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Planning Your Social Security to Better Pay for Retirement
Understanding Social Security Limits & Tax Consequences to be Prepared

Many Rely on Social Security
Many Rely on Social Security

The greatest benefits Social Security offers seniors is regular income that's guaranteed to increase over time and continues for as long as one lives.

As it stands today, there's no financial channel that's fights inflation increases (albeit, very little), longevity protection, investment risk, and spousal coverage like that of Social Security. It's benefits make it one of the most valuable sources of retirement income.

Retirees must learn more about the technicalities of social security to make it more useful to them.

Retirees do not understand how their Social Security benefits work. Sadder still, most never focus on how to help maximize the very benefits that may help sustain them throughout retirement.

Planning Your Social Security for Better Pay in Retirement

We've asked, Pamela Villarreal, NCPA expert on retirement, economic growth and tax issues about social security concerns:

  • Who it benefits most,
  • The rate of return on invested dollars,
  • Social Security lessens a worker's private savings.
Pamela Villarreal's take on the social security

Social Security, indeed, is the most valuable in terms of reliable income support for seniors. Even with potential future reforms to the program, it will likely never go away.

However, it has flaws that only private savings can cover:

First, it is more beneficial to some than others. For those who live to 100, it's a bargain, as they will receive payouts for 35 years. However, some demographic groups (such as minorities and lower-income) have shorter life expectancies. For those who only live to 75, and worked for 40 years and paid into the system, the money paid into social security will not pass to their heirs.

Second, while Social Security guarantees the rate of return, it's extraordinarily low and is declining for future retirees. For example, one of our NCPA studies found that median wage workers who retired in 1986 and later, would have received a better return on their investments had they invested their payroll taxes in equities funds.

Third, economists have long suspected that expecting Social Security crowds out private saving as much as 50 cents for every dollar of private saving. It is particularly troubling in light of existing low savings rates. Social Security just cannot replace every dollar of income during the working years.

-- Pamela Villarreal
National Center for Policy Analysis

Forty percent of Americans rely on social security for income in retirement.

Financial services firms place little emphasis on helping retirees learn best use of Social Security to help them generate optimal retirement income and risk protection. If there's any guidance, it may not give complete information.

Financial Expert Answers and Solutions

From this interview, we hope to give retirees a better understanding on how to stretch Social Security benefits - to help pay for long-term care costs.

Plan Wisely

Plan wisely so that social security helps pay for long-term care and avoid, as much as possible, it's high marginal cost of taxes:

  • Don't rush to collect the reduced benefits.

Should retirees consider drawing down their private retirement fund balances to delay drawing Social Security to boost benefits down the road? By putting off Social Security payments, it may qualify for lower income-tax rates as compared to the income provided by liquidating holdings in private retirement accounts first.

When to Draw on Social Security

This is a tricky situation because there is no general rule. For those who expect to live a long time, delaying taking benefits until age 70 is ideal.

Another alternative is to delay dipping into retirement accounts until the required minimum distribution kicks in at age 70.5. For those not retired, put retirement savings into a Roth IRA since it is not subject to tax, nor is it included in the "other income" determination of the Social Security benefits tax.

There is no longer an income limit on households if the retiree has money in a tax-deferred retirement account; one can convert into a Roth IRA and pay current taxes on the amount converted. However, be mindful of the current tax rates. Conversions of large quantities may trigger a higher tax bracket and the new Medicare tax on unearned income.

Moreover, the Roth IRA must sit for five years before funds are withdrawn. But once they are, those funds are tax-free!

-- Pamela Villarreal
National Center for Policy Analysis

Insights into Social Security Earnings Limit

  • Don't rush to collect spousal or survivor benefits.

If retirees start the worker, spousal, or survivor benefits before the Full Retirement Age, they'll be subject to the earnings limits and test.

Earnings test:

  • When a retiree starts the benefits early, in every year leading up to the year to Full Retirement Age, $1 in benefits will be withheld for every $2 earned above the limit for that year ($14,640 in 2012).
  • When a retiree reaches Full Retirement Age (age 66 for those born before 1955), benefits reduce $1 for every $3 earned above a higher limit ($38,880 in 2012), until the month reaching Full Retirement Age. At that point, the earnings test disappears. (Strong reason to put off collecting social security till Full Retirement Age)
  • When one waits beyond Full Retirement Age to claim benefits, a Delayed Retirement Credit of 8% per year will apply. While waiting to claim your benefits at any age from 62 to 70, the cost of living adjustments (COLAs) use and compound over time. If you delay benefits from age 68 to age 69, and the government declares a 3% COLA, the benefits grow 11%. For example the 8% Delayed Retirement Credit plus 3% COLA for that year.

Survivor Benefit

  • Learn ways married couples can integrate their benefits.

Delaying Social Security increases an individual's benefit, but also increases the benefit to a surviving spouse. Upon the death of a person, the spouse will receive the greater of:

(a) His/her then-current benefit, including any COLAs; or

(b) The deceased spouse's then-current benefit, including any COLAs. (In this case, #1 drops off whether it was a worker benefit, a spousal benefit, or some combination of the two.)

Don't Get Blindsided by Taxes

With all the employee's contributions to 401(k)s and other plans, employers' matches on contributions, earnings on matches and contributions, lead to tax-deferred income. It's just sitting there, rolled into an IRA. However, all of it will eventually be withdrawn and taxed.

Higher income yields higher taxes.

Often, taxes are higher for retirees than the marginal tax rate paid on their earnings when working and it's likely that these taxes will only increase due to the federal deficit.

Since Social Security income is not taxed the same as IRA income, should one reduce their taxes by choosing higher Social Security income and lower IRA withdrawals when developing the strategy for taking retirement income?

On the Social Security Benefits Tax:Since the Social Security benefit tax hinges on retirement/asset income plus half of one's SS benefits, the smaller the amount of retirement/asset income, the better chance of not hitting the benefits threshold. But again, individual situations vary.

  • For those with a very large retirement income portfolio, it's important to keep in mind the required minimum distribution that kicks in at age 70.5. It could put a retiree in a higher tax bracket, no matter what.
  • For those who are in poor health or with a family history of early mortality, it may not make sense to delay taking SS benefits until age 70.

-- Pamela Villarreal
National Center for Policy Analysis

Other Questions for Pamela Villarreal

Does it make sense to take at least twice the amount of income in the form of Social Security rather than in IRA withdrawals before hitting the "trigger point" where Social Security becomes taxable?

It makes sense in most cases, but as I mentioned previously, there are also special circumstances. It's best to run the numbers on paper or talk with a tax professional.

-- Pamela Villarreal
National Center for Policy Analysis

How feasible is it for middle-income retirees to delay Social Security and take higher Social Security income and lower IRA withdrawals?

In today's economic climate, it's difficult to pull this off. Many baby boomers are entering retirement ill-prepared.

Many work longer, but those who've been laid off or are having trouble finding later life employment, may decide to take Social Security benefits at age 62. Many households have had to change their retirement plans due to unemployment and debt, so what looks good on paper is not a retiree's reality.

-- Pamela Villarreal
National Center for Policy Analysis

How to bridge the income gap until higher Social Security benefits kick in:

  • Tap into IRAs, 401(k)s, or other investments to bridge income from the time they retire to the time higher Social Security benefits kick in.
  • Consider going back to work full-time
  • Think about getting a part-time job

Read Pamela Villarreal's article where she highlights how the Social Security benefits tax really sticks it to the middle class. If Congress and the president truly want to help the middle class, they might start by repealing the benefits tax.

***This information is not intended or designed as tax advice. Consult with a tax attorney or financial expert.

Carol Marak
Carol Marak

After seven years of helping her aging parents, Carol Marak has become a dedicated senior care writer. Since 2007, she has been doing the research to find answers to common concerns: housing, aging and health, staying safe and independent, and planning long-term.