It is critically important to be competent and persuasive to answer the all-important question that individuals who are approaching retirement (or are in retirement) routinely ask: “When is the best time to start taking my Social Security income?”
The answer in most cases is very simple: take as much Social Security income as you can, as soon as you possibly can.
MYTH #1: If You Wait, You Get More
The older you are when you start, the more Social Security monthly income you receive. The Social Security Administration thus entices people to wait longer. But let’s look at this a little deeper by using an example. Assume at age 62 a person’s Social Security monthly income will be $1,000 per month. However, if they wait until age 67, this monthly income increases to $1,500. More is better, right? However, to get this extra $500 per month, this individual had to wait five years. So, if we calculate the income this person did not receive, it comes out to $60,000 ($1,000 per month for five years).
The proper thing to do in this example is to analyze the pros and cons of waiting five years for the extra $500 per month. Using the example, the pros are simple. Waiting earns you an extra $500 per month, which is a good thing.
Now let’s take a look at the cons. How many months does it take someone to simply break even from a financial perspective? Well, if you divide $60,000 (lost income) by the $500 (additional income), it comes out to 10 years. However, the story does not end here. Remember, by waiting five years this person is now 67 years old. Therefore, in order to accurately calculate the lost income and “break-even” point, you also have to add in the five years this person waited (from age 62-67). Therefore, it really takes this person 15 years to simply break even and justify deferring their Social Security income.
“But wait, there’s more….” Some other key factors to consider are:
- Five years of potential lost interest or growth from the monthly income
- Five years of lost ability to spend and enjoy the extra monthly income
- Countless years of lost income due to a possible critical illness
- Countless years of lost income due to a premature death
- Countless years of lost income due to an unexpected illness or death of a spouse
- Countless years of reduced purchasing power as a result of inflation
- Countless years of lost income due to the potential for taxes to go higher
- Countless years of lost income due to potential reductions, changes or even the elimination of Social Security income
MYTH #2: My Income and Taxes Will Be Lower in Retirement
Far too often individuals, couples and financial professionals make major mistakes as a result of basing a financial decision upon tax consequences. (For the sake of brevity, I will not go into the various ways and rates Social Security income can be taxed.)
Most of us have heard the argument, “I will be in a lower tax bracket when I retire.” This statement never ceases to amaze me and, more importantly, disturbs me for several reasons. First, why do so many aspire to have a significant “pay cut” reduction in their income once they reach retirement? Retirement is commonly referred to as the “golden years.” This implies that you worked hard and long enough to have saved enough gold to live like kings and queens.
Second, when are you more likely to spend more money—while you are working or when you are on vacation? Since the obvious answer is while on vacation, isn’t it fair to say that retirement is supposed to be a wonderful, long and enjoyable vacation from work? Therefore, retirement is arguably the time when you have earned the right to spend and enjoy your hard-earned wealth and income.
Yes, more income does mean more taxes, indisputably. However, here is my theory on taxes: “Make a lot of money, pay a lot of taxes, and repeat the process.”
So again, let’s again analyze the pros and cons. The main pro for deferring Social Security income is simple. More income means more taxes, and nobody likes paying more taxes. According to Forbes.com, below is a quick rundown of what the Federal income tax brackets are expected to look like in 2012:
Married Filing Jointly
|10% Bracket||$0 – $17,400||$0 – $8,700|
|15% Bracket||$17,400 – $70,700||$8,700 – $35,350|
|25% Bracket||$70,700 – $142,700||$35,350 – $85,650|
|28% Bracket||$142,700 – $217,450||$85,650 – $178,650|
|33% Bracket||$217,450 – $388,350||$178,650 – $388,350|
|35% Bracket||Over $388,350||Over $388,350|
Now, let’s take a look at the cons using an example based on the tax brackets above. In 2012, Couple #1 earns $50,000 per year. Couple #2 earns $500,000 per year. Couple #1 paid less in Federal taxes (15%) than couple earning $500,000 per year (35%). In fact, on the surface (excluding any deductions and state income taxes) Couple #1 paid a mere $7,500 in taxes, while Couple #2 paid a whopping $175,000 in taxes. However, which of the following retired couples would you rather be?
Couple #1: Net Income (after taxes) is $ 42,500 per year, or $ 3,542 per month
Couple #2: Net Income (after taxes) is $325,000 per year, or $27,083 per month
“But wait, there’s more…” Some other key factors to consider are:
- Today we are in the sixth lowest tax bracket in history.
- A large majority of people today believe tax rates are going higher.
- There are many reasons a person’s (or a couple’s) taxable income can actually increase in retirement (employment income, asset and income growth, inheritances, spouse’s death and rental income, IRA required minimum distributions, loss of deductions, and more).
A Bird in the Hand…
When it comes to determining the right time to take Social Security income, too many individuals, couples and financial professionals conclude it is in their best interest to delay beginning to take Social Security income so as to increase their future income and/or minimize their income tax.
In most cases, choosing to defer one’s Social Security income for a higher amount in later years is a financially poor decision. Since nobody has a crystal ball with regards to life expectancy, future tax rates, or how much their future retirement income will be, hoping to pay less income tax is not a good argument for delaying Social Security income either.
This article’s goal is to help clarify some of the Social Security facts versus myths and, more importantly, empower and educate more individuals, couples and financial professionals to take a comprehensive look at the net effect to their wealth from delaying such an important decision.