“Every Rose Has Its Thorn”- Poison
Jim Shellenberger, CFA | Financial Advisor
While there are many pros and cons to Social Security, in the end, it has helped many individuals make it through their retirement years. The reason for the quote, “Every rose has its thorn,” is that even though Social Security is valuable to many, it can be a prickly and daunting topic to navigate. Education may help guide you through the decision. Social Security is complicated, but there are a few points I’d like to cover to help you understand the impact of when and how you decide to begin taking distributions.
- It can be a blessing to have the freedom of choice, but it can be stressful that one simple decision can impact retirement.
- Most people agree that it feels irrational to pay taxes¹ on something that already felt like a tax, but the good news is that not all of Social Security income is taxable income.
To adequately cover all the variables and intricacies of Social Security, it would take a lengthy book that would put nearly everyone to sleep. Thus, we will only cover the differences in benefits based on when you draw and the tax benefit of Social Security. There are many variables related to Social Security; therefore, generalizations will be made to help demonstrate my points for informational purposes.
What is the advantage and disadvantage of when I draw?
Full retirement age is when you get your “full” Social Security benefit based on the year you were born. For this example, let’s say you were born after 1960, putting your full retirement age at age 67. (It’s important to note that no matter when you were born, the earliest you can draw is 62, and the latest is 70, hence the freedom of choice mentioned earlier.) If you were to draw at age 62, you would get only 70% of the monthly benefit you would get at full retirement age.
On the other hand, every year you wait after 67, your Social Security benefit will increase by 8% until age 70. In essence, if you wait until age 70, your monthly benefit will be 24% larger than your full retirement benefit. So how do we best determine when we should draw? There are plenty of variables to consider, but a major one is life expectancy.
- If you wait until age 67 to draw vs. 62, you need to live to about 78 for your total benefit to be higher. This means at age 78, you will have received more money in total over the years for drawing at age 67 vs. 62.
- If you wait until age 70, you need to live to about 80 for your overall benefit to be higher than drawing at 62, or you need to live to age 82 for your total benefit to be more significant than drawing at 67.
It is nice to have this freedom to choose when to draw Social Security, but a lot is riding on the decision and how the next few decades of life go. Even though that may sound like a scary decision, a decision can be narrowed down with careful thought.
No one enjoys paying taxes on Social Security.
Taxes are another variable to consider when choosing to draw Social Security. Something that does not seem to get much attention is that you lose less money to taxes for Social Security income. Only 50% to 85% of Social Security income is reported as taxable income. For example, if you received $40,000 from Social Security, you would have to report at least $20,000 of it as taxable income and, at most, $34,000. There could be more taxable income if you have IRA distributions or other income in retirement. If you were in a 20% tax bracket, you would pay $4,000 less in taxes if it was 50% and about $1,200 less in taxes if it was 85%. It is not ideal that we have to pay taxes on Social Security, but the silver lining is that we don’t have to pay taxes on all of it. The thing to remember is 100% of your IRA distributions count as taxable income. The goal is to find that tax-advantaged balance between IRA income vs. Social Security income. When done right, finding this balance can play in your favor.
When you consider all the variables, it can be complicated to identify when the “perfect time” is to draw Social Security. With so much riding on one decision, I recommend you take the time and the opportunity to educate yourself. Do your due diligence and talk with your financial advisor and tax professional before making the decision. Don’t live trying to make the perfect decision but instead use your resources to make what the best decision today given your current circumstances. In the end, getting a monthly paycheck is enjoyable and helpful for retirement. Realize that Social Security is a benefit, and you have the freedom to make the decision that will best fit you.