In our most recent blog post, we discussed the import role that Social Security benefits play in the retirement income plan of most Americans, and provided a framework for understanding the various types of benefits. While sometimes dismissed as inconsequential, Social Security benefits provide a critical source of guaranteed income for most retirees. To wit, Social Security benefits comprise over fifty percent of the retirement income for two-thirds of current retirees and, critically, allow many seniors to live independently. In this blog post, we review how Social Security benefits are taxed and provide guidance on how and when to claim benefits. We encourage readers to review our previous blog post, A Primer on Social Security Benefits, as it provides important information that will aid in your understanding of the strategies outlined below. You can find that blog entry by clicking here.
To begin, an understanding of Social Security retirement benefits requires reviewing a few common terms that are key to making informed claiming decisions.
Social Security benefits represent an important, but often overlooked, component of retirement income planning. As a source of guaranteed income that cannot be liquidated, it is not often thought of as an asset. In fact, it is the single largest financial asset for many retirees, providing benefits for approximately nine in ten individuals age sixty-five and older and covering ninety-six percent of working-age adults.
Distributions from retirement accounts (such as IRAs and 401ks) are not only considered part of your taxable income, but are also generally subject to an additional 10% penalty for early withdrawals if you are under the age of 59 ½. However, there are a few ways to take early distributions while entirely avoiding the second penalty tax.
Here are 9 exceptions to the 10% Early withdrawal penalty:
1. IRA owner is age 59 1/2 or older
2. Death or disability of the IRA owner
3. Series of substantially equal payments over the life of the IRA owners (or joint lives of the IRA owner and beneficiary)
4. Payment to the extent qualified medical expenses exceed 7.5 or 10% of the AGI depending on the tax year
5. Payment of health insurance for certain unemployed individuals
6. Payment of qualified higher education expenses
7. Payment of qualified first time home purchases
8. Payment due to IRS levy
9. Qualified distribution made to certain military reservists
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