A few years or decades from now, retirement will inevitably come.
For many of us, whether we will be claiming social security benefits or not during retirement isn’t the question. In fact, it is a major part of our retirement plan, if not the only retirement plan we know.
The question we grapple with is: when is the right time to claim your social security benefits?
Knowing the answer to this question is crucial because social security offers potentially tremendous benefits when done correctly.
Whether you are nearing retirement or are still decades away from it, you might want to know the proper approach to using your social security benefits.
The earlier you start, the smaller your monthly payments will be
If you decide to start taking your social security benefits at 62, you will likely receive 25% less monthly compared to starting on your full retirement age (66 for those born between 1943-54; 67 for those born in 1960 and later). This is a fact of life which we cannot alter right now. However, if you can use a little bit of delayed gratification, you can actually take advantage of it.
Yes, social security rewards delaying gratification.
If you delay claiming your social security until you’re 70, you’ll get 32% more monthly payments. That means if you were born between 1943-1954 and collect your social security at age 70, a $3000 benefit will become $3960. If you collected your benefit at 62, it would be 25% less than $3000. That’s a significant different in monthly income.
Why is this so?
When you delay taking out your social security, it will earn returns of around 8% a year. That’s a remarkably high return for such a safe investment.
What to do to take advantage of social security?
Essentially, you need to wait until you are 70.
The ability to wait, however, implies that you have another option during retirement aside from your social security.
That’s where your other investments come in. And this is one of the reasons why we never get tired of reminding everyone to save and invest while they are still young and at the peak of their earning potential.
Use your 401(k) and/or IRA to transition to social security.
If you are contributing to your 401(k) plan or Traditional or Roth IRA, you can make withdrawals from these investments as you wait out until you are 70. Understandably, many people don’t want to touch these investments after working so hard to save for them. But you need to consider these.
IRAs are 100% taxable and if you use them later, you’ll end up paying more for taxes during retirement. On the other hand, social security is only taxable up to 85%, and that’s still subject to different income thresholds. If for example your and your spouse’s combined income is less than $32,000 (or $25000 if you are single), you may not have to pay income taxes at all.
If both of you and your spouse have social security income, it is also important to plan out when each of you will claim your benefits.
Ideally, you would want the spouse with the higher income to wait as much as possible to maximize your returns. Additionally, in case he or she passes away earlier, it will become the survivor benefit of the one who lives longer.
If you are single, you’ll be on your own so you need to maximize the returns from your social security.
Again, this requires you to wait until you are 70 years old. If you are contributing enough to your 401(k) or IRA right now, or if you have a private pension plan, then so much better. You should have no problem transitioning to your social security benefits. For people who have few choices, what they do is continue working or live off the rest of their savings, and wait for social security.
Claiming social security before full retirement age will undergo what they call an “earnings test.”
Earnings test means for every $2 you earn above the income limit of $15,480 (in 2014), $1 will be withheld. However, when you reach your full retirement age, your payments will be recalculated. The earnings test will no longer apply and you will still receive your full benefits.
What this means for us
All of us are aware of social security as a retirement income, but not many take the time to know its ins and outs. As a result, we fail to take advantage of the benefits that can help us extend our income and still enjoy life during retirement.
Remember, however, that having social security benefits in the future doesn’t mean you can be complacent about your saving and spending habits now. Your savings today will be your income in the future. Your spending habits now will determine your spending habits in the future. And as habits are notoriously hard to break, it’s best to develop healthy financial habits as early as now. This poses two advantages to you: You will be able to save more for your retirement and you won’t have much difficulty adjusting your lifestyle to your retirement income.