Donald E. Askey
---- — As baby boomers approach their full retirement ages, they face the big question: When do I or we take Social Security?
You’re eligible for a reduced benefit at age 62 and a maximum benefit at age 70. Between these two ages lies your full retirement age (FRA), which, as a baby boomer, is either 66 or 67 or some point between those ages, depending on your year of birth.
Whatever your FRA, you are entitled to the “full” benefit you’ve earned as a result of your wage history, pretty much since you first started working or contributing to Social Security. Every year you wait after your FRA to make a claim your full benefit increases by 8% until age 70, when you can claim the maximum possible based on your work history.
Many retirees are anxious to start their Social Security benefits as soon as possible, even as early as age 62, despite the lower life-time benefit. If you are in poor health, this makes sense. But if you are healthy, you may be at risk of forfeiting tens if not hundreds of thousands of dollars in payouts over your lifetime or, more importantly, the lifetime of your spouse, whose earnings record may not be as strong as yours.
The risk of living an unexpectedly long time is called longevity risk. Put differently it is the risk of running out of money in old age. This is the retiree’s greatest nightmare.
By postponing your election for Social Security to age 70 you have decided to provide the best way known today of protecting yourself and your spouse from longevity risk. Much better than any commercial annuity product available on the market today.
But there’s another great benefit to postponing your benefit claim. The farther out you push your claim, the less in income taxes you’ll pay. This is because Social Security benefits are taxed more favorably than newly earned income and distributions from your IRA.
According to a research paper published by Prudential at the end of last year, it makes sense to consider tapping your IRA to fund early years in retirement and delaying your Social Security claim. The tax savings doesn’t occur during this transition period. The tax savings are realized at age 70 or later when your enlarged Social Security benefits are taxed at their more favorable rate.
The provisional income formula, a confusing feature of the tax code little-known to the average retiree and confusing to everybody, is used to determine the amount of Social Security that is subject to taxation and your ultimate taxable income.
Many retirees, who seek a constant amount of retirement income, will find that the combination of larger delayed Social Security benefits with smaller IRA withdrawals will reduce their taxes from age 70 on.
Because the formula for calculating provisional income includes only half of any Social Security income, the greater the amount of total retirement income derived from Social Security, the greater the benefit derived from the provisional income calculation. By boosting Social Security income by delaying your claim for it, you not only have a greater Social Security benefit but you may also have reduced your overall tax exposure.
Everybody’s case is different. In the example cited in the Prudential research paper a couple seeks $90,000 in gross income in retirement. If they take Social Security early for a $45,000 payout and draw the other $45,000 from their IRAs, their taxable income is $71,000. If Social Security is delayed until they can take $70,000 in benefits and need only $20,000 from their IRAs, then their taxable income is half of the $71,000.
Before you are tempted to take the [Social Security] money and run, have a professional help you figure out the possible long-term tax advantages to delaying your claim.
Donald E. Askey, a fee-only financial adviser and planner with offices in Newburyport and Boston, can be reached at firstname.lastname@example.org.