Bridge the Gap – Delay Social Security
This comprehensive guide helps you Bridge the Gap to delay social security in order to maximize your social security benefit. Social Security optimization is an important component of financial security in retirement.
Is it Worth it to Delay Social Security?
By definition, delaying social security increases your income for life. Not only are the checks larger, in addition there is a larger cost of living adjustment. Get your delayed retirement credits!
Maximizing social security makes sense if you can close the gap: while retired, how do you pay for expenses before taking social security? Use Bridge Assets!
What’s at Stake?
Full retirement age is 67 for those born after 1960. If you claim at 62 you lose 30% of your Primary Insurance Amount (PIA—the amount you get from social security at full retirement age). If you claim at age 70, you get 24% more than your PIA! So, you can get anywhere between 70% and 124% of your PIA depending on when you claim.
Assume your PIA is $1000. You can get $700 a month or $1,240 a month. That is a 77% increase by delaying!
It can really make a lot of sense delaying claiming to increase your total net worth! Let’s have a look.
Example of Total Net Worth with and without Delaying Social Security
Figure 1 represents two strategies for social security clamming. In light green, you start claiming at age 62. You can see there is a slow increase in assets until about two decades later when inflation catches up with income.
Conversely, in dark green, delaying claiming until 70 causes a decrease in net worth originally, but once you start claiming at age 70, net worth increases over time given the increase in social security.
Note that the cross over point, the time when you have more net worth due to delayed claiming, is about age 86. This is a full 24 years after the earliest you can claim (age 62), and 16 years after the latest you can claim (age 70).
Who Should Delay Social Security?
If you can find other assets in order to delay social security, you should!
If you might live beyond 85 year of age, consider delaying social security! There is no better longevity insurance than a delay in social security. Other annuities don’t come close to the power of delayed social security.
It is especially important in a couple for the high-income earner to delay as long as possible. This is due to the Widow’s Tax Penalty, where the lesser of the two social security checks stops at the death of the first spouse.
Finally, if you want to have a Tax Planning Window and have unfettered access to your 10 and 12% tax brackets, delay claiming as long as possible. This allows Roth conversions, capital gain harvesting, and other advanced strategies discussed in Part 3.
Will Social Security Still be Around when I’m 70?
This is an important consideration. Legislative risk is present with social security, and changes will be made in the next decades or sooner.
Generally, changes in social security are made in the distant future, and folks approaching retirement age are grandfathered in.
To me, it doesn’t make sense to claim early if you are worried about social security being solvent. Any changes will likely be on a percentage of what you are earning. Thus, if you claim early, you will have a percentage change on a smaller amount of social security rather than on a larger amount.
Of course, if you are well to do, there will likely be increased means testing of social security in the future. In that case, if you make more in social security, and yet have a high income, will more of your social security be at risk?
In this case, who cares. Maximal social security is icing on the cake for those well off in retirement.
I think you have to make the best decision with the information you have at hand, and adapt. Planning is an active verb. You don’t make a plan, you do planning.
At least with planning you have the chance to shift course and adjust, rather than just react.
Social Security Bridge: “Bridge Assets”
Building a Bridge To Social Security
What if you want to retire before 70? How about at 62? When would you claim social security?
Full retirement age is 67 for those born after 1960. If you claim at 62 you lose 30% of you Primary Insurance Amount (PIA—the monthly amount you get from social security at full retirement age). If you claim at age 70, you get 24% more than your PIA! So, you can get anywhere between 70% and 124% of your PIA depending on when you claim.
This is a big decision and a lot of money is at stake.
If you decide to bridge social security yet retire, bills still need paid!
How do you bridge the time when income stops and social security begins most effectively?
Let’s look at some “Bridge Assets:” resources that are used to pay the bills while you delay claiming social security.
What are Bridge Assets?
Bridge Assets are resources, investments and strategies that allow you to live an active retirement until claiming social security at 70.
They are, in many ways, similar to Buffer Assets. These aspire to prevent Sequence of Return Risk, which is also an active concern of novice retirees.
Let’s modify a classification of Buffer Assets I developed and see how that works with Bridge Assets. The idea here is to generate a list of ideas to test on a fictional scenario.
- Flexible Cashflow—Income need in retirement is driven by expenses. You can control expenses or earn money, neither one is very much fun in retirement!
- Expense Modification: One can spend conservatively or have guiderails for spending
- Income Generation: Using human capital (a part to job or side gig)
- Additional Income: Income from rentals, patents or other passive income streams
- Investment Strategies—this is the mainstay of Bridge Assets.
- Ladders: “Ladders” of CDs, Bonds, or MYGAs. Consider laddering a combination of 2 or 3 of these assets depending on interest rates
- Planned Allocation Strategies: Rising equity glidepathsor bond tents are important considerations, as is baseline asset allocation during the delay years
- Goal Segmentation Strategies: Guaranteed fixed income “floor” provided through pensions, annuities or TIPS ladder
- Annuity Strategies: Income from immediate annuities, longevity insurance from deferred annuities, or period certain annuities during the delay years
- Income Portfolio: Preferred stock, dividend stocks, utility stocks, REITs, convertible bonds and MLPs are not infrequently used by investors for “bond-like” exposure and income
- Retirement Accounts: Traditional or Roth IRAs are tapped for income
- Income Replacement Funds: Also known as Managed Payout Funds
- Uncorrelated Assets
- Cash Reserve Strategies: Having a large cash reserve will bog down overall portfolio returns
- Classic Buffer Assets: Cash value life insurance and HECM (reverse mortgages) have low correlation to market returns and tax-free “income”
- Other Assets: Businesses, hobby collections, rental properties, or other assets can be sold for income
Now that we have thought of some ideas to test, let’s meet our fictional couple.
Consider a couple 62 and 58 years of age. They have a net worth of $1.2M and want to see what social security will add to their retirement. They both hope to live to 95.
Currently, $100,000 is in cash, $200,000 in a Roth, $300,000 in a brokerage account, and $600,000 in a traditional IRA. They have a 60/40 portfolio; stocks return 7% and bonds 3.5%.
They will spend $5000 a month in retirement (about 4% withdrawal rate). Inflation is 2% and healthcare starts at $5000 a year with 5% inflation.
Their PIA is $2000 and $1000 a month (so if they both claim at their full retirement age they will get $3000 a month in social security). The older partner was born in 1957, so his full retirement age is 66 years and 6M. The younger partners is born after 1960 so her full retirement age is 67.
Effect of Social Security Bridge
If they both claim as early as possible (age 62), they will start out with $18,000 a year, which increases to $28,000 a year when the younger partner turns 62. This increases by 2% a year in this model.
On the other hand, if they wait until 70 to claim, after 8 additional years they will make $36,000 a year which increases to $58,000 a year 4 years later.
See these numbers above above. In grey, they each claim at 62. In blue, 70.
Above you can see the different claiming strategies. Gray is early, blue is delayed.
The cross over point where they make more by delaying is at age 79 (15 years after retirement). If the younger partner lives until 90, they will earn $632,000 more over their lives with the delayed claiming strategy.
On Monte Carlo, early claiming has a 61% chance of success and delayed claiming 82%.
Let’s look at the portfolio total over time next.
Comparison of Portfolio Total with Social Security Bridge
Above, light green demonstrates early claiming. The total amount increases for about 20 years, and then gradually decreases. In blue bridge to social security at 70. Initially there is a draw down in the portfolio total. When they start claiming social security at age 70, the portfolio total slowly increases.
The cross over point, where delayed portfolio has more than the early, is at age 85, 13 years after retirement.
Good and dandy. So, with $60,000 in expenses a year, they can do pretty good if they delay claiming social security until age 70.
Modeling Bridge Assets that Maximize Social Security Claiming
Maximize Social Security: Flexible Cash Flow
The first section to Maximize social security: flexible cashflow.
Rentals or other passive income streams provide income. Human capital—part time work or side gigs—is also an important consideration. But isn’t the point of retirement not to work?
Decreasing expenses is also a thought. A bucket plan with flooring is intended to meet retirement expenses without decreasing spending through early retirement. Even if there is sequence of return risk, buffer assets fill the gap.
Flexible spending, however, is naturally what people do when the market is down. You can’t help but see the negative news and consider if you want an “A” vacation or maybe settle for a “B.”
Let’s look at our couple from part one and see what their plan looks like if they spend $5000 (the original plan) or $6000 a month.
Effect of Flexible Spending to Delay Social Security
Here, social security starts at age 70. In light green monthly income requirement is $5000 and $6000 in blue.
On top, returns are continuous overtime (stocks 7% and bonds 3.5%). You can see what large effects income needs have on remaining portfolio values. Monte Carlo odds are 82% for $5000 and 39% for $6000.
On the bottom the first decade is marred by sequence of return risk. In this case, sequence of return risk is simulated by the actual returns from 2000-2010. Here you can see why a lower withdrawal amount matters. You easily make it through 35 years with $5000 a month, but burn out at age 88 with $6000 a month.
Beyond lowering income requirements or making money during retirement, let’s look at some other strategies you can use to delay social security.
Investment Strategies—The Mainstay to Maximize Social Security
Using a bond/cd ladder toolkit, it costs approximately $290,000 to purchase an 8 year ladder with an expected current pay out of $40,000 a year, or $320,000 total. Given low current interest rates, it is difficult to see how CD ladders, bond ladders, or a ladder of MYGAs could be useful in building income for gap years.
Historically, interest rates have been about 2x what they are now. In that setting, locking in a ladder for income makes a lot of sense.
Planned Allocation Strategies
Rising equity glidepaths and bond tents are programmatic increases in equity during retirement. I have discussed this in detail elsewhere, but generally it is best if you start out with a 60/40 asset allocation at retirement and increase to 80/20 or higher during the first 10-20 years of retirement.
Seen above with continuous returns (on top), compare these results to figure 1. A rising equity glidepath improves the end-of-plan portfolio balance for both $5000 (green) and $6000 (blue) a month income needs. It also improves Monte Carlo odds for $6000 a month up to 48%.
With sequence of return risk (below), compare again to figure 1. With the lower withdrawal rate, you end up with more assets, but a rising equity glidepath is unable to save the higher withdrawal rate.
Rising equity glidepaths, while sexy, are not all that practical. Who is going to increase exposure to stocks with age in order to maximize social security?
The next strategy is more practical: Goal Segmentation
Goal Segmentation Strategies
In bucketing, you can have time segmentation (now, soon, and later) or goal segmentation. A good goal is to “cover” fixed (floor) income needs with guaranteed income such as social security, pensions, and annuities.
Delaying Social Security really is all about goal segmentation! Think about this: you need to cover certain expenses for a certain time period. The goal is to have income while you are growing your social security payment in the background. There is time segmentation as the income needs to last until you are able to tap into social security.
Additionally, the goal of finding income now for maximal social security later improves the guaranteed income for future fixed expenses.
Another way to guarantee income is with annuities.
Annuities are often mentioned as Delay Strategies, but I think they are mostly unsatisfactory for this purpose. If you have an expensive, complicated Variable Annuity or Fixed Indexed Annuity, you could consider making withdrawals from the annuity to fund a bridge. Don’t rush out and get one of these products, however, as they are expensive and complicated.
There are better products.
I cover single premium immediate annuities and deferred income annuities in excruciating detail elsewhere. A brief review here is in order in regards to Bridge Assets:
Single Premium Immediate Annuities (SPIAs)
With these annuities, you exchange a pot of money for life-long income payments from the insurance company. SPIAs are for guaranteed income.
A SPIA can provide life-long income but isn’t particularly useful as a Bridge Asset unless there is a period certain (see below). At today’s rate, a 58-year-old female can get a 5.5% yearly return, whereas for a 58-year-old male it is 5.7%. I did run a $300,000 SPIA on the IRA and it did not improve the outcomes in this simulation.
Deferred Income Annuities (DIAs)
DIAs are for longevity risk. If you are going to live a long time, you can exchange a pot of money for a future income stream, with a higher return than for SPIAs. DIAs are extremely useful along with a delay in social security if you plan have longevity in your family. Obviously, since the income is deferred to the future, they are not useful as Bridge Assets.
Annuities with Period Certain
Annuities with period certain are the most useful annuities in delaying social security. You can give a lump sum of money for a certain number of yearly payments. For example, currently a 5-year period certain will return 20.7% of the lump sum yearly for 5 years. For a 10-year term certain, you get 11.2% back every year for 10 payments. SPIAs with period certain certainly should be evaluated to cover income gaps of known duration such as you have when delaying social security.
I did test a few variations of SPIAs with period certain and did not improve Monte Carlo odds. Annuities cannot make more money out of thin air. For those who don’t like stock market risk, however, having an insurance company guarantee a fixed return for a certain number of years could be excellent planning.
Income Portfolio and delaying social security
In your brokerage account, you can focus on total return or income. If you switch from total market funds to REITS, preferred stocks, high dividend stocks and the like, you will get more taxable income every year.
If you are funding your gap through the brokerage account (selling assets and paying capital gains), it is unlikely an income portfolio will have much of an effect. Increasing dividends from 2% to 5% (with total return still 7%) had no effect on the current scenario.
Consider, however, if you fund a gap through non-brokerage assets, an income portfolio provides some income without selling assets.
Income Replacement Funds
There are major players in offering funds that pay out interest and principle over a set period of time. These funds launched just before the great recession in 2008 and have never gathered much popularity. Review comparison here.
Uncorrelated Assets and Social Security Delay
Finally, we have reached uncorrelated assets. These are assets that don’t drop with the stock market. Perhaps a better word is less-correlated rather than uncorrelated, as everything goes down if the recession is bad enough.
Cash Reserve Strategies
Cash is for spending. I don’t view cash as an actual Buffer Asset, but of course it is prudent in the withdrawal phase to have 1-3 years of cash reserve on hand. This is bucket 1 and is fed by bucket two or three depending on market returns.
Classic Buffer Assets
Named in honor of Dr. Wade Pfau, the originator of the term Buffer Assets. If you have cash value in a life insurance product, or a HECM (see below), “income” from these can be used to Bridge the gap.
Life insurance is a touchy subject. Aside from special needs trusts, estate tax issues, and perhaps leveraging life insurance if you don’t need your RMDs, there really is no need for permanent life insurance. Yet, it is often sold (rather than bought) and many people have cash value policies. If you have a permanent life insurance policy, a loan on the cash value is a non-correlated asset that can be used for income to prevent SORR or as a bridge to Social Security.
The home is often a large asset. Tapping the value of the home is an important consideration. Although most believe reverse mortgages are a last-ditch effort to save retirement, this needs to be reconsidered. HECMs are a type of reverse mortgage that can be set up at age 62.
Although not modeled in the current scenario, if you are going to run out of money at some point in the future, tapping home equity through a HECM early while you delay social security (rather than claiming early and tapping home equity when you otherwise run out of money) is almost always going to be a winning scenario.
Other Assets to Maximize Social Security
Other assets are important considerations. Business interest, hobby collections, rental properties and the like can be sold for an infusion of cash. These non-portfolio assets are important to keep in the back of your mind during retirement. If you have a stamp or coin collection you inherited from a grandfather, what a good time retirement is to attempt to monetize this, or donate it in order to do Roth conversions in the same year.
Maximize Social Security: Tax Considerations
Tax considerations during your Tax Planning Window are huge. This is the most important tax period in your life. Seriously, the window between income loss and required minimum distributions (RMDs) is like gold in your pocket. The tax planning window should be called the golden years rather than all of retirement!
In general, it is most tax efficient to withdrawal first from your brokerage account. When you sell assets, you pay capital gains on the increase from the purchase price. These are long-term if you have held the asset for more than a year and are taxed favorably.
After Selling Capital Gains for Income when Deferring Social Security
For income in your tax planning window, you first sell from your brokerage account (capital gains), then tax-deferred account (fully taxable at your effective rate), then your Roth account (tax-free).
However, the point is to pay the least in taxes over your lifetime.
How do you do this? By understanding your plan and your projected tax liability over the next 30 years!
You might want to do partial Roth conversions or do Capital Gain harvesting, or do non-RMD distributions from your IRA.
After you have harvested capital Gaines, you may want to look at partial Roth conversions.
Do partial Roth conversions make sense with our fictional couple above in their Bridge years? Before we look at that let’s look at the tax problems in the current scenario.
Tax Considerations and Problems with the Scenario
On top, see the expected tax liability for the $5000 per month (green) and $6000 per month (blue) withdrawal strategies.
Below left is the estimated effective tax rate for $5000 per month and below right for $6000 per month.
Note that there is state tax in the lower graphs. Federal tax is in dark blue, and state tax on top in light blue.
Basically, with the top figure, you can see it is lumpy and thus tax inefficient.
With $5000 a month (green on top and left lower), you pay state taxes but no federal taxes during your tax planning window. Then, the brokerage account runs out of money and there is a bump in taxes owed between 68 and 74. At that point, RMDs take over and the tax liability increases over time.
With $6000 a month (blue on top and right lower), the high demand for income make the tax payments even “lumper” and worse over time. When it goes to zero taxes, both the brokerage account and the IRA are decimated, and you are living off your Roth.
There must be a better way to defer social security!
Future Tax Planning and Filling in your Brackets
Yes, there is a better way! During your Tax Planning Window, and this is the power your have at the time, NEVER LET AN OPTIMAL TAX BRACKET DOLLAR GO UNFILLED.
Do you think I mean that? You have a short period of time in retirement where YOU control the taxes paid. After income and before RMDs is the tax planning window. You must act!
I have written about partial Roth conversions before. Do they make sense in this situation? No!
Let’s Take Advantage of the Tax Planning Window in this Scenario
Partial Roth conversions don’t make sense in this case.
So, how do you stay in the lowest tax bracket throughout not only your tax planning window, but also throughout all of retirement?
For both $5000 and $6000 a month accounts, you run out of money in your brokerage account rather rapidly, and then have to tap your IRA above and beyond RMDs to pay bills. This leads to the lumpiness seen in Figure 1. Instead, what if you used your tax planning window to take non-RMD distributions from your IRA?
For $5000, the optimal solution is to withdrawal $40,000 a year from your IRA. This results in Monte Carlo success odds increasing from 82% up to 86% and 8% more net worth at the end of the plan.
Taking money from your Roth didn’t improve this scenario. Again, Roth withdrawals may be necessary for other reasons where you want to minimize your income, but if just considering taxes and net worth, Roth withdrawals are not useful in this situation.
Affect of Non-RMD IRA Distributions During your Tax Planning Window
On top, see how $40,000 a year non-RMD distribution smooths out the taxes paid over time (in blue). This results in over $50,000 less taxes paid compared to no non-RMD distributions during the tax planning window (in green).
On the bottom, taxable social security (in lime green) starts at age 70 and slowly increases with age.
In orange are the fully-taxable withdrawals from the IRA. Prior to age 70, these are $40,000 a year; they are RMDs after that.
Do understand that since we made pre-age 70 withdrawals from the IRA, the RMDs are smaller over time as the account size is smaller! Again, complicated stuff but I hope it helps seeing the graphs.
And What if You Want Higher Income?
What about for $6000 a month income needs?
Here it is optimal to take $30,000 a year from the IRA and $5000 a year from the Roth. Yes, taking early distributions from the Roth helps in some circumstances!
Doing this increased Monte Carlo odds from 39% to 43%. Not great, but I’ll take it. There is also $155,000 more net worth at the end of the plan with the non-RMD and Roth distributions during the tax planning window.
On the top, you can see in blue the smoothing effect of the $30,000 IRA and $5000 Roth yearly non-RMD distributions. Still not great, but you do save taxes. Note that again blue is with the distributions and green is without.
You do pay more taxes during the tax planning window, but RMDs are less once you reach 70. Eventually, the brokerage account runs out and you are forced to withdrawal all income from the IRA leading to a large tax bill. The IRA runs out and you are left with the Roth which pays no taxes.
I almost certainly should have looked at continued Roth distributions after age 70 to smooth out the bump between age 82 and 91, but I didn’t want to get too complicated. Tax planning is a long-term process that is done yearly year after year. Have the big picture in mind but don’t be flexible and not too hung up on the future.
Let’s briefly move on to a few other tax issues.
Taxation of Social Security
The IRS taxes social security. In fact, above $34,000 for a single filer ($44,000 for couples), up to 85% of social security is included in taxable income. They look at “combined income.” To calculate combined income: adjusted gross income + half of social security benefits + nontaxable interest (such as municipal bond coupons).
Just assume you will have up to 85% of your social security taxed if you have significant income or IRAs in retirement.
Conclusions: Tax Considerations of Deferring Social Security
I hope you’ve enjoyed a brief look at the tax considerations of deferring social security claiming. They are complicated!
We’ve honestly just touched the surface in this three-part series, so I hope you don’t DIY this too much!
Professional planning software can make planning easier.
In general, social security is the best longevity insurance out there. If the higher-earner defers taking social security, you get cost of life adjustments on the guaranteed delayed retirement credits. As you may know, the surviving spouse gets to keep the higher of the two social security payments. In a couple, the odds of one spouse surviving into their 90’s is pretty good. Especially if you are rich and intelligent. You would not be reading this if you weren’t!