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Welcome to How to Retire on Time, a show that answers your questions about all things retirement, including income, taxes, Social Security, healthcare, and more. This show is an extension of the book How to Retire on Time, which you can grab today on Amazon or by going to www.howtoretireontime.com.
This show is intended for those within 10 years of their target retirement date or for those are are currently retired and are concerned about their ability to stay retired.
Welcome to How to Retire On Time, a show that answers your retirement questions. My name is Mike Decker. I'm a licensed financial advisor and fiduciary. And with me in the studio today is my colleague, David Franson, who will be reading your retirement questions. As always, you can submit those questions to (913) 363-1234.
Mike:Again, that's (913) 363-1234. David, what do we have for today?
David:Hey, Mike. When does it make sense to file for Social Security early so you can take the benefits and reinvest them?
Mike:Yeah. This is a common misnomer that if Social Security is allegedly going away, which it's not, or if you're not gonna use it, you already have enough assets for elsewhere, you might as well just take it and reinvest it in the market. So let me see if I can explain this by several trains of thought. The reason why people ask this question is because they'll say something like, well, I could just buy a couple of annuities, turn on the income stream, and then I have the income that I want. What do I do with this leftover benefit Social Security?
Mike:Maybe you don't need the Social Security benefit. Maybe you have a pension. K? And you're gonna live off the pension. You don't need Social Security.
Mike:So what do you do with the leftovers? Do you see how it's it's Social Security is thought as it's an afterthought.
David:The
Mike:problem I see with this is from a tax planning standpoint and a benefit planning standpoint. So let's run through a couple of scenarios. If you plan to keep working because you enjoy your work, then I don't see it making sense to file for Social Security before full retirement age 67 years old because you're going to get deducted your benefits based on your earnings or your w two or ten ninety nine income. In other words, if you make more than 20 some thousand dollars a year, you start losing your benefits. And there's a clause in that.
Mike:That's if you file before full retirement age. Now if you file afterwards, then who cares? It's your benefit at that point. Okay. So that's the first thing is if you if you wanna keep working, if you intend to keep working, whatever that reason is, it doesn't make sense to file early and invest it because you're going to have your benefit, first off, taken at a reduction.
Mike:And then second off, you're gonna have it basically deducted or reduced because of your earnings.
David:Okay.
Mike:K? So that's the first part. But let's say you are retired and all of your income is coming from pensions and other places, what do you do with the income? I would first ask, what are you doing with your portfolio? So let's say you have million dollars in April IRA assets.
Mike:You can either take income from those assets and grow your Social Security benefit. You can do IRA to Roth conversions and take your income so that there's not an RMD issue later on in retirement. That's the moment before you file Social Security that you can get things in alignment. That makes sense? If you did IRA or Roth conversions, and you took income from your portfolio, and you took on Social Security to reinvest it, you're creating additional tax issues.
Mike:You're bumping yourself up into a higher tax bracket. It's a lot of income. Social Security is a tax efficient income stream, because up to 85% of it is taxed based on your income. K? Based on income taxes, the brackets.
Mike:Right? If that's true, why would you want to start taking your Social Security early if you're also taking income from other sources, or you're doing IRA to Roth conversions, or you're doing these other things? Because you're gonna get taxed a 100% from your IRA assets. The ideal situation, in my opinion, is that you've done the majority of your tax planning, your adjustments each year. You're not kicking yourself into Irma, so you didn't do too egregious of an IRA to Roth conversion.
Mike:You've kind of settled things up so that when you turn on Social Security, you're also tax efficient in your other portfolio income streams.
David:Yeah. It sounds like what you're saying is that we have to be careful when you have all these different income streams, Social Security being one of them. And if you have too much income because you're taking it from all these places, then you're not tax efficient. You might have to pay higher for Medicare through the IRMA surcharge, as you mentioned.
Mike:And you got RMDs and all sorts of other things to be concerned about. Now there's another layer of complexity to this.
David:Okay.
Mike:There are a lot of people out there that are basically saying Social Security is going away, so you might as well just invest it and put it in the market. Maybe you don't need the income. Right. Why would you turn on Social Security for the sole purpose of reinvestment? When you take Social Security benefits, you put it into then a brokerage account that then will grow.
Mike:And if you actively trade it, you're creating short term capital gains, which creates a tax issue. Or you put it in long term, and then you've got long term capital gains. So when you touch it, you're also gonna create a taxable issue. And if you've got dividends being reinvested, you're creating income tax, which is another taxable issue. Instead, why wouldn't you just get a larger benefit later on and do more deliberate taxation later on?
Mike:And then you might say, well, I don't really need my IRA assets or these other assets. Okay. Fine. What happens when RMD's required minimum distributions start? How does it line up?
Mike:We did a plan recently for someone. I mean, basically, what we were trying to accomplish is how much do we take from their IRA assets? How much do we take from their brokerage account? Because they had one company in particular. That was the company they worked for for their whole career.
Mike:A lot of stock with a very low basis. So how do we take income out of that? And then how do we line up Social Security? The provisional income, which is what determines your Social Security taxes, it doesn't include standard deductions. So that's an issue.
Mike:But what we did figure out is how much we could take from their IRA assets, utilizing the standard deduction. Let's say IRA is about $4,050,000. They're married, so standard deduction takes out 30,000, so they're being taxed on 20,000.
David:Okay. I got it.
Mike:You're within the 10 to 12% tax bracket, and then we take a little bit out of their nonqualified assets, that single stock. That is a steady Eddie stock. It's not a volatile stock. It's pretty predictable. K?
Mike:I won't say the stock, but just think of like a Coca Cola like company. And we're taking some assets out of that as well, and we're kind of doing this for the first part of their retirement while kicking back Social Security. What did we just do? What we did is we allowed the Social Security benefit to increase over time while we have drained tax efficiently their stock under the 0% capital gains tax bracket while also utilizing the best we can within the lowest tax bracket, their IRA assets, so that when they turn 70, they don't have too much invested in one stock. They don't have too much in their IRAs, and then the balance that they have within their IRA assets, the remainder of the brokerage account, and their Social Security became a very tax efficient retirement plan from that point on.
David:Okay.
Mike:So do you see how we line things up so that when Social Security started, it was very tax efficient? These are the kinds of nuances that many people miss, and they panic by saying, well, I want tax free Social Security, so I'm going to and this is extremely popular online. They'll say, well, I'm just gonna max out the 24% tax bracket and just convert over and forget about Irma and forget about this forget about that, and I'm gonna save taxes on Social Security. I don't see how that really makes sense. And the reason is, and I can prove this, I can run that scenario in our software, our proprietary software that we built to run scenarios like this.
Mike:And I can look at, okay, more aggressive IRA to Roth conversions. You get there faster, but at what cost? And then look at their net worth. This is where people miss. Look at the net worth when they're 80, 90, and a 100 years old, just for three different landmarks.
Mike:And watch how their net worth is less by six figures, multiple six figures. When you more aggressively convert IRA assets to Roth assets, what you're doing is you're paying a higher premium on your taxes just to get to a tax free bet, and you're forgetting the principal amount of your your assets, the the dollar amount in your assets. That is a tax inefficiency. So even though you might move quicker into a tax free retirement, you have to ask yourself at what cost? And this is the part that's almost always missed by people that come to our office.
Mike:We have to explain to them and just show them the numbers. They'll think, well, I'm smart because I have a smaller tax bill. That's the wrong question to ask. That's the wrong metric to seek. Because the real metric is how much money are you keeping.
Mike:And those who slowly create a systematic IRA to Roth conversions, they fit effective tax rates that they've targeted for a longer term period of time. Keep more of their money. So even though and this sounds counterintuitive. Even though they have paid more in taxes throughout their lifetime, they've kept more of their money, which means more income for them and more income or assets to pass to their beneficiaries. It seems so counterintuitive, and people right now are probably saying, Mike, you're full of it.
Mike:Just read the comments. Oh, this isn't true, and they'll rationalize how they hate the government, how they're gonna pay the government less money. Forget about the government. How much are you really costing yourself to get to this place? And you could say, well, no one knows the future of taxes, and will taxes are expected to go up in the future?
Mike:They're expected to go up in the future, but they might not. No one knows.
David:Yeah. That's a real kicker. Nobody knows. So
Mike:what are you really solving? Is it to pay the government the least amount of money, or is it to maximize your portfolio so that you keep more of your money while taking a tax efficient income. There's a lot of layers here when it comes to optimizing your assets, your income streams, and so on that have to be able to dynamically change as your plan evolves to be able to capitalize on tax efficiency. It is extremely complex. It is extremely technical.
Mike:But once it's laid out, it's extremely simple to comprehend. You just have to know the right questions to ask and the right strategies to implement at certain times to get there.
David:So did we answer the question? Does it ever make sense to file for Social Security early and take benefits?
Mike:Yeah. If you need to live off of Social Security, chances are you wanna work as long as you can and file at 70 to have the most benefit possible. If you're looking to reinvest Social Security, I would question the tax efficiency of that, and how it could compromise other parts of your portfolio. It may work. It may not.
Mike:But most times when I hear people say, I wanna file early because and it's investment or Social Security is going away, the numbers typically don't work out in their favor. They're just using isolated thought processes of, well, this is Social Security. This is how I'm gonna treat this siloed strategy, and then here's my siloed strategy for income, and here are my siloed strategy for taxes. Anything you do affects everything else that you do. You've gotta look at it from a comprehensive standpoint.
Mike:It's not just isolated social security optimization. It's a collaborative effort. That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcast. Just search for how to retire on time.
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