The Five Big Mistakes of Delaying Your Social Security

Delaying Social Security can promise a higher lifetime income, but you may simply need the money now. Even if you think you may live long enough to benefit by delaying, you may not have enough cash flow now, from other sources, to delay. If that is the case, be thankful for it and file now.

If you anticipate not living long enough to hit the breakeven age, you probably want to file as soon as possible (earliest is age 62 in most cases). Read more on the government Social Security website.

You could file early, and if you are in a better financial position after full Social Security age, suspend and allow your Social Security payment to build credits for later.

You may choose to file early thinking Social Security will not be there for you due to financial problems with the program. This is a legitimate concern you can read about here, but the most likely solutions to fix the problem involve raising the payroll tax limit and delaying benefits for younger workers versus taking away benefits from senior citizens.

With a couple, there are many more what-if scenarios to consider than if you are single. While I have seen it make sense for the higher income earner to file early, in most cases it makes more sense for the higher income earner to delay. In the big picture, the lower income earner’s decision to delay is not usually as impactful.

Part of your decision-making process should involve considering scenarios of a premature death. This what-if often makes it even more attractive for the higher income earner to delay.

This is because at the death of either spouse, the lowest Social Security check will disappear. Maximizing the payment of the higher earner can therefore benefit the surviving spouse, whichever one it is, with a higher income. See What Happens to Your Social Security When You Die.

You may choose to retire but delay taking your Social Security for a higher income guaranteed for life. Social Security is a type of annuity that insures against living a long time, and it is not subject to market or interest rate changes. You can read more on the benefits of longevity planning in my article, "What is Safety-First Retirement Planning?".

But to retire and delay Social Security means you must pay for your living expenses with other income sources.  Often this means carving out a piece of your retirement assets to live from during the gap years. This gap must be managed carefully to ensure you don't sell assets during a down market. A high-quality bond ladder can be set up to have maturing bonds to cover expenses during the gap years.

However, this strategy makes no sense if there are too little remaining retirement assets after the gap period, no matter if your Social Security benefit is higher. The reason is that you'll need liquidity for spending shocks (and perhaps inheritance goals). Lifestyle and longevity are not usually your only goals.

In other words, you want to have available assets for big expenses that may arise; and increasing your Social Security income would not be worth spending down your retirement assets too low to cover these expenses.

Though you may not have filed early, you may be tempted to file for Social Security while your are still working and/or are in a high tax bracket. This not only subjects you to a lower lifetime benefit, but also to higher taxes on your Social Security.

Social Security has a peculiar taxation method that creates a “tax hike” and a “tax torpedo”.  The effect is your tax rate significantly rises for each additional dollar of ordinary income at certain points. This chart below illustrates how your tax rate on your Social Security dollars can spike to over 40% (the Social Security tax torpedo).

By delaying Social Security until your tax rate is lower, you may be able to minimize or avoid these high tax rates altogether.

You want to coordinate your Social Security timing with your earned income, capital gains, planned medical expenses, charitable giving, taking a pension, and other financial events for maximum financial gain to you. This requires a holistic planning approach.

If you are able to retire early and delay Social Security, you may have other tremendous tax saving strategies available to you.

For example, if you have IRA/401k assets and savings in bank accounts or taxable brokerage accounts, there are various ways you can flatten your tax curve and save thousands or hundreds of thousands of dollars.

Flattening your tax curve is the idea of paying taxes at lower rates to avoid paying taxes at higher rates. Sometimes it means paying zero taxes when you can. For example, a couple’s long-term capital gains (LTCG) tax rate is zero up to $80,000 of taxable income.

During the gap years (between retirement and Social Security and/or RMDs), a couple could spend some from their excess non-IRA savings while selling their highly appreciated securities in taxable accounts at a zero tax rate to avoid a higher rate later. The chart below illustrates the LTCG tax hike at $80,000 (for married filing jointly in 2020). This strategy is called tax gain harvesting.

Another strategy is withdrawing your assets in the most tax-efficient order along with doing partial Roth conversions during low tax years to avoid much higher tax rates in later years. This requires tax planning, which is looking ahead several years to estimate your future taxes.

Here is a graphic example of a fictitious couple who represents a real-life retired couple:

The proposed tax strategy above could save this couple more than $1,000,000 over their lifetimes!

Note: With CARES Act waiving the Required Minimum Distribution (RMD) in 2020, this would be a great year to consider flattening your tax curve by filling up a lower bracket this year to minimize your exposure in higher brackets later.

In our firm, we help our retiring clients optimize their Social Security income by evaluating hundreds of what-if scenarios and identifying the three to six best options based on their situation and goals. We are first looking at how to get the most benefit without leaving money on the table.

Here is an example of two fictitious characters, Jo and Janet, who represent a real-life married couple. Here are three what-if scenarios that show how much they would leave on the table compared to the maximum lifetime amount, assuming they lived into their 90s.

From the short list of best options, Joseph and Janet selected the plan that best fulfilled their cherished goals. In this case study,  one spouse delayed and the other spouse filed early. Here is the plan:

Janet files her own at 09/2018 at which point Joseph files for a spousal. Joseph files for his own at age 70 at which point Janet files for a spousal.

Filing Dates

• Joseph files for spousal benefits in Sep 2018, the year Joseph turns 67
• Janet files for retirement benefits in Sep 2018, the year Janet turns 66
• Joseph files for retirement benefits in Nov 2021, the year Joseph turns 70
• Janet files for spousal benefits in Nov 2021, the year Janet turns 69
• Janet files for widow(er)'s benefits in Dec 2044, the year Janet turns 92

This decision was not made by prioritizing the absolute maximum Joseph and Janet could receive assuming they lived into their 90s. The decision had to be coordinated with other aspects of their finances and personal goals.

Delaying Joseph’s benefit made a lot of sense in this case, especially since it allowed him to file for a spousal benefit when Janet filed. This is a strategy called restricted application, which is not available to younger retirees.

Now, think about the impact of combining this filing strategy with timely Roth conversions before Joseph's large Social Security payments begin at age 70 and his large Required Minimum Distributions (RMDs) begin at age 72. Joseph and Janet have optimized their income by increasing their Social Security payments for life (for both or either survivor if one dies early) and decreasing their lifetime taxes.

The financial impact of this strategy is enormous, giving them more money to fund their goals and dreams.

For more, see my PDF book, How to Maximize Your Social Security Income.