When should you start drawing Social Security? That can be a difficult question to answer and one with the potential to have a significant impact on your financial plan. An incorrect or inappropriate claiming strategy can result in significantly less income during retirement and can limit your ability to do forward-looking tax planning. To shed light on what goes into making this important decision, here are important considerations that can factor into when to take Social Security, along with several scenarios to help illustrate some options.

Major factors that impact a Social Security benefits strategy include:

• Age Difference: The age gap between spouses can influence optimal claiming strategy, particularly when considering survivor benefits and the timing of each spouse’s claim.
• Life Expectancy: Estimating life expectancy can help determine whether it’s beneficial to delay claiming Social Security benefits to maximize lifetime income.
• Benefit Difference: The disparity in Social Security benefits between spouses based on their earnings records is crucial in strategizing the most effective claiming approach.
• Earned Income: Continuing to earn income while claiming Social Security can affect benefits due to the Social Security retirement earnings test (RET), which may result in reduced benefits if claimed before full retirement age.
• Need for Income: Immediate financial needs may necessitate claiming benefits earlier, even if it results in reduced monthly benefits.
• Benefits Gained by Delaying Social Security: Delaying claiming benefits can create a larger window for making Roth conversions and tax gain harvesting, potentially leading to significant long-term tax savings and increased retirement income.

Scenario 1: Spouse A is Older and Has a Significantly Higher Earnings Record Than Spouse B

In this scenario, the strategy often revolves around maximizing the higher earner’s benefits to ensure a larger survivor benefit. Here’s the approach:

Strategy: Spouse A delays claiming Social Security benefits until age 70 to maximize their monthly benefit. This delayed claim increases the benefit amount by approximately 8% per year after reaching full retirement age (FRA) until age 70.

Impact: This ensures that Spouse B will receive a higher survivor benefit if Spouse A passes away first. Spouse B can claim their own benefits or spousal benefits, whichever is higher, depending on their financial needs and the timing of Spouse A’s claim.

Scenario 2: Both Spouses Have Similar Earnings Records and Are Close in Age

For couples with similar earnings records and ages, the strategy focuses on balancing immediate income needs with maximizing long-term benefits:

Strategy: Both spouses may choose to claim their benefits at their respective full retirement ages to avoid reductions. Alternatively, if they can afford to delay, they can enhance their benefits by waiting until age 70.

Impact: By claiming at FRA, each spouse receives their full benefit amount based on their primary insurance amount (PIA). If delaying, they can benefit from increased monthly payments due to delayed retirement credits, which also enhances survivor benefits.

Scenario 3: One Spouse Claims Early, Other Spouse Delays

Spouse A has a lower earnings record and might need income earlier, while Spouse B has a higher earnings record and can afford to delay.

Strategy:
Spouse A claims their benefits early (e.g., at age 62) to provide some immediate income.
Spouse B delays claiming their benefits until age 70 to maximize the benefit amount.

Rationale:
• Provides immediate income from Spouse A’s reduced benefits.
• Maximizes Spouse B’s benefits by delaying, which also increases the survivor benefit if Spouse B passes away first.
• However, Spouse A cannot switch to a higher spousal benefit later if they claimed early due to the deemed filing rule.

Scenario 4: Spousal Benefits Strategy

In situations where one spouse has little to no earnings record, the spousal benefits strategy becomes crucial:

Strategy: The lower-earning or non-earning spouse (Spouse B) should claim spousal benefits based on the higher-earning spouse’s (Spouse A’s) record. This can be up to 50% of Spouse A’s PIA if claimed at Spouse B’s FRA.

Impact: Spouse A should still consider delaying their benefits until age 70 to maximize the spousal benefit for Spouse B and ensure the highest possible survivor benefit. This approach helps Spouse B receive a higher benefit than they would based on their own earnings record.

Additional Consideration: Benefits of Delaying Social Security for Tax Planning

Delaying Social Security benefits until age 70 can create a larger window for strategic tax planning—specifically for Roth conversions and tax gain harvesting. This can be particularly beneficial for individuals with large tax-deferred accounts and substantial gains in taxable accounts.

Roth Conversions

Converting funds from a traditional IRA or 401(k) to a Roth IRA can be advantageous, as it allows for tax-free growth and tax-free withdrawals in retirement. By delaying Social Security benefits, you can perform Roth conversions during years when your taxable income is lower, potentially resulting in a lower tax bracket.

Strategy: From retirement age until you begin receiving Social Security (and potentially until Required Minimum Distributions (RMDs) start at age 73), you may have lower taxable income. This period is an ideal time to convert traditional retirement account funds to a Roth IRA at a lower tax rate.

Benefit: Reducing the balance in tax-deferred accounts through conversions can lower future RMDs, thereby reducing taxable income later in retirement and potentially lowering your overall tax liability.

For further reading on Roth conversions, consider checking out these blogs, which provide information on the benefits and strategies for executing Roth conversions effectively: “Should You Consider a Roth Conversion?” and “Roth Conversions – Common Pitfalls & Misconceptions.”

Tax Gain Harvesting

Selling investments in taxable accounts to realize gains while in a lower tax bracket can reset the cost basis of your investments and potentially reduce future capital gains taxes.

Strategy: During the window before claiming Social Security benefits, you can sell appreciated assets and repurchase them, thus harvesting gains at a lower tax rate. This process resets the cost basis to the current market value.

Benefit: Harvesting gains when your income is lower can result in paying a reduced capital gains tax rate, or possibly none at all if you fall within the 0% capital gains tax bracket.

Example Scenario for Tax Planning

For this scenario, let’s consider a hypothetical individual who retires at age 65 and plans to delay taking Social Security benefits until age 70. This individual has substantial savings in a traditional IRA and a taxable brokerage account with significant unrealized capital gains.

Strategy: From age 65 to 70, the individual performs annual Roth conversions, converting only enough funds to stay within a lower tax bracket. They also strategically sell appreciated assets in their taxable account to take advantage of the 0% capital gains tax bracket.

Outcome: By the time they start receiving Social Security benefits at age 70, they have significantly reduced the balances in their tax-deferred accounts, resulting in lower RMDs. Additionally, they have reset the cost basis on their taxable investments, reducing future capital gains taxes.

Summary

Determining the optimal time to draw Social Security benefits requires careful consideration of a variety of factors such as age difference between spouses, life expectancy, benefit disparity, earned income levels, immediate income needs, and the possible tax advantages of delaying benefits. By understanding these key considerations and exploring common scenarios, individuals can make informed decisions that align with their overall financial plan and maximize their retirement income.

Delaying Social Security not only increases monthly benefits but also opens up valuable opportunities for Roth conversions and tax gain harvesting, which can lead to significant long-term tax savings and a more secure retirement. Feel free to reach out to us and receive guidance tailored to your specific circumstances and goals, ensuring that you make the most of your Social Security benefits and tax planning opportunities.