Start Social Security Earlier to Smooth Lifetime Tax Liability

0:00This week on the Retirement Quick Tips Podcast, I'm talking about when you shouldn't delay social security five smart reasons. You may want to consider claiming early. And today I'm talking about one final scenario worth considering, and it's a big one when deciding whether or not to start social security earlier, or wait, maybe until full retirement age, maybe even until 70, and that is to smooth out your tax liability in retirement over, you know, decades long retirement. So here's a, just a very basic scenario. Let's say you retire at 62, and you start social security that same year. Oh God, for a bit. No, don't do it. No, I'm kidding. Let's say you have a pension of about $1,200 a month. That starts at 65, you have $2 million in retirement savings, about 70% of that is an IRA 401k tax deferred type accounts, and the remainder about 600,000 is in taxable brokerage

1:06accounts. You have some stocks, bonds, and then you also have another $100,000 in savings. In this scenario, most higher earning individuals were going to receive pretty substantial social security check, especially if you wait. You'll elect to wait until at least their full retirement age of 67. Many might wait as long as possible until age 70. But I want to look at this scenario from a tax standpoint, because I suggested that you retired at 62, but you also started social security this same year. So what does that look like? Well, there's a few different phases of retirement here. The phase one is early retirement age 62 to 64. Now, you've started social security, and you're receiving a reduced benefit. You took a haircut because you started as early as 62. And you're not getting your pension yet, which, if you recall, I said starts at age 65. So right now, you have income sources of just social security, and then whatever you withdraw

2:13from your portfolio. So I'm going to assume you're receiving $36,000 a year from social security. And you're withdrawing another $84,000 or so from your investment portfolio. Now at this income level, social security will likely be taxable, at least a portion of it. And I'm going to assume you're going to pull maybe a little bit more than half of your withdrawals from your brokerage account, where you might have some capital gains. And then you might pull some money from your IRA as well. And that will add to your income. So you have an IRA withdrawal that says about $34,000. You have your social security. That's $30,000. You have some capital gains. Let's say you have about $15,000 in capital gains. Now your total income is pushing $80,000 in those years. Now you have the standard deduction, which reduces your taxable income. And based on that, you're probably going to be in the 12% tax bracket.

3:14And you're going to owe maybe $5,000 to $7,000 of federal taxes. Here's a key observation of why a lot of people will forego social security because they don't want that income in the early years of retirement. They want to keep their income as low as possible. But here's the thing. When you started social security at 62, it was still a pretty low tax year. You were in the 12% tax bracket. So there's still room in this scenario to do Roth conversions. You can harvest potentially harvest some of your gains at lower capital gains tax rates. And I was intentionally drawing down some of those IRA assets as well because those were being taxed at much lower rates. It works. You can start social security and keep your tax bracket low. A lot of people think that they can't. They can't have it both ways. But in this scenario and a lot of others that look just like it, you can't. So you just have to be strategic and take advantage of the fact that you will likely be in

4:16a lower tax bracket if your money situation looks anything like this one. And then we have phase two. So this is age 65 to 72. Again, we have our social security, but now the pension has started. So we have social security income. We have pension income. We have portfolio withdrawal. So I'm assuming that the combined of all those is going to be probably somewhere in the $120,000 range. And again, we're taking some strategic IRA withdraws. Social security is taxable. Looking at income down at the pension has started of maybe a hundred, around $100,000. We have some capital gains. So interestingly enough, most of our income at this phase, even after the pension starts, it's probably still in that 12% bracket. Some of that we might be bumped up to the 22% bracket, but it's only for a pretty likely, a pretty small portion of our income, especially when you consider the standard

5:22deduction and how that can reduce your taxes. So even after the pension starts for many people, you're still going to have a pretty manageable tax bracket. You're still going to be in a fairly low tax bracket. Again, most of your income using some of the numbers in this scenario is still taxed at the 12% bracket, with maybe only possibly a little at the 22% tax bracket. Okay, then we get to phase three. This is something that very few people consider when they're making their social security decision. And that is once RMDs begin. So RMD age starts for different ages, depending on when you were born. I'm assuming that this is somebody who is already in their late 60s or starting their RMDs today, even at age 73. So again, you want to look up what this is, it depends on what your year of birth is. But for RMD start age, if you were born between 1951 and 1955, it's 73.

6:26If you were born in 1960 or later, that RMD age is 75. So you may have a bit of a longer window in that phase two, say 65 to 74. So anyways, regardless of when your RMD start age is though, something very important happens once RMDs begin. I'm going to assume that you're still going to have about the same balance, about $1.4 million in tax deferred investments, fast forward to RMD age today. We're going to assume you were taking withdrawals, but it was also growing over that time. So there wasn't a big drawdown where you saw the balance go down significantly. And so, and if you have even more growth than that, where it's instead of 1.4 million, it's worth 1.6, 1.8 million, 2 million, that's very possible, especially given the returns we've had over the last several years. So in that scenario, you could have a required minimum distribution at your RMD age of 65,

7:31$75, $80,000. Now your income looks more complicated. So we have the RMD, let's say it's 70,000. Then we have your pension income still, we have your social security, and then possibly some additional portfolio withdrawals. So now our income is quite a bit higher because of those RMDs. And now we have social security, definitely taxable, up to 85% of your social security is taxable. You're likely pretty well in that 22% tax bracket for a good portion of your income. Now you have some potential, Irma exposure with those Medicare surcharges. You could possibly be in a higher capital gains bracket. And your estimated federal tax is now probably north of $20,000. Now remember early on in retirement, it was like $5,000 to $7,000. And that actually will likely increase over time.

8:32That's just given today's tax rates. That's not including any potential tax increases in the future. So a lot of people have this tax trap and retirement, where if they're not strategic about taking withdrawals, or if they wait until age 70 years long as possible, it's only going to increase their income even more in those later years, increase their tax burden, potentially even more in those later years. So again, you want to consider the tax implications and potentially the opportunity to smooth out your tax liability and retirement simply by starting your social security earlier, rather than later. All right. That's it for today.