One of the most important and common questions that retirees face is when to take social security benefits. Regrettably, there is no “one-size fits all” solution to the question. The social security question has many considerations, but we hope to provide some thoughts to help guide the decision. As with all financial decisions, the Cornerstone team is always available to help plan for your specific situation.
So, when should you take social security benefits? It starts with your retirement goals and cash flow needs. When are you retiring? What does retirement mean to you? Will you be spending more earlier on or later in retirement? Do you need the money? Are you going back to work? Do you have a spouse, and how do his or her benefits influence the decision? As mentioned, much of the analysis is customized, but here are some guiding principles to consider.
Let’s start with the basics. To qualify for social security, you need to have 40 credits which equals about 10 years of work. The earliest you can file is age 62, or you can delay up to age 70. The year you were born determines your full retirement age, which ranges between age 66 and 67. Your exact full retirement age is then used to determine your Primary Insurance Amount (PIA). That amount is used to calculate your benefit based on several factors, such as when you choose to take benefits or available spousal benefits. For example, if your full retirement age is 67, and you want to file early, your benefit is reduced about 6% per year calculated from full retirement. Conversely, if you delay it past 67, it will increase about 8% per year. Social Security has been simplified in the recent past, taking away more complex strategies such as “File and Suspend”. Keep in mind, if you are currently married or have been married for a time period in the past, there are additional filing complexities to consider.
What does the math say?
Actuarily, the Social Security Administration estimates that a male retiring at 67 years old will live another 17 years or so until age 84. For a female age 67, they expect her to live another 19 years or so until age 86. Furthermore, financial planners are now planning for their clients to live into their 90’s (as we don’t want to plan for an actuarial average and then have someone outlive their money). With those figures in mind, delaying your social security to full retirement age or up to the maximum age of 70, you will maximize your total benefit paid if you live past the age of about 78 to 80 – the so-called breakeven. That is the time when you would have made more money from social security than if you had filed at the earliest age of 62. Keep in mind that this is purely an actuarial equation which does not consider individual health or longevity, cost of living increase, pay increases or any individualized financial planning.
The Income Tax Reduction Opportunity
A typical client at Cornerstone will be receiving social security and will also usually have some pre-tax money from a traditional IRA or 401(k). This reality gives our planners the opportunity to adjust the timing of social security to minimize overall taxes during retirement. As an example, imagine retiring at age 65. That person might plan to start taking social security as late as possible (age 70) which will actuarily provide the greatest benefit over time. Then, between the ages of 65 and 70 (when social security starts), that same person can strategically withdraw money from his or her pre-tax account to incur (but also responsibly limit) the total ordinary income for any given year. Perhaps he or she can work to stay below the 12% tax threshold for those years or convert to a Roth IRA at a very favorable marginal tax bracket. Then, when social security kicks in, the withdrawals from the pre-tax source would be substantially reduced or even eliminated in some years. Required Minimum Distributions from traditional IRAs begin at age 72. Because that person has taken money out of the IRA between the ages of 65 until 70 or 72, the RMDs would be lower. The assets converted to a Roth IRA are no longer subject to RMDs.
Our Practical Approach
Not every decision in life should be driven by tax planning or actuarial numbers. For most of our clients (though certainly not all), we like to look at a more practical approach. That is, when do you expect to spend more in your retirement? Are you planning on spending more money doing the things you love prior to age 78 (the breakeven point for delaying)? Or, are you planning on spending more money after that age? When we look at it this way with clients, they often agree that they like the idea of having an increased cash flow earlier in retirement to allow them to do the things that they love. And, they are willing to sacrifice the actuarily determined gains they could otherwise achieve utilizing the “math equation” approach.
* Licensed, not practicing.
The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendations for any individual or entity. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment Advice offered through Cornerstone Wealth Strategies, Inc., a registered investment advisor and separate entity from LPL Financial.