, there is no guarantee that your portfolio assets will be there as well. An evaluation of your portfolio withdrawal rate will help to determine if your current withdrawal rate is sustainable throughout your retirement horizon. With this evaluation, the decision of when to claim Social Security benefits, in concert with your other retirement income sources, can help to increase the sustainability of your portfolio assets.
Finally, if you are retired but still generate earned income through part-time employment or consulting, those wages can reduce your Social Security benefitsopens PDF file if claimed prior to your Full Retirement Age. If you are considering claiming Social Security prior to the year of your Full Retirement Age and your annual earned income exceeds a certain limit ($18,240 for 2020), it’s important to be aware that the Social Security benefits you’d receive would be decreased by $1 for each $2 you earn above the $18,240 threshold. This earned income limitation threshold is higher ($48,600 for 2020) if you were to file for benefits in the year of your Full Retirement Age but prior to your actual Full Retirement Age month.
The income limitations and Social Security benefit reductions described above do not apply if you claim Social Security at or later than your respective Full Retirement Age.
An often undervalued benefit of Social Security income is it’s preferential tax treatment. When assessed against comparable retirement funding sources, such as retirement account withdrawals, pension income, short-term capital gains, and non-qualified dividends, Social Security benefits are taxed at a much lower effective rate. While the marginal tax bracket of all these types of income is the same, only a portion of your total Social Security benefits are considered taxable income.
Depending on your “combined income” for the tax year (defined as adjusted gross income plus nontaxable interest plus ½ of your Social Security benefits), 0%, 50% or 85% of your Social Security income will be subject to federal taxation. Even better, most states (including California) do not tax Social Security benefits at all!
If reducing your current tax liability is a priority, accessing Social Security benefits to fund your income needs may be beneficial and could equate to nearly a 19% tax savings versus comparable sources of ordinary income (assuming the highest federal and California marginal tax brackets).
While Social Security benefits may be advantageous in mitigating current tax liability, this may not hold true when evaluating a retiree’s cumulative tax liability. Although Social Security benefits can be an attractive direct alternative to retirement account withdrawals, the IRS removes this direct, either-or decision at a certain point through Required Minimum Distributions (RMDs). By mandating annual withdrawals from retirement accounts once you reach age 72 (or age 70½ prior to the SECURE Act), a great deal of flexibility and control over your taxable income is reduced. Often, we find that retirees are pushed into higher tax brackets because the IRS is essentially forcing them to generate taxable income through RMDs, regardless of their actual need for that income.
This is where the strategy behind Roth Conversions comes into play and why it may make sense, from a tax perspective, to delay Social Security benefits. By delaying Social Security benefits and selectively redirecting that potential portion of your annual taxable income towards Roth Conversions, you are willingly paying taxes now in an effort to reduce the mandatory, and potentially higher, taxes that you’ll be required to pay later. At the historically low federal tax rates that we currently have, Roth Conversions can be an attractive strategy that should be considered in conjunction with your Social Security claiming strategy.
Your Social Security claiming strategy is not a straightforward decision and often has conflicting considerations. Whether you are far from retirement, in early retirement or approaching your Full Retirement claiming age, developing a plan of action for the decision of when to claim social security can be valuable and help to guide other retirement planning opportunities and strategies.
At Dowling & Yahnke Wealth Advisors, our Financial Planning team can evaluate how various claiming strategies fit into your financial picture. As part of our comprehensive financial planning services, our financial advisors analyze each claiming strategy within the context of your overall financial plan and determine the optimal strategy based on your unique financial goals.
Contact our team of experts for your financial planning opportunities.