Best Age to Collect Social Security: Taxes May Make It Sooner Than Later

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A Social Security plan is an essential part of any income strategy.

Many financial experts say that the age when you should start collecting Social Security benefits is 70, even though you can begin as early as age 62. The “full retirement age” is between 65 and 67 depending on the year you were born.

Experts often recommend waiting until age 70 to start collecting benefits because the later you start, the more money you will receive each month from the Social Security Administration.

Social Security rewards people who wait with more money and punishes people who start early with less money.

Putting it another way, the earlier you start receiving benefits, the less money you will receive each month and in total over the remaining years of life.

The reduction has become steeper in recent years. People who reached age 62 in 2013 or earlier and started collecting benefits at that age faced a maximum reduction of 25 percent of the total payout at full retirement age (FRA).

That maximum reduction gradually increases to 30 percent for people born after 1959.

But that doesn’t mean starting benefits at age 62 is a bad choice.

When to start collecting Social Security benefits depends on your health and your taxable income. In brief:

  1. High-income retirees in good health should wait until age 70.

  2. Low-income retirees should wait until age 70 unless they need the SSA income earlier. Many of them do.

  3. People with serious health problems should start at age 62 because of the risk of dying earlier than the average American.

  4. Middle-income retirees may find it is best to start at age 62 because of the impact of income taxes.

Social Security estimates do not include the impact from income taxes. Chart source: Social Security Administration
Social Security estimates do not include the impact from income taxes. Chart source: Social Security Administration

Social Security Poll

When do you plan to start collecting Social Security benefits?

  • Age 62
  • Age 66
  • Age 70
See results without voting

Income Taxes Change Everything

The above chart shows why the Social Security Administration recommends that people should wait to start taking benefits at age 70.

But it doesn't take into account the impact of income taxes on those benefits.

How Benefits are Taxed

Social Security provides a safety net for people with low incomes or living in poverty. So benefits at the lower amounts are not taxable, while benefits at higher amounts face larger tax bites. For a couple filing jointly, benefits are taxable this way:

  • None are taxable on a combined income up to $32,000.
  • Up to half are taxable between $32,000 to $44,000.
  • up to 85 percent are taxable above $44,000.

“Combined income” is an IRS concept that is the starting point for the tax formula. It includes three parts:

  1. The filer’s adjusted gross income
  2. Tax-exempt interest income (such as municipal bond funds)
  3. Half of their Social Security benefits.

Prepare yourself for government mathematics.

Step 1 in the Formula: Benefits That Aren't Taxed

The first seven lines of the IRS taxable benefits worksheet will show if any benefits are taxable.

The formula for a married couple filing jointly is simply:

$32,000 - combined income = taxable benefits

Couple A is thinking about retiring at age 62. They will have $20,000 of Social Security benefits and $20,000 in other income such as pensions, IRAs and tax-exempt interest.

Their combined income is $30,000 because they have to count only half of their SSA benefits. Because the $30,000 is less than $32,000, they won't have any taxable benefits.

Step 2 in the Formula: 50% of Benefits are Taxable

The second part of the SSA formula begins if combined income is more than $32,000 and less than $44,000. It taxes half the difference between the two numbers.

Combined income - $32,000 = sum x 0.5 = taxable benefits

For example, Couple A wonders if they should wait until age 70. They will receive about 75 percent more benefit income per month if they wait until then.

In today's dollars, they may have $25,000 of income from other sources because they worked longer and $35,000 in benefits.

Their combined income will be $42,500 from the first $25,000 plus half of their benefits. The formula produces this result:

$42,500 - $32,000 = $10,500 x 0.5 = $5,250 in taxable benefits

Step 3 in the Formula: 85% of Benefits are Taxable

The third step in the formula taxes benefits above $44,000 at the 85 percent level.

Couple A manages to increase their income from other sources to $35,000 a year. If they retire at 70 instead of 62, their total income including benefits will be $70,000 a year. Their combined income will be $52,500.

They will pay taxes on $6,000 in benefits or half of the total between $32,000 and $44,000.

They will pay taxes on $8,500 in benefits or 85 percent of the total combined income above $44,000.

In total, they will pay taxes on $14,500 of their benefits.

That was simple, right?

But the tax factors don't end there.

Social Security Benefits Tax Worksheet

The IRS worksheet shows whether an individual pays taxes on Social Security benefits. Fill out the first seven boxes to see if any benefits will face a tax.
The IRS worksheet shows whether an individual pays taxes on Social Security benefits. Fill out the first seven boxes to see if any benefits will face a tax.

$6,600 in Extra Taxes -- or $15,750

The current average lifespan of men and women in the United States who are still alive at age 65 is about 84 years.

In a real world example, a couple will receive about $21,000 a year if they start taking benefits at age 62 or $37,000 if they start at 70. (See the section below about total lifetime earnings.) Their income from other sources is $30,000.

The SSA formula shows they will pay taxes on only $3,000 of their benefits. At the 10 percent tax bracket, they would face $300 a year in extra taxes or $6,600 total between ages 62 and 84.

If the start at age 70 with the higher benefits, they would pay $750 a year in extra taxes or $9,000 total between ages 70 and 84.

The difference is small, but there are other risks.

Tax risk #1: If they wait for that boost in benefits until age 70, their total taxable income will likely exceed $18,550 on IRS form 1040 or the line between the 10 and 15 percent tax brackets

They would pay $15,750 in extra taxes just on the extra Social Security benefits. Waiting until 70 will increase their SS benefits and also their income taxes.

Tax risk #2: The income levels for non-taxable benefits are not increasing each year with inflation. The longer a couple waits to tap benefits, the less impact they receive from the tax rules.

Tax risk #3: The income tax rates may go up at some point in the future because of federal and Social Security deficits. Waiting increases the risk of being pushed into a higher tax bracket.

Tax risk #4: The impact is even greater in the 13 U.S. states that also tax benefits. (Tax tip: When retiring, think about moving to a state that doesn't tax benefits.) How much they tax depends on whether the states leave lower amounts of benefits alone and tax only the higher amounts.

These tax laws may be a reason to start benefits early because lower monthly benefits mean a lower combined income that is taxable.

It is important to note that many variables go into a decision about when to start collecting benefits. Each individual or couple should analyze their unique situation or get the help of a financial planner.

Beneficiaries by age. Source: Social Security Administration
Beneficiaries by age. Source: Social Security Administration

When Do You Plan to Die?

Few people plan the timing of their death. But it is possible to make some predictions based on current health, family history and the normal human lifespan.

The SSA has actuarial tables and calculators that predict how long the average male and female in the U.S. will live.

A male who turns 62 this year will live on average another 22 years, according to the latest SSA actuarial tables. If that male is still alive at 70, the SSA predicts he will live to age 86.

The average female who turns 62 this year will live about 24 more years, according to the SSA. If she is alive at age 70, she will have another 18 years ahead.

The fact that the lifespan is longer for someone who is alive at age 70 than someone who is alive at age 62 reflects the simple fact that a growing number of people die between age 62 and 70.

A person who decides to wait until age 70 and passes away before that date will receive no benefits, although a living spouse will receive a reduced amount (about half).

So the first part of the decision about when to start taking Social Security benefits depends on the health factor. Healthy people have a reason to wait. Chronically unhealthy people have a reason to start early.

Lifespan Determines Total Income

A worker with the maximum taxable income for Social Security will receive the following amounts each month in 2016 depending on his or her age and when they start collecting benefits. These totals come from the SSA Web site and use 2016 limits.

  • Start at age 62 - $2,102
  • Start at age 66 - $2,639 or 25.5 percent more than age 62
  • Start at age 70 - $3,576 or 35.5 percent more than age 66

The above numbers show that starting benefits at age 70 will provide far more monthly income than starting at age 62.

But there is another important consideration: total lifetime income.

If You Live Until 84

If a male lived to age 84 and had the maximum benefits above, he would earn the following totals depending on the age at which he starts taking benefits:

  • Start at age 62 - $554,928
  • Start at age 66 - $570,024 or 2.7% more than age 62
  • Start at age 70 - $600,768 or 5.4% more than age 66

The difference between age 62 and 70 is $45,840 in total lifetime earnings. Waiting until 70 sounds like a better option, but remember that the big jump in annual earnings will increase taxable income and risk a higher tax bracket.

The example at the beginning of the article shows that a couple who jump into the 15 percent tax bracket will incur $26,658 in additional taxes. That lowers the lifetime gap between age 62 and 70 to $19,182 IF both couples live to age 84 or older.

If You Live Until 80

Watch what happens if that same person passes away at age 80 instead of 84:

  • Start at age 62 - $454,032
  • Start at age 66 - $443,352
  • Start at age 70 - $429,120

A person who risks dying at age 80 or earlier because of poor health will see that taking benefits at age 62 produces better results than ages 66 or 70.

The impact of income taxes makes it clear that starting at age 62 will provide more after-tax income.

If You Live Until 90

Finally, the person who is fortunate enough to live to age 90 ends up with a different set of results:

  • Start at age 62 - $706,272
  • Start at age 66 - $760,032
  • Start at age 70 - $858,240

The healthy person who takes a chance and waits until age 70 will receive far more total income if he or she lives beyond age 84..

A longer than average life is a winning lottery ticket for people who start benefits at 70.

Watch Out for Earnings Limit

The SSA has an earnings exemption test that limits how much in benefits someone will receive between age 62 and the full retirement age (FRA).

The earnings limit for workers who are younger than FRA (age 66 for people born in 1943 through 1954) is $15,720. The SSA will deduct $1 from benefits for each $2 earned over $15,720.

But the amount deducted will simply be deferred until FRA. So a person expecting $20,000 a year will receive $15,720 and receive the remaining $4,280 after reaching FRA.

A person who has the potential to meet the full earnings limit of $2,102 a month in 2016 or $25,224 for the year will actually receive $1,310 a month or the limit of $15,720. SSA will pay the difference after FRA.

The earnings limit for people turning 66 in 2016 is $41,880. The SSA will deduct $1 from benefits for each $3 earned over $41,880 until the month the worker turns age 66.

For example, someone who starts benefits on Jan. 1 and turns 66 on July 1 will have a part of their benefits withheld between those two dates.

Social Security does not have a limit on earnings for workers who reach FRA or older for the entire year.

The monthly benefit will increase permanently to make up for the months in which the benefits were withheld.

Related Facts

  • The average age of retirement in the U.S. is 62, according to a Gallup poll and other sources.
  • About 50 percent of men and 60 percent of women begin taking Social Security benefits at age 62, according to the Journal of Accountancy.
  • Nine out of ten people age 65 and older receive Social Security benefits.
  • Social Security benefits represent about 39% of the income of the elderly.
  • Among elderly Social Security beneficiaries, 53% of married couples and 74% of unmarried persons receive 50% or more of their income from Social Security.
  • Among elderly Social Security beneficiaries, 22% of married couples and about 47% of unmarried persons rely on Social Security for 90% or more of their income.

© 2016 Scott Bateman

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