Last week we started looking into retirement plans such as 401ks and IRAs, and the different strategies that people use to manage their finances as they enter into retirement. Sometimes you don’t have to pay taxes on the money you invest into retirement plans, like IRAs, so one strategy is to hold off on withdrawing from your account until you’re in the lowest possible tax bracket. People who follow this practice will wait until their taxable income decreases substantially enough that they enter into a lower tax bracket than they were in when they were working, so that they have to pay less on the money they withdraw from their retirement accounts.
When people try to avoid withdrawing from their retirement accounts, they will often file to receive their Social Security benefits from the government. You can apply for Social Security as early as age 62, but the government doesn’t consider you to be of “full retirement age” until 66. When you start claiming benefits before age 66, you won’t receive the full amount to which you’re qualified. This is potentially detrimental, because once you start claiming your benefits, you’re locked into whatever payment amount you receive.
For example, if the amount that Henry earned before he retired qualified him to receive $2,000/month when he reached 66, but he started claiming benefits at 62, he would only receive 75% of his benefits. That means that for the rest of his life he’d be getting $1,500/month, plus cost-of-living adjustments (COLAs).
However, he’s allowed to wait as long as 4 years after “full retirement age,” and can start claiming his Social Security benefits at age 70 if he wants. By doing that, his monthly payments would increase by 32% of his total allowance, from $2,000 to $2,640, plus COLAs. If you ignore the COLAs, Henry winds up collecting an additional $13,680 annually for the rest of his life!
Clearly, there’s a significant benefit to holding off from collecting your Social Security benefits if you’re able. That’s not to say that you need to withdraw your entire IRA before you claim your Social Security, but trying to live as conservatively as possible as long as you can until you reach age 70 winds up paying off. Once you start receiving your Social Security benefits, that will reduce the amount that you’ll need to rely on withdrawals from your IRA. Social Security benefits are only partially taxable, while withdrawals from your IRA are fully taxable, so this method also saves you some money when tax time rolls around.
Waiting in order to bulk up your Social Security benefits is especially beneficial for married couples. When the first spouse dies, if his or her Social Security payments exceeded his/her partner, the surviving spouse will receive the decedent’s payments. This means that if you’re able to wait to start collecting, you’ll be providing extra support for your spouse after you pass.
Financial planning strategies will work for some, but not for others, so it’s important to calculate your individual numbers in order to figure out what’s best for you. Sitting down with a tax professional is a great way to make sure you’re making the best possible decision for your future. Get in touch with the experienced Certified Public Accountants at DeFreitas and Minsky LLP to start your financial planning strategy today!
