Veteran personal finance journalist Robert Powell answers your questions for USA WEEKEND.
My
wife would like to retire at 62. Would it be better for to use the
funds from her 401(k) first to get to the age of 65 before filing for
Social Security?
— James Baker, Missoula, Mont.
Every
situation is different. But it can be beneficial for many individuals
to consider waiting to at least full retirement age (FRA) before
starting Social Security and using 401(k) or IRA distributions to fund
the "bridge period" between the time retirement starts and Social
Security is claimed, says James Mahaney, a vice president with
Prudential Financial.
The reasons are two-fold. One, if your wife
starts Social Security at age 62, she'll lock in a permanent "real"
reduction of 25%. "I say 'real' because the lower benefit will provide a
smaller base on which cost-of-living-adjustments will apply into the
future," says Mahaney.
How much your wife's benefit will be
reduced will depend on her age. If your wife was born in 1952, for
example, she'd receive a monthly benefit of $750 by claiming at age 62
instead of $1,000 had she waited to claim at age 66, or FRA.
Also
consider delaying beyond FRA. Why so? Social Security benefits are
increased by a certain percentage (depending on year of birth) if your
wife and you delay claiming Social Security beyond FRA. The yearly
increase is 8% for those born in 1943 or later. Or put another way,
instead of getting $1,000 per month from Social Security if she claims
at FRA, she stands to get up to $1,320 per month if she waits to claim
at age 70, the oldest age for which you can earn delayed retirement
credits.
"A Social Security benefit starting at age 66 or later
would provide a higher lifetime income stream to your wife and earn
higher cost-of-living-adjustments," says Mahaney.
By contrast,
let's say your wife has $100,000 in her 401(k) and she withdraws what
she would have received had she taken Social Security early; say $9,000
per year for three years. So, her 401(k) would be worth, not including
investment gains, $73,000. To be sure, that sounds painful on the
surface, but the second reason why the "bridge" tactic works is this: By
drawing down your retirement account, you potentially reduce your
future required minimum distributions (RMDs), which she would have to
take after age 70½. Having a large RMD can often put you into a
higher-than-expected tax bracket, as well as cause your Social Security
income to become taxable.
Yes, her future investment returns in
her 401(k) will be off a smaller base. But consider what your wife gains
in the tradeoff. One, a higher guaranteed for life,
adjusted-for-inflation monthly Social Security benefit. She can't get
that kind of guarantee from her 401(k) or IRA. Or put another way: You
can't guarantee that you won't outlive your assets, but you can
guarantee that you won't outlive your Social Security benefit. "Keep in
mind that today's low interest rate environment makes it challenging for
retirees to generate a dependable lifetime income stream similar to
what Social Security provides," says Mahaney.
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