← Ready For Retirement
Loading summary
Transcript1 lines
- [00:01]
A
Most people think the right age to collect Social Security is when you're going to get the biggest check. But after years and years of working with real retirees, I can tell you the right age isn't just about maximizing the spreadsheet. It's about what fits best into your life and your overall financial plan. So today I'm going to show you why collecting too early or even too late can quietly cost you far more than you realize. The important thing to realize about Social Security is that too often it's presented just as a trade off or it's presented just as a break even, where if you live past some age, you're better off delaying your benefit. But if you pass away before that age and you're better at collecting early, that's part of it. But that's a very narrow part of it. And what I want to show you today is how Social Security, your decision of when to collect, impacts all of your actual retirement strategy. And when I say all of it, I mean it impacts your taxes, it impacts your portfolio, impacts your surviving spouse's ability to protect their income. Those are the things I want to cover today to help you understand when it might be best for you to take your benefit. So to understand this in its proper context, let's back up and understand. How is Social Security calculated in the first place? You have what's called a primary insurance amount. That's the amount that you'll receive at your full retirement age. For most of you, your full retirement age is going to be somewhere between the ages 66 and 67. My guess is for most of you watching, it'll be at 67. So how is that primary insurance amount calculated? Well, it's calculated by Social Security taking a look at your highest 35 years of earnings. So over the course of your working lifetime, maybe you had some odd jobs in high school, maybe you had some odd jobs in college. Maybe you work sporadically in your 20s, 30s, 40s. Whatever it is, Social Security looks at your top 35 years of earnings. Now, I know what you're thinking. You're probably earning a whole lot more today than you are 30 years ago. That's why Social Security inflation adjusts this. They look at what's called your average indexed monthly earnings. So taking inflation into account, how much did you pay into Social Security every single year? Social Security then uses all of that and it goes through a calculation that helps them calculate or helps them determine how much you are eligible for at your full retirement age. That's called your primary insurance amount. Your PIA is what you are eligible for at your FRA or your full retirement age. Now, what if you don't have 35 years of earnings? We don't have 35 years of earnings. Let's say maybe you have 30. Social Security will use zero for those remaining five years. And that will be averaged then across the 35 years that they're looking at to calculate your benefit. So that's how your benefit is calculated at your full retirement age. Now, you can collect early all the way as early as 62, or you can wait all the way until 70. Now, how does that impact you? Well, if you collect early the three preceding years leading up to your full retirement age, there's an 8.3% annual reduction in your benefit. So for example, if your full retirement age is 67, but you collect at 66, you will receive an 8.3% reduction in your primary insurance amount. So by collecting early, you're cutting into your benefits by 8.3%. That happens for the first three years, by the way. It's actually a monthly calculation. So if you collect six months early, it's one half of that 8.3% that you're accepting as a reduction to your benefit. But that's the reduction for the first three years prior to full retirement age. Then the years after that, you're accepting a 5% reduction. So any year you collect early, you are accepting a lower benefit. Now, that's not necessarily as bad as it might seem. And I'm going to explain in just a second. You may want to do that, you may not want to do that, but that's how the formula works. Now, the opposite is true. If you delay your benefit past your full retirement age, you get something called delayed retirement credits. And delayed retirement Credits are an 8% increase to your Social Security benefit every year that you delay collecting after your full retirement age. So if your benefit at 67 is $2,000, then your benefit at 68 would be 8% than that $2,160. That's a lifetime locked in amount that you're now receiving. Now, that 8% increase is helpful, but it's not a true 8% return on investment like most of us think it is. Let me illustrate why. I'm going to give you an option. You can either take $1 this year and $1 next year, or I can give you $0 this year and $2 next year. Now, if you say, wow, $2 next year, that's a 100% rate of return on what I would have received if you in the first example, you can see how you'd be incorrect in doing that. You're receiving the same amount in both of these, but in one, you're deferring your benefit, you're delaying your benefit, and therefore your benefit is higher. Well, that same concept applies to Social Security. From an actuarial standpoint, Social Security is trying to say, how do we normalize this benefit such that you would receive the same amount over the course of a normal life expectancy? Social Security looks at this from the standpoint that if you wait longer, we'll pay you more. So you collect early, it will pay you less. All in all, on average, we're planning to pay out about the same amount of benefits for an average life expectancy. So it's not truly an 8% rate of return like most people think, which doesn't mean it's a bad thing. It's just don't necessarily equate delayed retirement credits with the same as getting an extra 8% return on investment that you might get in other areas. So that's just the math so far that's setting the context of how you receive benefits and how much benefits you might receive. Now let's look at pros and cons of collecting at different ages. Age 62 if you collect at age 62, you might think that it's like a freedom now approach. Sometimes you just need the money. If you don't have income coming in, if you're not able to work, if you need to meet your needs, you have the option of collecting Social Security. Now that's immediate income. You have it, you own it, it's yours to spend. You're locking in a lower benefit. So don't make this mistake prematurely or don't make this mistake without looking at the full context. Are you still going to be okay long term? But that's the freedom now approach. Pros and cons to this. The downside. The con, of course, is you're accepting a lower benefit. The other downside is there's an earnings limit. So if you turn 62 and you start collecting Social Security but you're still working, you have a cap on how much you can earn before Social Security begins withholding some of your benefits for 20, 25, that cap is $23,400. Every $2 that you earn above that threshold, Social Security withholds $1 in benefits. So for example, if you collect Social Security and you earn exactly $33,400, you are $10,000 above the cap. So because you're $10,000 of earnings above that cap, Social Security will withhold half of that. So $5,000 from your benefit. So if you're continuing to work and you're collecting early, you might want to reconsider that decision. It might make more sense. In many cases, it does make more sense to delay your benefits unless you're earning an amount that's less than that cap. Now, just to make sure, we're showing all aspects of this, if Social Security does end up withholding some of your benefit and it ends up getting paid back to you down the road, but if you're going to have it withheld anyways, reconsider. Does it even make sense collecting in the first place? Now, the other downside to this, this only applies if you're married, is if you pass away first, your spouse is eligible for a much lower survivor benefit. One of the best things about Social Security is the way you can use it not just for your income, but to protect a surviving spouse. If you collect at 62 and you pass away first and your spouse did not have a higher earnings record than you, your spouse's survivor benefit is locked in at that lower amount, too. So if you're going to do this, make sure that you have contingencies in place. Make sure there's a plan in place to make sure this is something that you could afford and your spouse could afford, depending upon timing of when you both pass. Now, here's the potential positive of this. I mentioned the one positive, which is, of course, if you need the money, you have the money now. You can spend the money now. What some people fail to grasp is this. Let's assume you retire at 62. While you retire at 62, you need to pull income from somewhere. And some people look at Social Security and say, I don't want a reduction. I don't want to collect a lower benefit today. That benefit is going to keep growing if I delay it, if I defer it. And they see that, and they know exactly what that deferred growth is going to be. So they do that. What they fail to take into account is this while you are deferring Social Security, you must be living on something. So if you're pulling income from your portfolio, yes, you're increasing this income on this side from Social Security, but you're permanently reducing your portfolio size and there's an opportunity cost for what you're pulling out of your portfolio, and that that amount is no longer going to be growing for you long term. So if you hear people talking about a break even Age chances are very good. They haven't actually done the entirety of the math here where it's not just the break even of Social Security. In a vacuum, you have to think through what's the opportunity cost and what's the break even. When you factor in the impact of earlier distributions from your portfolio, knowing that those are withdrawals that can no longer keep growing and compounding for you. So those are some of the pros and cons of collecting at 62. The next stage some people might think about collecting is at full retirement age. So 67. You might consider this the balance ground, the middle ground benefits of this. You've achieved your primary insurance amount, you've hit full retirement age. You get what's considered your full benefit, not your max benefit, because you could increase this even more, but your full benefit, your primary insurance amount. At this point, the earnings cap goes away. Leading up to your full retirement age, there is still an earnings cap. But as soon as you turn full retirement age, you can earn as much as you want from outside income and it's not going to cause Social Security to withhold any of your payments. So that's the benefit of this, if you can collect and earn outside income if you choose to do so. So if you're of average health, of average longevity expectations, this could be a good time to take your benefit. It's kind of that middle of the ground option. It's not the earliest, it's not the latest, but you're free to take that. You're collecting your full amount. And here's the nice thing about Social Security. When you have Social Security coming in, the tax benefit of Social Security is such that most states don't tax it. I'll check with your individual state because some do, but most states don't tax it. And at the federal level, a maximum of 85% of your Social Security benefit will be subject to federal taxes. So when you do begin collecting it, understand that $1 from an IRA withdrawal is, is not quite as valuable as $1 from a Social Security benefit. Valuable in the sense that that dollar is the same amount, but the after tax amount of each of those is going to be different. You will in almost all cases have more money after taxes from $1 of Social Security than you would from $1 of an IRA or 401k distribution. Then you can wait until age 70, play the long game. And by the way, you don't have to collect at 62 or 67. At 70, you can collect at any age that you want. These just tend to be the three major milestones that most people think about. But any age, even in between this. But at age 70, pros and cons. The pro is you've absolutely maximized your benefit. Your benefit is at least 24% higher than it would have been at your full retirement age because you've taken full advantage of delayed retirement credits. This strategy typically works best in the following cases. Number one, for those of you who are in good health and have high longevity expectations, you think you're going to live a long time. It is true that the longer you live, the more it makes sense to delay Social Security. So if you knew for certain you were going to live into your 90s or 100, even by delaying until age 70, you've maximized your benefit and that benefit becomes an income floor for you for as long as you live. The other benefit here is by delaying until 70, that opens up a great window for you to implement a Roth conversion strategy. Let's assume you retire at 65, and from 65 until 70 you're delaying Social Security. You're living on your cash and brokerage accounts. Your tax bracket is likely going to be very low. If you're one of those investors or savers that's accumulated quite a bit of money in your portfolio via your 401k or your IRA. Congratulations, you did very well there. RMDs are going to be a bigger issue for those of you with larger pre tax account balances. So if you have 50,000, 100,000 in an IRA or 401k, RMDs shouldn't be such a big deal for you. It's not going to materially make a difference for the most of you. But if you have $2 million, $3 million, $4 million, the 401k or IRA, then the required distribution you'll have to take from that is going to be substantial. Most likely. That's why so many people who are in that situation, so much of the work that we do with clients here at Root Financial is working with those individuals to say what can you start doing in your early to mid-60s to start converting pieces of your pre tax account to Roth accounts and do so in that tax planning window before Social Security started at age 70, before required distributions kick in, before, but after you retire, when you're in a lower income tax bracket. Those are the perfect opportunities to implement a Roth conversion strategy. So you can start to see how your Social Security decision isn't just about maximizing income. It also impacts your portfolio and the growth on it. Or lack thereof. And it's going to impact your tax strategy, either freeing you up or compressing the amount of time that you have to implement certain tax strategies. So with that context of mind, let's look at some quick hitting decisions of when might certain strategies make sense. If you don't have a long life expectancy, if you're not in great health, probably makes sense to collect earlier. You're not going to maximize your benefit, but you get that money today. That money today is not money that will go with you once you pass away. So if you want that money and you're not going to live a long time, the better off you're going to be collecting early. But consider the impact of a spousal benefit or a survivor benefit with that. Now the opposite of that is what if you expect to live a long time? None of us of course, has any idea how long we will live. But the longer you live, the better off you're going to be on average delaying that benefit to later and later years. Now here's an interesting angle that some people don't consider. What if you retire, you're delaying your benefits and then the market drops. When the market drops and you're living on your investments, that can be a very scary place to be. That can be a dangerous place to be if you spend too much of your investments while they're down in value. You could use Social Security as a part of your dynamic strategy to say, I was planning to collect later, but there's a market drop here. I might pull that benefit up not because that changes anything about the break even age, but, but by doing that, that allows me to avoid spending my investments at the worst possible time. So you can use Social Security as this additional lever in your plan to say if there's a downturn. Even if I'm planning to delay, I can always change. I can always pivot and potentially start one benefit and maybe even both benefits if you're married. So the takeaway is this. Instead of just asking how can I maximize my Social Security benefit, ask instead, how does this fit into my overall income plan, tax plan, investment plan, and most importantly, life strategy? That shift, that shift from a date strategy to a life strategy is what changes. It's from a best guess to an actual strategy that's going to reinforce your plan and allow you to do more of what you want to do in retirement. It.