Decumulation Confusion: Social Security Claiming Strategies
In Part 1 of our decumulation series, we discussed the oft-overlooked topic of decumulation, or the spending of retirement plan assets during retirement years. In Part 2, we explored annuities as a decumulation strategy and the associated confusion for retirees. In Part 3, we examined the 4% rule, a time-honored method of withdrawing funds from retirement plans. In this edition, we address a critical element of decumulation: Social Security-claiming strategies.
Retirees and/or their spouses, ex-spouses, widow/widowers, have a variety of methods in which they can claim Social Security benefits; thus, selecting the optimal method can be difficult. However, those who take the care to select the optimal strategy for their situation are often rewarded with an improved financial position in retirement. Some of the more significant variables that can impact income and expenses derived from Social Security benefits include:
- Claiming age — Benefits can be generally claimed at any age from 62 to 70, although widows and widowers may be as young as age 60 to claim benefits. While delaying Social Security benefits can result in higher benefits, that is not always the case, particularly when a spouse is involved. The difference between the best and worst claiming strategies can result in tens of thousands of dollars less in overall benefits paid, so it is important to get this right.
- Earnings test — Prior to the normal retirement age (67 for those born after 1959, with lower ages for those born in 1958 or earlier), if a retiree earns over a certain amount of money ($18,240 in 2020 for those attaining normal retirement age in 2021 or later, and $48,600 for those reaching normal retirement age in 2020), the amount of Social Security benefits received is reduced. However, these benefits are NOT lost, they are simply added to benefits that are paid after normal retirement age. The earnings test only applies to earned income; thus, investment income and retirement plan distributions don’t count. Having said this, the earnings test can throw a monkey wrench into any phased retirement plans.
- Taxation of Social Security benefits — At any age, Social Security benefits are taxable based on an individual’s adjusted gross income, non-taxable interest, plus ½ of the Social Security benefit. If that amount combined is over a certain threshold ($25,000 if single in 2020, $32,000 for married couples filing jointly), then up to 50% of the benefit is taxable. If the combined amount is over a higher threshold ($34,000 if single, $44,000 for married couples filing jointly) then up to 85% of your benefit is taxable. Non-Roth retirement plan distributions DO count towards adjusted growth income, so the amount of retirement plan distributions received in a year can affect Social Security taxation.
And, while not directly related to Social Security, high income earners can also pay higher premiums for Medicare, since retirement plan distributions affect income for this purpose as well. This is another area in which those contemplating retirement should plan ahead.
Navigating all of this can be confusing, which is why retirement plan participants should address these issues well ahead of retirement. Plan sponsors can help by sharing articles such as this one, or some of these other helpful resources:
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.
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