By Pam Martens: March 25, 2014
Last week the Wall Street Journal ran an in-depth review by two financial experts on when one should begin taking Social Security benefits – at age 62 at a reduced rate; at age 70 when one qualifies for the maximum payment based on salary history; or at some point in between?
The article gets off on fine footing, explaining the basics: “It shouldn’t surprise anyone that how long you live is one of the biggest factors in determining whether your decision is the right one. To calculate a person’s monthly payments, the Social Security Administration looks at lifetime earnings, their age when they start to collect, and their average life expectancy at that age. Say you are a 65-year-old man who starts receiving benefits. Up until the age of 84 (your average life expectancy), you will have earned more in total than if you had started to collect at 70. But if you make it past 84, then waiting until 70 was most likely the better choice.”
But then the Wall Street Journal ran two starkly opposing views, leaving readers completely befuddled.
Jane A. Rose, a vice president at RTD Financial Advisors Inc. in Philadelphia advises readers to “Fight the temptation to start collecting your Social Security benefits as soon as you qualify. You are giving up free money. For most people, the objective should be to delay benefits until age 70.” (The italics on the word “most” is made by Wall Street On Parade.)
Paul J. Tully, a financial adviser with Eagle Wealth Strategies in West Deptford, New Jersey says that for the “majority” of people, “starting to collect your benefits early not only helps you pay your bills, it gives you more financial choices and the likelihood of achieving the best long-term personal outcome.”
The problem here seems to be how Rose and Tully view the financial condition of “most” Americans.
Rose says “if you have planned ahead and saved enough money to live on…you can retire whenever you wish while still delaying Social Security, thereby maximizing the amount you’ll receive over your lifetime.”
Tully makes the observation that “Reasons to start collecting as early as possible include: the recent financially devastating recession; historically small retirement savings (some estimates are as low as $30,000 for people 55 and older); increased taxes at certain levels; and senior lifestyles that are more active and expensive. Most people ages 66 to 70 are no longer working, and many are struggling to pay for necessities such as health care. Additionally, fixed-income rates on savings are as low as they have been in 60 years with little prospects for significant change in the near future.”
Tully clearly has a much better handle on the financial state of affairs of “most” Americans. But the real answer is that each individual’s situation is unique and until that unique situation is analyzed, there is no pat answer. Here is one of the most overlooked considerations.
Many individuals are now retiring with large sums in their 401(k) plans. Those accounts can be rolled over to traditional IRA accounts without triggering a taxable event where the individual has more conservative choices like Treasury notes and FDIC insured Certificates of Deposits as well as mutual funds for the more aggressive.
Preserving the tax-deferred status of these traditional IRA accounts should be seen as a critical part of the deliberation of when to begin taking Social Security benefits. Here’s why:
The tax-deferred shelter of a traditional IRA is one of the greatest tools for building wealth. The contributions go in pre-tax and compound thereafter without taxation until mandatory distributions begin at age 70 ½. At that point, only the distributions are taxed. If the investments inside the IRA grow at a rate higher than the amount of the mandatory distribution, the principal will continue to grow.
Unknown to many people, IRAs can be left to children or grandchildren as well as to a spouse, thus stretching out the tax-deferred compounding to benefit a second generation if properly managed. The assets in the IRA owner’s account do not have to be liquidated at death but can be rolled over in kind in whatever percentage is designated on the beneficiary account form you fill out when you open the account. (For example, each child could be left one-third of the IRA.) These accounts become known as IRA Beneficiary accounts and are designated as such in the account title. Distributions must be taken by the non-spousal heirs and the calculation will differ based on whether the original owner has or has not started taking mandatory distributions at age 70 ½. (See the detailed IRS rules on how beneficiaries must take distributions here.)
Some retirees may feel they’ve done enough for their children already and choose to spend down their IRAs with no thought to the wealth-building value of the tax-deferred compounding inside that IRA. Others, with a more altruistic bent, may have an overarching desire to help children or grandchildren have a more financially secure future. Depending on the unique desire of the individual, it might be better to take the Social Security benefits early in order to leave the IRA untouched and compounding tax-deferred to the latest possible date.
There is a Golden Rule of money management: always use your cheapest source of funds first.
Another aspect of the IRA that is frequently neglected for consideration is the ability to sell a highly appreciated stock inside the IRA account and pay no capital gains tax on the profit. Let’s take the example of an individual who elects to take Social Security payments early so he does not have to withdraw from his IRA and uses an appropriate portion of his IRA to buy several Blue Chip stocks. (Blue Chip, by the way, is defined by Wall Street On Parade as a stock that has paid consecutive dividends without interruption for at least 50 years.) The stocks are placed on dividend reinvest inside the IRA and allowed to compound from age 62 to age 82. At age 82, let’s say the IRA owner takes the stocks off dividend reinvest and has the dramatically increased dividend income paid out monthly by his IRA custodian to supplement his income. Only the distributed income will be taxed while any continuing principal growth in the share price inside the IRA remains untaxed. At the owner’s death, the stock can be transferred in kind to his children named as beneficiaries of the IRA, who, if they elect to sell the stock inside the Beneficiary IRA, will pay no taxes on 20 years of gains.
There are a multitude of other reasons unique to an individual for taking Social Security payments early or later. We know of the following examples of people who decided to wait until age 70: (1) the individual had a large fixed pension and did not need the money from Social Security; (2) the husband had taken a single life payout on his pension to maximize monthly income and wanted to be sure his wife would have an adequate income from his Social Security payment at age 70 if he died early; a couple sold an expensive home at retirement, purchased a more moderately priced home and was living off the difference to delay taking Social Security payments until age 70.
The only way of making a decision that is correct for one’s own unique goals and attitude toward heirs is to sit with a professional and hash out the pros and cons. And Tully makes one final point that is also hard to ignore: “A generation ago, retirees often could count on a pension. Now there are doubts even about Social Security’s stability. A future Congress could increase taxes on benefits, or lower the cost-of-living adjustments. Means testing could be introduced, posing a barrier for some to start collecting their benefits. Taking everything into account, it’s a wonder that anyone waits at all.”