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When it comes to personal finance advice, delaying Social Security benefits until age 70 to lock in a higher benefit for life is a popular strategy. The main perk of waiting? It boosts your benefit by 8% each year after you reach full retirement age (67 for people born in 1960 or later) up until age 70. Who doesn’t like to get a raise?
Moreover, waiting until 70 can be a smart strategy for protecting your spouse’s benefits should you pass away first.
But there’s a catch: you need to be able to generate enough income in those so-called “gap years” to replace the Social Security check you’ve put on hold. To do so, you’ll need to build a financial bridge with your savings and investments to close the funding gap.
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Step 1: Survey the landscape — is a bridge realistic?
Just as you would only construct a bridge if you were certain you had the materials and budget, you should also assess your chances of spanning 62 to 70 without tapping Social Security. Is it even possible? “Analyze your living expenses and see whether you can generate enough income from your assets to support your objective of deferring Social Security,” says Brian Vendig, chief investment officer at MJP Wealth Advisors.
Don’t forget to account for the Medicare gap; you’ll need to cover health insurance premiums and other expenses between the ages of 62 and 65, unless you are on your spouse’s health plan.
Veteran Kiplinger readers may have already done this preliminary step. If so, congratulations! You can now go to step 2.
If not, don’t be discouraged.
You will ideally work with a financial adviser, or at least, consolidate your accounts into “aggregator” software so you can review your assets all at once. While the pros use some of the best tools around (like eMoney or RightCapital), there are affordable software solutions for DIY planners as well.
First, focus on your assets. Determine the balances of your savings accounts, traditional IRAs and 401(k)s, taxable brokerage accounts, Roth IRAs, and other income sources that could cover the funding gap. What amount of income could you reasonably generate each year? (We’ll get into more detail later, so an estimate is fine for now.)
Next, assess your transactions to determine your average annual spend during your bridge years. A review of statements over the past 12 months can help answer that question.
Finally, ask yourself if your estimated income could cover your annual spending needs.
If the answer is no, waiting until 70 to turn on benefits likely isn’t viable. However, don’t despair. Depending on how large the gap is, you might be able to build a shorter bridge to Social Security, say, for just a few years. Or you could pick up some consulting or part-time work to stretch your savings between the ages of 62 and 67. (You won’t have to face the Social Security Earnings test in that period, since you won’t be claiming Social Security.)
But if you do have adequate resources to replace the delayed Social Security check, the next step is to figure out the best way to build a bridge to pay the bills from age 62 (the earliest age you can claim benefits, but which comes with a 30% reduction in benefits) until you turn your benefits on at age 70.
Step 2: Create a systematic withdrawal strategy
This strategy is akin to a typical retirement drawdown plan that pulls from various accounts, such as a 401(k), taxable fund portfolio, and Roth IRA — with the main difference being that Social Security won’t be part of the income mix until age 70.
“The most common strategy is a systematic withdrawal strategy,” says Andrew Wood, a retirement planning adviser with Daniel A. White & Associates. If you need $4,000 a month, for example, map out a withdrawal strategy that works on autopilot and pulls from one or multiple accounts in a way that best minimizes your tax liability. “You want these (regularly planned) withdrawals to mimic a Social Security check,” says Wood.
Step 3: Mind your tax brackets and withdrawal order
When taking withdrawals, be mindful of how much income you’re generating to avoid bumping up into a higher tax bracket and paying more in taxes, adds David Kressner, managing adviser at Altfest Wealth Management. For example, if you’re nearing a higher bracket, set up a drawdown system that pulls from a tax-free Roth account, a brokerage account that benefits from lower capital gains rates (married couples with income up to $98,900 pay zero capital gains, and 15% up to $613,700) as well as from traditional 401(k)s and IRAs that are taxed at ordinary income tax rates.
“The idea is to pull from these different pools of money in the most tax-efficient manner,” says Kressner. “You could potentially be able to sell some investments and take those profits (to create income) with little or no tax consequences. Selling assets with the largest unrealized gains can give you more bang for your buck” (if the tax impact is nil).
“I really like using pre-tax IRA and 401(k) money during the bridge period.” — Andrew Wood
To best manage the tax hit on account withdrawals, make sure you pull from the right account. The most common pecking order is to withdraw from taxable accounts first. “Taxable assets are the first place to go,” says Vendig. Why? The tax hit won’t break the bank. If you pull some money from cash or a CD, for instance, you pay zero taxes. If you sell a stock, you may pay zero capital gains.
Next in line are traditional IRAs and 401(k)s. While these withdrawals are taxed at your ordinary income rate, which ranges from 10% to 37%, there are benefits from lowering your account balance. For example, if you take distributions in years when your income is low, such as in the early years of retirement, you’ll be able to take the money out at a lower tax rate. What’s more, pulling money from traditional accounts before age 73 or 75 (depending on your birth year) when required minimum distributions (RMDs) begin means those forced withdrawals will be smaller. That could help you avoid hurdling into a higher tax bracket. “I really like using pre-tax IRA and 401(k) money during the bridge period,” says Wood.
Advisers typically recommend withdrawing from Roth IRAs last, as they allow tax-free withdrawals. “We prefer to use Roth IRAs as opportunities for growth in portfolios,” says Vendig. Of course, if pulling mainly from traditional accounts pushes you too close to the next higher tax bracket, you can add a Roth withdrawal into your overall monthly withdrawal. “We might take that weighted, blended approach assuming it keeps them in the same tax bracket,” says Vendig.
Finally, talk to your adviser about doing a Roth conversion during these bridge years. Ages 62 to 70 are often a sweet spot for conversions, but you’ll need to align them with your tax planning.
Step 4: Build steady income streams
The magic of Social Security is that benefits are guaranteed and paid out in monthly installments. Another way to bridge the income gap to age 70 is to create guaranteed income streams on your own, or at the very least, sources of income that can be counted on to deliver consistent income no matter what the financial markets are doing.
Consider an annuity that expires at age 70.
One option to consider is a single premium immediate annuity, says Wood. This is a contract with an insurance company that converts a lump sum into an income stream guaranteed for life or a set period of time.
Since you’re trying to bridge the income gap from age 62 to age 70, Wood recommends a “period-certain annuity,” which pays out cash flows for a set number of years, typically five to 20 years. So, if you’re 60, you could convert a portion of your savings to an annuity that pays out for 10 years until age 70. If you’re 65, a period-certain annuity of five years will suffice. If the annuitant dies early, payments go to a beneficiary.
Period-certain annuities differ from life annuities, which pay until death, so don’t convert them if you want to maintain a death benefit. These annuities provide predictable financial security for a set period. Since the annuity doesn’t guarantee payments for life, your monthly payments are higher. “When the annuity period ends at age 70, you switch over to Social Security,” says Wood.
Consider a bond or CD ladder.
Since income is what you’re trying to solve for in the years before Social Security kicks in, you can build a fixed-income portfolio made up of bonds that are benefiting from today’s higher yields. You could, for example, build either a bond ladder with individual bonds with different maturity dates or a CD ladder that divvies up your cash across multiple CDs with staggered maturity dates.
This laddering strategy gives you regular access to funds while earning higher yields than traditional savings vehicles offer. “It’s a good approach to keep income generation consistent,” says Vendig. You can also add income to close the gap by having your dividends on stocks and bonds and mutual funds sent directly to you, rather than reinvesting them.
Now build your bridge to Social Security
The bottom line: with the right “materials” and “blueprint,” you can build a solid bridge to that larger Social Security check at age 70. You’ll likely need to blend many of the options described above.
“Looking at comprehensive planning, usually it should be a combination of all these strategies,” says Wood.