Social Security income is the foundation of many retirees' financial security, and it pays to get the most out of this valuable benefit. For many people, that means single retirees and the primary wage-earner of a married couple should delay the start of benefits as long as possible. Not only does this enhance the expected lifetime payout for the worker, but it can also increase the retirement paycheck for a surviving spouse.
But there are a few pervasive myths about Social Security benefits that some people use to rationalize starting benefits as early as possible:
Myth #1: Social Security funding is in trouble, and the trust fund is forecast to be exhausted. I'll never get anything if I don't start collecting my benefits soon.
This ignores the fact that most of Social Security's benefits for current retirees are funded by the taxes paid by current workers. Only about one-quarter of benefits for retirees are paid by the Social Security trust fund. It could be completely exhausted, and roughly three-quarters of current benefits would still be paid.
In addition, Social Security is one of the federal government's most popular programs; lawmakers would pay a severe price by eliminating the program. After all, everybody has parents or grandparents. Politicians might make needed changes, as they've done in the past, but these would most likely improve the funded status of the program.
As long as we have democracy and workers paying taxes, you'll get some income from Social Security. If you really believe that Social Security will go away entirely, however, then you'd better boost your savings significantly to replace the benefits you think you'll lose.
Myth #2: The federal government will cut Social Security benefits to improve its financing. I'd better start benefits as soon as possible so my benefits won't be cut.
When our leaders have reduced benefits in prior years, they made the changes prospectively, applying them to groups according to their age, regardless of when they started benefits. They've always protected people who are close to retirement or in retirement. This principle is being applied to various changes that are currently being considered, including possible changes to the retirement age.
If history repeats, you won't need to let your claiming decision be influenced by possible future reductions to Social Security.
Myth #3: I can do better if I start Social Security as early as possible and invest the money.
Actually, to have even a chance of succeeding with this strategy, you'll need to invest most of your Social Security benefits in stocks and achieve returns that reflect historical averages. This strategy assumes substantial investment risk, whereas delaying Social Security benefits entails no investment risk.
But if you invest significant amounts in bonds or if your net returns are reduced by high fees to advisors, there's a very good chance this strategy won't succeed. This has been confirmed by a recent report from the Stanford Center on Longevity.
Myth #4: I'll reduce my taxes if I start Social Security benefits early.
Actually, this might be true, although it's not a good enough reason to start receiving Social Security early. Understanding this issue requires a little background. A portion of your Social Security income is subject to income taxes; the exact portion depends on your total income. The higher your total income from all sources, including taxable withdrawals from IRAs and 401(k) accounts, the higher the portion of your Social Security income that's taxable will be. The taxable portion for many people is 50 percent, and the maximum is 85 percent.
So this myth might be true due to a very basic tax principle: Reducing your taxable income usually results in reducing the income taxes you'll pay. So if you reduce your Social Security income by starting benefits early, you'll pay lower income taxes, compared to paying higher income taxes on a higher Social Security income. Net of taxes, however, you might still have more money to spend by delaying Social Security.
One feature of this myth refers to the possibility that if you delay making taxable withdrawals from IRAs and 401(k) accounts until age 70-1/2, you might increase the amount of Social Security income that's subject to income taxes when you start taking taxable withdrawals at that time.
But consider that in this case, at least 15 percent of your Social Security income won't be subject to income taxes. It's generally a good idea to have a larger Social Security benefit for which 15 percent is not subject to income taxes.
It might make sense to make taxable withdrawals from your IRA and 401(k) accounts before age 70-1/2 to enable you to delay starting Social Security income. Not only will you increase your Social Security income by doing this, but you'll reduce the taxable withdrawals you'll need to make at age 70-1/2, thereby mitigating the possibility that your tax-free portion of Social Security income is only 15 percent after age 70-1/2.
Analyzing a strategy to coordinate your IRA/401(k) withdrawals and Social Security claiming is extremely complex, however, and there are many factors to consider that can be highly individual. It's hard to make broad conclusions that apply generally, but certainly a general conclusion that you'll reduce your income taxes by starting Social Security benefits early is hard to support.
Bottom line: Don't be influenced by when your relatives, friends and co-workers start Social Security benefits. Learn how to enhance this valuable benefit for your unique circumstances, including visiting helpful online resources. If you aren't comfortable making this decision on your own, find a competent and unbiased financial advisor to help you.