If you’re living on your retirement savings, while waiting to start taking Social Security benefits to full retirement age or even age 70, you might be costing yourself thousands in taxes.
Good Grief! You’ve worked your whole life and paid taxes on those earnings. Now you have to pay taxes on your Social Security benefits. However, depending on your asset level, you may want to start getting those benefits earlier.
There are many good reasons to wait and take Social Security at full retirement age to get the full benefit amount. In waiting longer to file, the benefit can grow 8% a year from full retirement age to age 70. However, this one-size-fits-all advice may not be appropriate for everyone, especially for the wealthy.
The issue is that everyone wants to up their benefits on the front end. However, if there is no plan to boost those dollars on the back end, by keeping more of your Social Security dollars for yourself instead of paying taxes, it’s not worth it. For many seniors, by the time they see they’re going to be giving up to 20% to 30% of their Social Security away in taxes, it’s too late.
Of course, conventional wisdom says that, if possible, you should wait and claim bigger Social Security benefits at age 70. That’s something high earners in many instances can do, but there is an increasing number of couples who’d be better off filing at age 62 and using that income to preserve and build their nest egg.
Look at this example: say that a husband was retiring at age 62. Without his regular paycheck, he and his wife were both about to find themselves in the lowest tax bracket they had been in since their first jobs: the 10% bracket. The question for them, like many Americans, is whether to tap into their IRA and 401(k) in retirement. These are typically the most significant accounts in terms of amounts saved through the working years. If this couple didn’t start Social Security at age 62, they’d need to withdraw heavily from pretax retirement accounts. Based on the monthly distribution rate needed to maintain their budget, those dollars (which are taxed at current income tax rates) would immediately place them into a higher tax bracket (perhaps the 22% bracket under 2018 tax rates).
However, if they take their Social Security payments at age 62, the monthly distribution amounts needed from their retirement savings accounts would be much less. This couple doesn’t want to drain their retirement accounts early in retirement because it can mean lost opportunities for compounded growth of assets over a 20-to-30-year retirement. If the couple were to take their Social Security at age 62—while in a 10% tax bracket from age 62 to 70—the amount of tax they’d pay on those Social Security benefits would be minimal, maybe even zero.
Talk with your estate planning attorney, who has a clear picture of your tax situation in retirement and has likely designed your estate plan to minimize taxes. Make sure that your plan for when to take Social Security benefits makes sense from a tax perspective.
Reference: Kiplinger (September 7, 2018) “Why Wealthy People May Want to Take Social Security at 62”