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WSJ Your Money Briefing
Common Social Security Mistakes and How to Avoid Them
00:11:07
People rely on Social Security as a major source of funds in retirement, and mismanaging it can have a big impact on their personal finances. WSJ contributor Neal Templin joins host J.R. Whalen to discuss common pitfalls like claiming benefits too early, and the so-called "tax torpedo."
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Here's your money briefing for Monday, May 10th. I'm J.R. whalen for the Wall Street Journal. We Once you retire, Social Security will be a major source of funds to help you live comfortably. Sounds easy enough. But if you make a mistake in planning for Social Security, it can cost you dearly right when you need it the most.
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So if you want to get the very most longevity insurance, you can get the best protection against a very long life where you may run out of assets. The best thing you can do is to make your Social Security check as large as possible.
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In a moment, our contributor Neil Templin will run through some common Social Security pitfalls to avoid, from retiring too early to fears of earning limits and something called the tax Torpedo. Yeah, that's coming up after the break.
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This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day. Washington Wise from Charles Schwab is an original podcast that unpacks the stories making news in Washington. Listen@schwab.com Washingtonwise.
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Whether you've just started working or you're getting ready to retire, you've had Social Security deductions taken out of your paycheck. That system is there to make sure you've got an income even after your working years are over. But there's a lot more to Social Security than just paying into it now and and getting monthly checks later. And it's easy to make mistakes when planning your retirement finances. WSJ contributor Neil Templin has been keeping track of these, and he joins us now to talk about them. Neal, thanks for being with us.
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My pleasure. Nice to be here.
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Okay, Neil, you spoke with several experts about this topic, and they said a very common mistake is to start claiming Social Security too early. Can you tell us about that?
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I mean, one way of viewing Social Security is it's a very generous annuity or longevity insurance that will pay out for the rest of your life and has a lot of things in its favor. It's inflation adjusted. It has survivor benefits, and for a typical household 55 to 64, it is like 60% of their retirement assets are the net present value of their Social Security. Thus, it's in your interest to make your Social Security check as large as possible. And the way you do this is you wait as long as possible to claim it. If you claim it 70 versus 62, you get at least 76% more benefits. Your check is at least 76% larger. So it's a huge difference. And that's a lifetime check. You're going to get, you know, 76% bigger check for the rest of your life. And it's not just you. What happens is, if you're the top earner in your family, when you die, if you're married, that will go to your spouse, and your spouse will get that larger check for the rest of his or her life. So if you want to get the very most longevity insurance, you can get the best protection against a very long life where you may run out of assets. The best thing you can do is to make your Social Security check as large as possible.
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Yeah, that's a big issue when it comes to people's finances down the line. Are Americans getting that message?
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They are, to a degree. You know, the number of people waiting is growing, but still there are fewer people that are taking it at age 62. But there still are not a huge number of people that are going all the way till 70. And it's only like 6% of people go all the way till 70 to maximize their benefits. So, I mean, a lot of people, I think, worry about the wrong thing. Gee, I put all this money into Social Security. I. I want to start taking it out. What happens if I die early? And this is insurance. When you buy insurance on a house, you don't think I'm wasting money. The house isn't going to burn down. You are buying insurance in the event that your house catches on fire or something happens to it. And this is the same deal. If for some reason you die early, you know other people are going to live much longer. And you just don't know whether you're going to be a person that dies soon after retirement or a person that lives till 100. And if you're in that latter category, this is the best insurance you can get to protect yourself or your spouse.
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B
Now, in addition to deciding when to start claiming Social Security, everyone has to make a separate decision as to when to stop working. Why is that decision significant?
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A lot of people, as soon as they stop working, essentially don't have savings, so they're going to have to start claiming Social Security. So if you want to make your Social Security check as big as possible, for a lot of households, that means working as long as possible. You know, there's another issue, and it just depends on your earning history. But Social Security, the size of your check is based on your 35 top earning years. So if you're making a good salary in your 60s, working several more years will result in a bigger check. But I should add that there are still other people that do not need Social Security early, but take it early just because they want to make sure they get their money out of the system. And that's just generally not financially a smart decision unless your health is poor and your spouse's health is poor.
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Some people also worry about the fact that there are limits on Social Security contributions based on what they earn around the time that they retire. How does that work and is it something that people should worry about?
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So Social Security has what's called an earnings limit for people before they hit full retirement age, which depending on your age, is between 66 and 67 years old. And if you earn money before you hit full retirement age and you earn more than currently this year, more than 18,960 doll, the government will reduce your benefit for a dollar for every two dollars in excess of that amount. So a lot of people will actually not go back to work, you know, because of that, because they think, well, this is terrible, I'm earning money and all it's doing is reducing my Social Security benefit. I've already started drawing Social Security. But that's a mistake because you will get that money back. The way it works is your benefit is reduced by that amount before full retirement age. But when you hit full retirement age, it then increases your benefit above what it would otherwise be to compensate for the money they took away. It's almost a chance to do a do over. It creates a larger pension, much as working longer does. Let's say you lost your job last year during the pandemic and the pandemic induced recession and you needed to take Social Security. Now the economy's bounced back much quicker than people thought and you're offered a job again. Don't worry about the earnings limit. Go take that job, earn money, take it, you know, as long as you want and it will help you down the road with your Social Security benefit. So it's like a do over. Don't let it stop you.
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Now people often have additional retirement savings accounts once they stop working. 401k, maybe IRAs completely aside from Social Security. So how should people prioritize which funds to tap into and when?
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Some people will start drawing Social Security early, so, so they don't have to take out of their retirement accounts their tax deferred accounts. I think the more conservative measure is to spend down your accounts to get the Social Security Check as big as possible. You just don't know what markets are going to do in the future. And you need to have, it's really important to have an adequate base of safe, secure income to cover your expenses and not be dependent upon turbulent markets. So even if it means spending down some of your 401k to delay taking Social Security, it is generally a good idea.
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All right, I have to ask about taxes you knew Uncle Sam was going to get mentioned in this interview. Social Security is considered taxable income, at least in part. What are some of the tax pitfalls that people often overlook?
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I mean, one of the biggest is called the tax torpedo. Everything about Social Security is complex, including its taxation. And the maximum you can get taxed on your Social Security is 85% of your benefit, but it's a phased in taxation. And there are certain points where you're just beginning to enter the phased in portion of the taxation and every dollar you earn will essentially you'll get taxed on that dollar through normal tax and then it'll cause another 85 cents of Social Security income to be taxed. And so effectively, if you're in like a 22% bracket, it makes it into a 40 over a 40% bracket because of this extra Social Security taxation. So, you know, it's not the end of the world. But it just there are in certain income ranges people could really benefit from taking money from any way they try to keep their income below a certain level to avoid getting that hitting that Social Security tax torpedo.
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Yeah, a lot of tax deferment issues to keep in mind, whether it's Social Security or a 401k that you're thinking about.
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Right. I mean, the conventional wisdom has been to delay taking tax deferred accounts as long as possible to allow them to grow as long as possible. But there's another way of viewing it, and that is always being sure to fill out your, your brackets. In other words, if you're in a low tax bracket early in retirement, which can be the case for a number of people that are living on after tax investments and haven't yet begun receiving Social Security or taking required minimum distributions from accounts, sometimes you want to be taxed actually more at that stage when you're in the low tax bracket rather than avoiding taxation as long as possible and having to pay and having draw money out of a tax deferred account and get taxed at a higher rate later in retirement. So it's a little bit contrary to the conventional wisdom, but sometimes early in retirement, particularly before you Begin taking Social Security. It can make tax sense to take money out of a tax deferred account.
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You know, I see now why financial planners get paid so much money. There are a lot of complex details that people really shouldn't miss.
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It's very complex. And the rules for Social Security are just hundreds of pages. And the more you learn about it, the more you learn what a complex and byzantine system it is. But the bottom line is it gives a lot of protection to people. So it really is worth spending a little time to understand the basic rules or working with a professional. It can help you maximize your benefits.
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Now, before going into the details with a financial advisor, are there resources people can use for the basics, like even just finding out how much in Social Security benefits they've accumulated?
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Yeah. The Social Security Administration sends forms yearly talking about what they believe based on your current earnings history, what sort of benefit you should have at your full retirement age. And you can also create an online profile. I've got one you can go and check and it'll tell you, and it's constantly getting updated that you're going to get this much money at full retirement age. And from that full retirement age, then you can sort of work forwards or backwards to get how much you'd get money you'd get at different ages. I think the Social Security Administration also gives you a couple of different points, but here's the deal. After you hit full retirement age, your benefit goes up by 8% per year. So if you have a full retirement benefit of $1,000 of age of 67, then you would get $1,240 or 24% above by waiting till 70.
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All right. That's WSJ contributor Neil Templin. Neil, thanks for coming on the show.
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My pleasure.
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And that's your Money briefing. I'm J.R. whalen for the Wall Street Journal.
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This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day. Washington Wise from Charles Schwab is an original podcast that unpacks the stories making news in Washington. Listen@schwab.com WashingtonWise.