Social Security Maximization
Art by Jackson Joyce
The conventional wisdom about how someone should draw down his various assets to maximize retirement income—noted by many of the big recordkeepers in their retirement tools and calculators—is that a person should take out all of his taxed money first until it is gone, and only then draw down tax-deferred money. Then, he should take the tax-exempt dollars.
According to William Meyer, founder and managing principal of Social Security Solutions, this rule of thumb is pervasive, but new analytical tools show it actually, in most cases, is the opposite approach of what would maximize lifetime wealth for a given individual.
Why is this? According to Meyer, when one retires, on average he will indeed drop into a lower tax bracket, because he is moving out of his prime earning years and starting to live off savings. But when this individual soon reaches and starts drawing full Social Security at age 70—likely just a few years after retirement—that is right about the time when required minimum distributions (RMDs) kick in. When that happens, at i.e. 70-1/2, many retirees’ income jumps pretty significantly, and, as a result, the Social Security benefits they waited so patiently to claim will be taxed at potentially up to 85%, because this rate is based on overall income including withdrawals from tax-deferred retirement accounts, Meyer warns.
Given this fact, by instead first winnowing down the tax-deferred 401(k) or individual retirement account (IRA) assets while waiting to file for full Social Security, this could reduce the lifetime impact of RMDs and reduce the taxes, potentially quite significantly, on the net income from Social Security. As Meyer and others agree, Social Security claiming is always a complicated matter to discuss in the abstract, but there are some general rules and principles to know.
The first consideration when it comes to maximizing Social Security income is to work for at least 35 years, as the benefit takes into consideration one’s highest 35 years of income history. The second, even more important, consideration is when to start taking Social Security. Benefits are reduced by up to 25% if an individual claims before full retirement age, but are increased by up to 35% if the person delays claiming past full retirement age, up to age 70. Roughly speaking, every year one waits to take Social Security, the benefit goes up by 8%.
Experts agree that the better one’s health and the longer the person and his or her spouse expect to live, the more it makes sense to take Social Security later—as long as the couple is not putting a strain on its investments. Another factor is employment. If someone plans to continue working, it may make sense to delay taking Social Security, as benefits are reduced by $1 for every $2 earned before full retirement age. This changes to $1 for every $3 earned at full retirement age for earnings over $45,360.
Recently, Edward Jones published an analysis finding that if a person decided to start taking Social Security early, at 62, his first annual benefit would be $18,000. By 80, he would receive a benefit, adjusted for a 3% cost-of-living increase every year, of $30,633. For a person whose full retirement age is 66 and who starts Social Security that year, the benefit would start at $26,988 and rise to $40,812 by the time he turned 80. Someone starting Social Security benefits at 70 would receive $40,092 in the initial year and $53,783 at 80.
Kimberly Blanton, author of the Squared Away Blog published by the Center for Retirement Research at Boston College (CRR), says one area where workers neglect making the most of Social Security is the spousal and survivor benefits. She points to the fact that two out of three men and women in a recent survey by RAND Corp. were unaware of the fact that a divorced person who was married for at least 10 years is entitled to a deceased spouse’s survivor benefit. In fact, the divorced spouse would even get the benefit if the other spouse had remarried, Blanton notes.
“In the case of couples who were still married when the spouse died, the marriage had to last only nine months for the survivor to get the benefit,” Blanton says. “Fewer than half of the people surveyed by the RAND researchers were aware of this rule.”
According to Blanton, there is also little understanding that the Social Security survivor benefit is based on the higher-earning spouse’s work record. Today, this is still typically the husband, meaning that a wife who used to work and is collecting Social Security based on her work record is eligible to switch to her husband’s greater benefit after he dies.
“To make the switch, the widow must file with the Social Security Administration [SSA],” Blanton says.