Most workers will one day be eligible for multiple entitlement programs. One of the most critical retirement decisions a soon-to-be-retired worker needs to make is when to collect Social Security benefits. Having dependable income as early as possible certainly relieves a lot of the anxiety about suddenly losing a regular paycheck, but you can't ignore the huge increase in benefits if you delay collecting Social Security by eight years.
The best age to claim Social Security will be based on each person's circumstances. But, in general, delaying Social Security is going to be the better choice. Here are a few reasons why:
The biggest retirement risk is longevity, and delaying Social Security will substantially reduce the risk of running out of money. Retirement planning would be much simpler if we knew how long we are going to live. Estimating how long we might live adds a bit of uncertainty to our retirement plans. By delaying our Social Security benefits, we will get a bigger check every month. That means more stable income we can count on even if we miscalculated our retirement planning and spend every penny of our savings and investments. Your monthly payments will increase by 7 to 8 percent for each delayed year, which could make a huge impact on your retirement finances.
Each cost of living adjustment (COLA) will be bigger too. Our Social Security benefits increase each year to keep up with the cost of living by a percentage of the current payout. If we start collecting a higher amount by delaying our start date, the same percentage COLA increase will have a higher dollar value than if we started at a lower base.
We can minimize regret by delaying our Social Security benefits. A retiree will generally get a larger lifetime benefit after age 78 by delaying claiming Social Security benefits. This means that if we live past 78, we might start regretting taking our benefits early because our lifetime payments will be smaller than if we had delayed claiming. Those who don’t live past 78 would have been better off claiming earlier.
You can convert your pre-tax nest egg to a Roth IRA at a lower tax rate. A portion of Social Security payments could be subject to income taxes. By delaying Social Security during the early part of your retirement, the monthly payments will not be included in your adjusted gross income. This means you can convert your pre-tax nest egg, including your traditional 401(k), to a Roth IRA at a low tax rate.
Let's say a family no longer has regular income because both spouses retired. Based on 2012 tax brackets, they can convert up to $70,700 of pre-tax income to a Roth IRA and pay just 15 percent of that amount in taxes. After that, all investment income derived from that $70,700 throughout their lifetime will be tax free once the money is in a Roth IRA.
There are some nuances, of course. Roth conversions have the potential to increase your exposure to tax audit risk. So, it’s a good idea to speak with a tax professional before attempting such a move. However, this could be said about anything that adds complexity to your tax return, and making the conversion could be a huge benefit for those who can take advantage of this tax maneuver.
The odds are getting better that we will live longer. With advancements in medicine and wellness research, we could learn to live longer as time passes. Delaying our benefits will be the better choice for many healthy retirees. While waiting to claim your benefit certainly has costs, it will give you more income in your later years when you are likely to need extra money the most.
David Ning runs MoneyNing, a personal finance site that shares money moves you can make to significantly increase your chances of having a comfortable retirement. He likes to share simple changes that anyone can make, such as picking the best online savings account and figuring out whether a 0 percent balance transfer credit card makes sense.