Social Security Timing: Maximize Your Benefits, Minimize Taxes
by Gabriel Lewit
If you are in your 50s or early 60s and are nearing retirement, one important part of your retirement planning process should be determining when you will begin taking your Social Security benefits. This timing could also impact your spouse, who may qualify for Social Security benefits.
While many people think that question is a no-brainer, when you begin taking your benefits can significantly impact your financial well-being for the rest of your life.
As financial advisors in Buffalo Grove, IL, we help pre-retirees assess the complexities of Social Security and help them determine when they should begin taking benefits.
This guide covers essential aspects of Social Security timing, including penalties for working while receiving benefits, the financial impact of different start dates, and the tax impact of Social Security with other sources of retirement income.
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Penalties for Working While Receiving Benefits
If you’re considering continuing to work while drawing Social Security, you must know the potential penalties. These penalties depend on your current and full retirement age (FRA).
If you were born between 1943 and 1954, the age to receive full retirement benefits is 66. This age incrementally rises for those born from 1955 to 1960, culminating at 67. If your birth year is 1960 or later, you’re eligible for full retirement benefits at 67.
If you are still working while receiving Social Security benefits and are below full retirement age, there are penalties for exceeding certain income limits. Here’s what you need to know:
- If you are younger than full retirement age, Social Security will deduct $1 from your benefit payments for every $2 you earn above the annual limit. The annual limit may change yearly, so it’s important to check the current limit. For example, in 2024, this limit will continue to apply.
- Once you reach your full retirement age, there are no penalties for working while collecting Social Security benefits. Your payment may also increase at this point.
- It’s important to note that your Social Security benefits may be reduced temporarily if you earn more than the allowed amount. However, these reductions are not permanent, and once you reach full retirement age, your benefits will be recalculated to account for the months in which benefits were withheld.
Monthly Payout Can be Impacted Based on Your Starting Age
The age at which you start taking Social Security significantly affects your monthly benefit amount. While you can start as early as 62, your payout will be significantly less than waiting until you reach your FRA.
The percentage increase in benefits for each year of delay is typically 8%. For instance, if your full retirement age is 66, and you choose to start benefits at 67, you’ll receive approximately 8% more per month than if you had begun at 66. This gradual increase continues until age 70 when you would receive around 32% more than your full retirement age benefit amount.
As you can see, the timing of your decision can impact your overall retirement income significantly. And, the longer you and your spouse live, the greater the overall benefit.
Another strategic decision related to when you begin receiving Social Security is an analysis of your other retirement income streams and how this combined income will affect your current tax bracket.
You may receive income streams based on Required Minimum Distributions (RMDs) from traditional IRAs or 401(k) plans, passive income from other investments, and more. These sources of income are typically taxed at your ordinary income tax rates, which range from relatively low to considerably higher percentages for higher-income individuals.
When you combine your Social Security benefits with your other sources of retirement income, you could end up in a significantly higher tax bracket.
Don’t forget that passive income derived from your investments, including dividends and capital gains, adds another layer of complexity to your tax liabilities. These gains, if not strategically managed, can increase your taxable income and potentially push you into a higher tax bracket.
The timing of initiating Social Security benefits plays a pivotal role in managing this tax exposure. If you begin taking Social Security benefits while still earning substantial income from other sources, you may find yourself subject to higher tax rates on both your Social Security income and other earnings.
On the flip side, delaying the start of Social Security benefits can provide several advantages from a tax perspective. By postponing, you can reduce reliance on other taxable income sources during your latter retirement years.
Consequently, this strategic delay can help reduce the risk of higher tax brackets and allow you to manage your tax liabilities over the long haul.
Tax Strategies for Social Security
Social Security benefits are subject to federal income tax, and understanding how this taxation works and how it will impact you is important for effective financial planning in retirement.
When taxing Social Security benefits, the IRS employs a formula known as “provisional income.” This calculation includes not only your Social Security benefits but also other sources of retirement income. These sources typically encompass pensions, Required Minimum Distributions (RMDs) from retirement accounts like IRAs and 401(k)s, and passive income from investments.
The IRS uses a tiered system to determine the taxation of your Social Security benefits. The more substantial your provisional income, the higher the percentage of your benefits that may be subject to taxation. Sometimes, up to 85% of your Social Security benefits can be included in your taxable income.
This is another example of the analysis that should go into the timing of your benefits and the importance of working with a fiduciary retirement planner in Buffalo Grove, IL.
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