Theory Behind taking Social Security Early?

[sengsational]

The problem with this article is that it assumes that 'rich people' have to take their income from tax deferred accounts and then pay more taxes. This could not be further from what usually happens. Most 'Rich People' have substantial assets in their Taxable accounts and pay nothing in taxes when they spend them down.


This was my objective when I delayed to age 70.... Mostly the only income I've had in the last 5 years is my Roth conversions. One of the primary reasons I have delayed S.S. is so that I would reduce taxes. Quite the opposite of this article. I have taken advantage of staying in a low tax bracket and have moved quite a few $$$ into my Roth Accounts.

Based on what I was able to tease out, the couple had 1.3M. Not terribly rich for 62 year olds looking for over 30 years of retirement. Yes, the article scenario is not very realistic, given the couple has no Roth funds and there is no mention of conversions.

actually if you want to retire early, you are very limited in the amounts you can stash in tax deferred accounts. I always contributed the max, but the brunt of my savings went into taxable accounts. So not in my case, not even close!

For someone 62 now, they had more opportunity to save tax deferred; for someone 10 years older, they may not have had as much opportunity to save tax deferred since 401k plans we're not implemented during a large fraction of their careers. For the self employed that came along late enough, the SEP allowed huge tax deferred savings. Can't say I got too much mileage out of that, but I did get some.

 

[Independent]

This is the table I used.

https://www.ssa.gov/oact/cola/examplemax.html

Had he took SS at 2016 at FRA, he would have received $2491, today in 2018, he would have received $2549. But I think he gets a lot less than that, but above $2000 when he started, going by memory. I don’t remember the exact amount.

I think you misread something, it’s not $5000 per month, it’s $5000 per year. Between $400-$500 per month.

I understood that the $5,000 is an annual number.

I don't think the issue is retiring at 64 1/2 instead of 65. The reduction factors just aren't that big. I'll guess that he did not have "steady earnings at the maximum level since age 22". (Actually, he only needed 35 years at the maximum to get those numbers.) Did he really exceed the wage cap for 35 years?

 

[Fedup]

I understood that the $5,000 is an annual number.

I don't think the issue is retiring at 64 1/2 instead of 65. The reduction factors just aren't that big. I'll guess that he did not have "steady earnings at the maximum level since age 22". (Actually, he only needed 35 years at the maximum to get those numbers.) Did he really exceed the wage cap for 35 years?

He didn’t work here 35 years. I think that’s the probably the reason.
I now feel better that we didn’t miss out by a hair for a large chunk of money.

 

[ScottS]

I'm in the take it somewhat early camp. Single and my family's hereditary doesn't lean towards living into the 90's and beyond.
I've ran several scenarios in Firecalc and a few other calculators and the difference between 65 and 70 was not significant in my situation. It was only a 10 or 20 thousand dollars difference of the final amount at the end of 30 years. Not enough to significantly improve my situation by waiting.

 

[Independent]

He didn’t work here 35 years. I think that’s the probably the reason.
I now feel better that we didn’t miss out by a hair for a large chunk of money.

Thanks, that seems to clear it up.

 

[Independent]

I set this guy's scenario up in i-orp.
...
Generally the i-orp scenario was this: Both age 62, 30 year plan (ending at 95), both have K$650 in their 401k and nothing in taxable, nothing in Roth, both have PIA of 25K/yr.

i-orp is always something of a black box to me. So, I took your setup and did my own math.

The result is that, yes, you can lower FIT at ages 62-65 by taking SS at 62. However, that also raises taxes at ages 66+. In this particular case, it's pretty extreme.

These are the start-at-62 numbers, for all years, ignoring inflation.

$37,500 -- SS benefit (75% of $50,000)
$52,000 -- IRA withdrawal (4% of $1.3 million)
$28,738 -- Taxable portion of SS, per FIT worksheet
$80,738 -- Adjusted Gross Income
$54,138 -- Taxable income, after standard deduction of $26,600 *
.$6,116 -- Tax, per tax rate schedule
$83,385 -- After FIT spendable income

These are the start-at-66 numbers, for years 62-65

$00,000 -- SS benefit (75% of $50,000)
$90,695 -- IRA withdrawal (backed into this to provide equal after tax income)
$00,000 -- Taxable portion of SS, per FIT worksheet
$90,695 -- Adjusted Gross Income
$64,095 -- Taxable income, after standard deduction of $26,600 *
.$7,310 -- Tax, per tax rate schedule
$83,774 -- After FIT spendable income

Yep. The IRA withdrawals have to be $38,695 bigger to cover the missing SS.
Part of this is just the SS benefit of $37,500. The other $1,195 covers the extra tax.

Now, the start-at-66 numbers, for ages 66+ (again, ignoring inflation)

$50,000 -- SS PIA
$36,753 -- IRA withdrawal (backed into this to produce equal after FIT income)
$21,090 -- Taxable portion of SS, per FIT worksheet
$57,843 -- Adjusted Gross Income
$31,243 -- Taxable income, after standard deduction of $26,600
.$3,479 -- Tax, per tax rate schedule
$83,774 -- After FIT spendable income

Now the IRA withdrawals can be $15,247 lower, because the SS benefit is bigger.
Part of this is just the additional SS benefit of $12,500. The other $2,747 is the tax savings.

So deferring SS to age 66 led to an extra $1,195 of annual taxes for four years. And, led to reduced annual taxes of $2,747 in the remaining years. The payback on that is pretty high.

I think this is a quirky case where the SS benefit and IRA withdrawals happen to be in that band where small changes in non-SS income lead to significant changes in the taxable fraction of SS, and hence in taxes. (Or, it's the not-so-quirky case where I've just got a spreadsheet error.)

I wouldn't expect this extreme result in general. However, it seems to me the end case where incomes are so high that 85% of SS benefits are taxable in both scenarios leads to a trade-off that is identical to the basic benefit trade-off for deferring from 62 to 66.

At any rate, the lesson is that you should expect the tax savings at ages 62-65 that come from starting at 62 to be offset to some extent by extra taxes at ages 66+.

------------------------
Caveats:
"ignoring inflation" isn't trivial in this case. Since the factors that determine SS taxability aren't indexed, the tax savings after age 66 will erode with time.

* Yes, I know that the $26,600 is for people 65 and older, so It doesn't apply at 62. I wanted to use the same number for all years to simplify comparisons. I think the over 65 number is "conservative" for this example.

 

[Cessna152]

The plan is to put the funds into an index fund total market style investment vehicle.

How does your plan, labeled A below, differ from the plan B that others who take SS early inherently must be following?

(A) Invest the $S/year social security into retirement funds F(year), drawing $X/year of living expenses from retirement funds F(year) which changes by R each year.
I.e.: F(year + 1) =(F(year)*R+S)-X

(B) Draw $X of living expenses from $S social security as well as retirement funds F as needed. F changes by R each year.
I.e.: F(year + 1) = (S-X)+F(year)*R

Mathematically identical plans, just rephrased/rearranged (I believe the money in the variables is said to be fungible; or that addition operator commutes.) The multiplier R that can be inserted at different points in the equations, but (A) and (B) can always be made identical. But B is already implicitly covered by retirement planning tools like FireCalc, so....

P.S. I suppose it is possible something in your case somehow makes your expenses non-fungible with the incomes/gains. Or I missed/elided some subtle difference.

 

[shotgunner]

Yes! I like that. We have I-Bonds and really old EE bonds that are getting 4% + cash gives us a 4 yr cushion either way. Can decide anytime to supplement with SS.

I have about 100K in I-Bonds at present. They have 17 years to go to maturity. A potential issue they present down the road is when they reach maturity, 30 years after purchase. At that point they stop earning interest. If one waits to redeem them at maturity to move them into another investment vehicle all the taxable interest will be taxable income in that year.

 

[rayvt]

I think this is a quirky case where the SS benefit and IRA withdrawals happen to be in that band where small changes in non-SS income lead to significant changes in the taxable fraction of SS, and hence in taxes.

Yes, there is a band of income where the marginal rate jumps from 15% to 28%, and then drops back down to 15% until you hit the end of the 15% bracket and it jumps up to 25% (pre-2018 brackets.)
This band runs from where 50% of the SS gets taxed up until the entire 85% is taxed.

It's complicated, you really have to plug numbers into experimental TurboTax what-if runs. When I did this with 2014 TurboTax a few years ago, using above average SS benefit ($36K/yr), this band was from $35K to $55K of non-SS income. The next bracket began at $70K of non-SS income.

At below average SS ($20K/yr) it ran from $36K to $47K of non-SS income.

I've ran several scenarios in Firecalc and a few other calculators and the difference between 65 and 70 was not significant in my situation. It was only a 10 or 20 thousand dollars difference of the final amount at the end of 30 years.

I have long said that deferring SS mainly changes the shape of your income stream but has only a minimal effect on the total amount you receive. More income when you are 62 vs, more income when you are 82. I think that an extra $20K at 62 is more useful to most people than an extra $30K at 82.

 

[misshathaway]

I have about 100K in I-Bonds at present. They have 17 years to go to maturity. A potential issue they present down the road is when they reach maturity, 30 years after purchase. At that point they stop earning interest. If one waits to redeem them at maturity to move them into another investment vehicle all the taxable interest will be taxable income in that year.

Yup, same here. When I bought them I was not thinking of tax implications so far down the road. Now I am cursing young self for picking large denominations and doing it all at the same time. That's when I was taking my financial advice from pundits.

 

[Independent]

Yes, there is a band of income where the marginal rate jumps from 15% to 28%, and then drops back down to 15% until you hit the end of the 15% bracket and it jumps up to 25% (pre-2018 brackets.)
This band runs from where 50% of the SS gets taxed up until the entire 85% is taxed.

It's complicated, you really have to plug numbers into experimental TurboTax what-if runs. When I did this with 2014 TurboTax a few years ago, using above average SS benefit ($36K/yr), this band was from $35K to $55K of non-SS income. The next bracket began at $70K of non-SS income.

At below average SS ($20K/yr) it ran from $36K to $47K of non-SS income.

Yes. Of course, there is another option, copy the FIT worksheet into a spreadsheet and do your own calculations (checking a few points with TurboTax). That's what I did for the post.

I did this back when I retired. I convinced myself there was a tradeoff - lowering taxes today meant raising taxes later. When I tried to optimize, it seemed that the taxable share is so sensitive to various assumptions that it was very hard to feel confident of any result.

 

[NW-Bound]

Yup, same here. When I bought them I was not thinking of tax implications so far down the road. Now I am cursing young self for picking large denominations and doing it all at the same time. That's when I was taking my financial advice from pundits.

I learned from Alan on this forum that it is possible to cash out an I-bond in part. The user interface on the Treasury Web site indeed allows this.

 

[pb4uski]

^^^^ That tip alone has saved misshathaway the annual subscrition fee to early-retirement.org!

 

[Lawrencewendall]

My own numbers match the article when comparing start dates.

 

[sengsational]

i-orp is always something of a black box to me. So, I took your setup and did my.....

Sorry for the weird quote I'm on my phone.

I agree that the black box aspect of i-orp is hard to get past. I built a spreadsheet that recreated all years numbers from the first year, so I do have some confidence in the results. But one column I couldn't completely automate the tax column. It certainly does the 85% of SS being taxable, but I never got a specific algorithm that matched exactly. I don't think the source code is available, but I thought I remember seeing someone else had done an offline linear program with the same functionality as i-orp.


As you said in your footnote, if anything gets left out to simplify the calculations, it also stands to change the result. The good news is that if the minor assumptions change the result, the payoff or cost of each strategy is typically pretty small.

 

[kaneohe]

My own numbers match the article when comparing start dates.

....and the world is waiting with bated breath and eager anticipation...........
we're from Missouri

 

[NW-Bound]

^^^^ That tip alone has saved misshathaway the annual subscrition fee to early-retirement.org!

And I was reminded of the tax burden on the accrued interest on the I bonds I have held for 15 years.

Oh boy, tax everywhere.

 

[Fedup]

I wonder about those who take SS earlier than FRA, like my husband for example, and use that money to pay for premium on his life insurance, not a new one, but he is currently paying $170 per month for $750k life insurance, he should be on this premium for another 11 years before the life insurance will be decreasing by 30%, would his estate be bigger than waiting to take SS at age 70. This is only theoretical question, since most people who plan to take it early, don’t think or believe they will live long enough. The life insurance path doesn’t work well if one lives until the ripe old age. But the insurance payout is tax free and no RMDs. Any thoughts on this?

 

[Lawrencewendall]

....and the world is waiting with bated breath and eager anticipation...........
we're from Missouri

I've posted this several times in other places. My FRA is 67. Based on this:

https://www.ssa.gov/OACT/ProgData/ar_drc.html

Postponing at 62, 63 and 64 only gets me a 5% increase. Postponing at 65 and 66 gets me a 6 3/8% increase. So as long as my investments do better that 6 3/8%, it is better to take SS and let my investments ride. Even postponing at 68 and 69 only gets me an 8% increase and historically, my investments were 8.8%. Those few percentage differences between SS and portfolio really add up out 10, 15, 20 years to the tune of having 300k MORE in the portfolio at age 80 by taking SS at 62 vs 70. This is assuming I need the money to cover expenses so it's SS or portfolio.

 

[youbet]

Slightly different perspective.....we plan on taking dh’s SS around 62. He’s 3.5 yers older than me and I won’t get social security. I also won’t get his. So it seems to make sense to take it ASAP.

+1

That's pretty much our scenario too. I started SS at 62 and invested every penny including reinvesting the divs and CG's (a low cost TSM fund) since 2009. That has generated a sum which at a prudent WR covers the delta between my age 62 SS and what I would have gotten had I taken the risk of waiting until 70 for the higher SS. Plus, we had the important extra benefit of providing some financial protection for DW who doesn't get SS nor can collect based on mine.

We got the best of both worlds I guess. We have approximately the same SS driven income and longevity insurance (given that future markets are no worse than the worst of the past) and DW has financial protection she would not have received had I deferred to age 70.

IMHO, it's important to consider the time value of money, and not just break even analysis, when calculating when you want to start SS. This is especially true in cases such as yours and ours where you want to financially protect a loved one who will not benefit from your SS (due to GPO, unmarried couples, etc.).

If DW could collect SS based on my work record, I likely would have delayed. If DW had her own SS coming, we would have used one of the strategies that enhances total SS for a married couple. But, that's not our case and it sounds like it isn't yours either.

 

[Independent]

I've posted this several times in other places. My FRA is 67. Based on this:

https://www.ssa.gov/OACT/ProgData/ar_drc.html

Postponing at 62, 63 and 64 only gets me a 5% increase. Postponing at 65 and 66 gets me a 6 3/8% increase. So as long as my investments do better that 6 3/8%, it is better to take SS and let my investments ride. Even postponing at 68 and 69 only gets me an 8% increase and historically, my investments were 8.8%. Those few percentage differences between SS and portfolio really add up out 10, 15, 20 years to the tune of having 300k MORE in the portfolio at age 80 by taking SS at 62 vs 70. This is assuming I need the money to cover expenses so it's SS or portfolio.

If you're willing make decisions today based on your expectation of earning at least 6 3/8% real return in the future, then taking SS early makes sense.

I assume you also feel that an annual withdrawal of 6 3/8% is "conservative" - allowing you to live off the return while letting the principal grow with inflation.

 

[youbet]

"I assume ........"

Seems to be a lot of that going on when we discuss SS.

 

[Winemaker]

I have asked this question before on other SS threads and never got an answer. Has anyone used the RETIREE PORTFOLIO MODEL V18 Excel spread sheet? I got the link from Bogelheads years ago, and updated it from Google after new tax law. You can change your SS scenario and conversion scenarios and get comparisons.

https://www.bogleheads.org/wiki/Retiree_Portfolio_Model

 

[Rianne]

DH/me same age, 61. I'm taking my SS at 62 and he'll wait until 66.5 My yearly SS is $9000. He has a small consulting business, income $42,000 plus our investment income that we re invest (do not touch). How is my SS taxed? Is it combined with the other income then taxed?

 

[pb4uski]

.... How is my SS taxed?...

Click here: LMGTFY