When it comes to Social Security Income (SSI), the most common question relates to when benefits should start. No matter your stage of life – between entering the workforce and the years leading up to retirement – saving for retirement is crucial. Contributing money into qualified accounts (e.g. 401Ks and IRAs) is financially prudent and has many tax advantages. However, if the bulk of your savings ends up in pre-tax retirement accounts, it may be beneficial for you to collect Social Security sooner rather than later. Let’s look at a couple of examples.
The most common answer on when to start collecting Social Security benefits is to defer it as long as possible, that is until age 70. This maximum deferral results in the highest payout since benefits increase by 8% per year from your “Full Retirement Age” until age 70. While maximum deferral boosts your payout, it’s not always the right choice.
Retirees may claim Social Security early due to health issues, the emotional relief of tapping savings accumulated in government coffers or avoiding unnecessary taxes on IRA distributions. The answer on when to start collecting is largely dependent on the composition of your investment accounts once distributions begin.
For those who have accumulated a significant portion of their retirement savings in pre-tax accounts, taxes on IRA distributions between ages 62 to 70 can be detrimental to your bottom line. If you need $120,000 from your IRA for annual living expenses, you must draw significantly more than that to account for Federal/State and sometimes Local taxes.
The compounding effect of those additional distributions over time can result in a hit of hundreds of thousands of dollars to your balance sheet. In lieu of grossing up retirement account distributions to cover taxes, collecting Social Security earlier can be one technique to preserve IRA balances for future generations.
In the table below, we illustrate a scenario for a married couple with each spouse taking their respective social security benefit at age 62 vs. age 70. All the following variables remained constant in each projection with the only difference being the age they take Social Security:
We see that by delaying Social Security, the couple must dip into their retirement assets right away. Fast forward to age 70 to show the difference between the two values now that Social Security will be taken for the age 70 Column (right section). Once again, we fast forward to the end of the projection at age 90 and see that taking Social Security at age 62 resulted in $1,660,544 of additional portfolio assets than delaying Social Security until age 70.
The best way to understand when to take Social Security is by running a scenario analysis as part of a comprehensive financial plan. Each individual/family is unique, so the key is gaining a firm understanding of how your personal situation applies.
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