Lately it seems like every other e-mail that hits my inbox is touting Social Security as the new marketing “secret-sauce” to attract the Boomer generation and their assets. Social Security Maximization – Social Security Timing – The Wrong Choices Can Cost you a Fortune – Do You want to Maximize your Social Security Income? Sound familiar? Many of these advertisements are inferring that it’s generally a mistake to start you benefits before you absolutely must. So this brings me to my question; Does it really make sense to wait until age 70 to receive a larger Social Security benefit? Let’s begin to answer that question by studying the chart below.
Clearly, the longer you wait, the greater your Social Security benefits will be. This chart illustrates, assuming Full Retirement Age of 66 and a benefit of $2,000 at Full Retirement Age, the monthly benefit will be $2,000. If benefits are claimed prior to FRA, the benefits can be reduced as much as 25%. Conversely, if benefits are delayed until age 70 the monthly benefit can be increased to as much as 132% of the normal benefits if taken at age 66 (FRA).
In this case claiming benefits at age 62 would produce a monthly benefit of only $1,500 per month compared to $2,000 per month by waiting until age 66 (FRA). If benefits are delayed until age 70, the monthly benefit will grow by 8% per year (not compounding). So in the case above waiting until age 70 will increase benefits from $2,000 to $2,640, an increase of $640 a month for the rest of your life. If you throw in a cost of living adjustment, the difference will be even greater. So getting back to the original question; Does it really make sense to wait until age 70 to receive a larger Social Security benefit? The best answer is; not always.
With the winding down of company sponsored pension plans and the dramatic increase in IRA and 401k contributions and account values, advising clients when to begin their Social Security Benefits can be tricky and could cause additional and unnecessary income taxes. Before saying wait as long as you can and you’ll get more, other retirement accounts like IRAs, 401(k)s, 403(b) plans, Sep IRAs, 457 and TSP plans should be taken into account.
It’s true that waiting until age 70 will produce the highest possible Social Security benefits but what about the potential income tax on those benefits. Your clients may be forced to pay income tax on as much as 85% or their SS Benefits or they could be taxed on as little as 0% of their Social Security Benefits. Distributions from qualified plans are counted 100% in the formula to determine if Social Security Benefits will be taxed and what percentage of the total benefit will be subject to income tax. My point is: taking Social Security timing out of the context of other retirement plans can be a tax disaster and create tremendous liability for the unskilled advisor.
The solution is not complicated. Combine Social Security Timing with IRA Distribution Planning. Keep in mind; the more the participant takes out of their qualified retirement plans, the more likely they will pay taxes on their Social Security Benefits.
A brief excerpt from my book, Top 10 IRA Mistakes, will help put the problem into perspective:
On August 14, 1935 President Roosevelt signed the Social Security Act into law.
This piece of legislation was intended to help Americans supplement their personal retirement savings, not replace it. Federal legislators recognized that American workers were not saving enough and might need government support to ensure they had the basic living necessities during their retirement years.
It was never the government’s intention to return our income tax dollars so we could retire comfortably at Uncle Sam’s expense. In fact, government leaders have struggled with this issue throughout history.
To ensure that the money would be available for its intended purpose, President Roosevelt promised that as long as he lived, Americans would pay no income tax on their Social Security benefits. In 1983, Congress broke that promise and today, if you have an income of $25,000 and are single, or a combined income of $32,000 and are married, you will pay income tax on 50% of your Social Security benefit. It gets worse: if you have income of $34,000 and are single, or an income of $44,000 and are married, you will pay income tax on 85% of your Social Security benefit.
Working Americans pay into the Social Security system with after tax dollars, and those who are receiving benefits and continue to have income over the thresholds are also paying income tax on their Social Security benefits. Uncle Sam gets to double-dip, while senior citizens struggle to make ends meet and are left without the safety net the federal legislators originally intended.
The better people do to earn income to support themselves during their retirement years, the more likely they will end up paying income tax on their Social Security benefits. This is important because distributions from a traditional IRA are taxed as ordinary income. Increases in your taxable income can increase the tax on your Social Security benefits.