Determining the ideal time to begin collecting Social Security retirement benefits is challenging enough, but combining this decision with when to begin drawing from your retirement assets can be positively daunting. In our most recent blog post, we presented several claiming strategies that, by and large, favored waiting to collect benefits. This week we’ll discuss whether waiting always makes sense and how to pay for it.
Delaying benefits results in higher guaranteed inflation-adjusted income for life, which helps protect against poor investment performance and overspending. This security, however, may come at the cost of using more retirement assets in the early years of retirement to fund spending needs. As the Social Security retirement benefit is an inflation-adjusted annuity, the decision may be viewed as a tradeoff between retirement plan (i.e., 401K, etc.) preservation and maximizing retirement income. American retirees have shown a clear preference for the former, as evidenced by the high percentage of retirees that collect Social Security benefits prior to attaining full retirement age. This desire to maintain liquid assets is understandable but often robs retirees of much needed income.
Paying to Delay
One common approach to retirement income planning is to collect Social Security benefits at a younger age and continue to defer retirement assets for as long as possible. Under this approach, a retiree collects a larger number of smaller checks from Social Security but retains more of the tax-deferred growth and liquidity of their portfolio.
This approach may be appropriate in certain cases, most notably when life expectancy is less than the relevant actuarial average, or when Social Security benefits are a very small component in the retirement income plan. It is worth noting, however, that the less guaranteed income that is generated by Social Security, or alternative sources, the more vulnerable the investment portfolio is to poor performance. Moreover, collecting benefits early means foregoing the inflation-adjusted growth and any cost of living increases that are earned. Outperforming the Social Security deferral benefit alone is a very high hurdle for any investment manager to overcome, particularly in today’s low interest rate environment.
A Taxing Debate
While tax deferred growth of retirement assets may be compelling, the benefits of tax-deferred growth of Social Security income can be even better. In most cases, retirement plan assets are fully taxable at ordinary income tax rates while, even for those with very high income, only a portion of Social Security benefits are taxed. Taking retirement plan assets to defer Social Security benefits results in lower required minimum distributions, which can in turn help shield a larger portion of the Social Security benefits from taxation.
This, of course, means having less retirement assets and liquidity, which presents an enormous psychological hurdle for many retirees. The angst of having less cash in the bank may, however, be tempered by the larger check that arrives each month.
Back to Bill
In our last blog post we introduced you to Bill, a 65-year-old man that would like to retire next year. Bill has a retirement plan valued at $1,000,000 and his Social Security primary insurance amount (PIA) is $2,000 per month. Bill was never married and expects to live to normal life expectancy. He requires $70,000 per annum adjusted for inflation for expenses and resides in a state that does not assess state or local income taxes. Our Social Security analysis suggests that he should consider a strategy of deferring his benefits until age 70, earning a 2 /3 of 1% additional benefit for each month of deferral. The cumulative benefit is an additional $53,662 of income, if he lives to life expectancy.
Assuming that Bill earns a 5% annual rate of return on his tax-deferred retirement portfolio, and his expenses grow at 3% per annum, if he begins collecting Social Security at full retirement age his portfolio will last until age 84. He will continue to collect Social Security benefits if he lives beyond life expectancy.
What if, instead, Bill waits until age 70 to collect his Social Security benefits and uses his retirement assets as a bridge from ages 66 to 70? In this case, Bill’s retirement portfolio would last approximately 18 months longer. As in the previous scenario, Bill would continue to collect Social Security benefits if he lives beyond life expectancy, but in this case they would be significantly larger.
Bill’s case illustrates the importance that Social Security can have in the retirement income plan, and the potential benefits of delayed filing. It’s important to note that changes in tax or inflation assumptions and the introduction of tax-free or taxable retirement assets could provide further flexibility and better results. Marriage and the potential eligibility for spousal benefits can also make deferring retired worker’s benefits much less painful. New and improved computer software make quick work of the number crunching
It is important to remember that the decision of when to retire and when to collect Social Security benefits are not inexorably linked. Every retiree wants to get their “fair share” from the system, but that concern should be secondary to running out of money. Generally, the more dependent a retiree is on Social Security for their retirement income the greater the impact of delaying benefits.
For many retirees, Social Security benefits represent their largest asset- often worth more than their house or retirement plan. A combination of disappearing pensions, inadequate savings and increased longevity have transformed Social Security from an ancillary benefit to a core component of retirement income. Getting it right is more important than ever.
John Male, CFP®
The Gassman Financial Group
G&G Planning Concepts, Inc.
The Retirement Maven ™
9 East 40th Street, Suite 1500
New York, NY 10016
Tel: 212-221-7067 Ext. 17