13 Dec How can I decide the best time to take Social Security?

Q. I’m starting to plan for retirement for real. For maybe two years in the future. I have about $800,000 in a 401(k), $600,000 in an inherited IRA and I’m 60, so not taking Social Security yet. I know Social will be higher if I wait, but then I would have to take out more from the retirement accounts. How can I decide if it’s worth taking Social sooner so I can let the investments grow?
— Planning

A. Congratulations on your approaching retirement.

And indeed, retirement can feel scary because you no longer have the reliable paycheck from work.

It’s important to develop an income strategy to replace the paycheck and create your own “retirement paycheck,” said Jeanne Kane, a certified financial planner with OneDigital in Boonton.

She said when to claim Social Security is a part of your income strategy.

“It is important to know how your Social Security is calculated because there are multiple factors that go into your monthly benefit when you start taking it,” she said.

The first step that Social Security does is to calculate your Average Indexed Monthly Earnings (AIME). This is essentially your average income that you earned throughout your lifetime after it’s been adjusted for inflation, Kane said.

“However, Social Security only uses the highest 35 years of earnings in this calculation,” she said. “These don’t have to be a consecutive 35 or last 35, just the highest 35 years.”

If you worked less than 35 years because you retired early or took time off to raise your children, your earnings will be $0 for those years, Kane said.

“The SSA then applies a formula to your AIME to calculate your Primary Insurance Amount (PIA),” she said. “PIA is the value of your benefit that you would receive at your Full Retirement Age (FRA)”

Your FRA depends on when you were born. If you were born before 1954 or earlier, your FRA is 66. The age then increases by two months for every year until you get to 1960 and later when the FRA is 67, Kane said.

You can claim as early as 62.

“Claim early and you’ll get more checks, but the benefit will be permanently reduced by as much as 30%,” she said, “For every year after your FRA that you claim, you get an 8% bump in your PIA benefit. That’s on top of any cost-of-living adjustment.”

There is no benefit for claiming after 70. Your benefit is maxed out, Kane said.

Waiting to claim at 70 will give you a guaranteed 8% increase per year above your PIA at your FRA. It doesn’t matter when you stopped working, she said.

Kane offered this example: Let’s assume that your FRA is 67. If you wait to claim until you’re 70, your benefit will be 24% higher than if you claimed at 67.
She said she generally recommends that if you can afford to, that you should wait as long as possible to claim your benefit.

“That’s because you are guaranteed an 8% increase in your benefit each year you wait after your FRA,” she said. “Guarantee being the key word here. You can earn 8% or higher return on your investments in a given year but there are few, if any, investments that can guarantee it.”

Kane said she’s a big fan of guaranteed income because it’s not subject to market downturns and Social Security has an annual cost of living adjustment (COLA) for inflation.

“This is particularly important if you’re married. When one spouse dies, the surviving spouse claims the higher of the two benefits. They don’t get to claim both,” she said.

If you were the higher earner, you should max out your benefit, so your spouse receives the highest amount possible when they’re surviving on only one Social Security benefit, she said.

There are situations where it makes sense to claim earlier, such as if you have a serious illness and aren’t sure that you have a long lifespan, she said.

“If you could tell me exactly when you are going to die, I could tell you the best time to claim Social Security,” she said.

If you think that you’re not going to live long because you have a serious illness, it makes sense to claim earlier. You’ll get a smaller payment but receive that payment earlier, she said, and if you are healthy and have family longevity, it makes sense to claim later. You’ll get a larger payment but for a shorter period.

She notes the break-even point between claiming early and claiming later is 78 to 80 years old.

Next you need to look at all your potential income sources, including a pension and any retirement accounts, plus Social Security. You need to determine your potential income stream from each.

“Guaranteed income such as a pensions and Social Security are your foundation. Then consider IRAs and 401(k)s that have required minimum distributions (RMD) that you must take,” she said.

Traditional or rollover IRAs start at 73 or 75, depending on your age. If you were born Jan. 1, 1960 then your RMD age is 75, and if you were born Dec. 31,1959 or earlier, your RMD age is 73, she said.

“If you’re still working at your RMD age, you won’t have to take RMD from your 401(k) but if you’re retired, you will,” she said.

You said you have an inherited IRA, and this will also create an income stream for you. How much and when depends on who you inherited it from, when you inherited it and whether the person you inherited from was already taking RMDs.

“Prior to 2020, most inherited IRA beneficiaries were required to take distributions out over their lifetimes, spreading out the distributions,” she said.

For 2020 and beyond, the rules are more complex.

For example, if your parent died and they were taking their RMD prior to death, you will be required to take a minimum distribution and fully deplete the account within 10 years. If your parent died and they weren’t taking RMDs, you wouldn’t have to take an RMD but the account would need to be fully depleted within 10 years.

“Know which rules apply to you as this will have an impact on your income – are you subject to the 10-year rule where distributions are sped up or can stretch distributions over your lifetime?” she said. “The 10-year rule speeds up distributions and help you potentially delay social security.”

Overall, you need to understand how much you want to spend in retirement and what income you have from pensions, Social Security, required distributions, investments, etc. If there is a gap between your spending goals and your income, you have to decide how to fund the gap.

“We spend so much of our lives saving and planning for our retirement. It’s equally important to plan for spending in retirement,” Kane said. “A financial planner can help you develop that plan.”

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This story was originally published in December 2024.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.