June 2014 Bar Bulletin
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June 2014 Bar Bulletin

Retirement Income: Beans or Steak?

By Bridget Burgess

 

My mom and dad retired several years ago and are now in their late 70s. They live on a farm in Eastern Washington and seem to be getting by okay.

They collect their Social Security checks, take the required minimums from their IRAs and get some income from the wheat crop. But they don't have much extra money; they eat more beans than steak, so to speak. I wonder how much more comfortable their lives would be now had they done things a little differently when they first decided to retire.

My parents' situation comes to mind more often these days because I'm getting more and more questions from baby boomers about retirement-income strategies. My parents, like many other Americans, could have netted thousands of dollars more over the long run by not taking income from retirement plans at the very first opportunity and filing for Social Security benefits at the minimum age.

Understanding the most tax-efficient way to use your taxable savings, the most beneficial time to access your retirement accounts and how to optimize Social Security strategies could be the difference between eating beans and eating steak.

Weighing Your Options

Social Security was never intended to be the primary source of retirement income. The average amount of benefits paid by Social Security is a little more than $17,000 per year for men and a little more than $13,000 per year for women (2014 estimates).

Social Security was to be one of three legs on a stool, along with private pensions and savings. As many of us know all too well, one of the stool legs, private pensions, has been reduced or eliminated entirely, making for a very unbalanced stool. We need more than just Social Security to retire comfortably. The balance must be made up through savings.

The most obvious source of savings for retirement is employer-matched retirement plans - max those out. Secondarily, build up a cushion of non-retirement savings - spend below your means and bank the rest. And lastly, maximize your Social Security benefits.

Social Security Strategies

So, what are your options regarding Social Security benefits?

Obviously, filing at age 62 gives you the earliest retirement benefit, but also the lowest monthly payment for the rest of your life. Filing later yields a higher monthly payment, but fewer payments. Here are a few ideas that could get you closer to enjoying steak:

Know your break-even age. If your full-retirement age is 66, there are a couple of "break-even" points you need to know about: age 78 and age 82½.

Filing at age 62, instead of 66, puts you "money ahead" until age 78. Those four years of early payments pay off for a good number of years. But at age 78, the age-66 filer has caught up, and from then on is ahead, with higher monthly payments for the rest of his or her life.

The bottom line: If you want the most dollars from Social Security and expect to live past age 78, file at age 66, not 62. Filing at 66 instead of 70 puts you money ahead until age 82½. After that, the age-70 filer is ahead for the rest of his or her life.

Sometimes early filing makes sense. If you have not saved outside of your retirement accounts and your only option is to use tax-deferred retirement savings, then it may make more sense to file early. For the most-beneficial growth opportunity, tax-deferred accounts need to be preserved as long as possible.

Tax-deferred accounts compound at a faster rate than taxable dollars and all withdrawals from tax-deferred accounts are 100-percent taxable as regular income. In contrast, Social Security payments receive annual COLA (cost of living adjustment) increases, and at least 15 percent of Social Security income is tax free. Therefore, in this case, using Social Security payments to supplement income until the last possible moment is advisable.

File and suspend. This is a strategy that many married couples use because it increases their Social Security claiming options by allowing them to take advantage of spousal benefits and "delayed retirement credits" simultaneously.

Yes, your spouse can receive benefits even if he or she has never worked under Social Security. If he or she is at least 62 years of age and you are receiving or eligible for retirement or disability benefits, your spouse may be able to get benefits.

Let's refer to the couple as the "main beneficiary" (the person filing) and the "spouse." Under current law, a spouse cannot claim a spousal benefit unless the main beneficiary claims benefits first. However, once full retirement age (FRA) is reached (age 66 for those born between 1943 and 1954), a main beneficiary can file for benefits, but then immediately suspend receipt of those benefits until some future date.

By doing this, his or her spouse can claim a spousal benefit, and the main beneficiary can let his or her own retirement benefit grow at 8 percent per year until age 70. In addition, if both the main beneficiary and his or her spouse have reached FRA, it is possible for the spouse's own benefit to grow due to delayed requirement credits if he or she elects to receive free spousal benefits (also referred to as the restricted application option).

The file-and-suspend strategy is also potentially useful for couples in which only one person has reached FRA. In this case, the benefit of the main beneficiary will continue to grow, but the spouse's benefit will not. The advantage to the spouse, however, is that he or she has the opportunity to draw a spousal benefit in addition to his or her own benefit when the file-and-suspend option is utilized.

Restricted application. This strategy pertains to those circumstances in which a married person and some divorced persons can claim spousal benefits without also being forced by Social Security to claim their own retirement benefits. That is, you are "free" to take a spousal benefit while letting your own retirement benefit continue to grow.

The advantage of taking "free" spousal benefits is that you are receiving the spousal benefit while your own retirement benefit grows at 8 percent a year until age 70.

Making the right moves by supplementing retirement savings with taxable savings, knowing when to use each type of account, and which Social Security benefit to file for at what time may just have you eating steak ... unless you are a vegetarian of course, but that's a different article.

Bridget Burgess, is a Certified Financial Planner and a client advisor for Laird Norton Wealth Management.

 

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