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Steps Before Taking Social Security

It’s not surprising that most clients who are eligible to collect Social Security retirement benefits are interested in initiating the income stream as soon as possible (even if doing so is an admittance that they are officially “old”). But if clients start collecting their checks without a little advance planning, they could miss out on thousands of dollars they’re entitled to, and pay as much or more in taxes that could otherwise be avoided.

Here are five steps that your clients should take before they take their first Social Security checks—and one they should do if they choose to wait as long as possible.

1. Convert IRAs to Roth IRAs
You of course know that IRA distributions are usually taxed as ordinary income, while money taken from Roth IRAs is almost always tax-free. Hopefully you also are aware that unlike IRAs, Roth IRAs have no mandatory distribution age.

But you may not be aware that unlike earnings, interest income, pension payments, IRA distributions, dividends, capital gains, and even interest from tax-free bonds, distributions from Roth IRAs are not included in the formula that determines if (and to what extent) Social Security payments are taxable.

So clients who convert some or all of their IRAs to Roth IRAs before initiating Social Security will avert any future taxation (and required minimum distributions) on those funds. They will also prevent having future distributions trigger Social Security as taxable income.

2. Take the gains
Speaking of paying taxes before taking Social Security, it might also behoove clients to realize capital gains (and the ensuing taxes) before the clients get their first government checks.

Selling an appreciated asset now ensures the gains won’t push future Social Security payments into taxation. Plus, the clients may benefit from both a higher sale price and a lower capital gains tax rate today than what they might receive later on.

3. Stop working
Those who take Social Security and continue to work may feel like they’re getting an extra “bonus” every month from Uncle Sam. But the earnings are likely to render the Social Security benefits taxable, and at the client’s highest marginal tax rate.

The penalty for working and collecting is even more onerous for those under “full retirement age” (66 years old for those born between 1943 and 1954). In 2010 Social Security recipients under FRA lose $1 in benefits for every $2 over $14,160 that they earn.

Between the earnings penalty, reduced benefit, and potentially higher tax bill, clients could net nearly twice as much monthly money by waiting to initiate Social Security until they actually retire, or reach FRA, or both.

4. Get someone else’s check
Clients may receive Social Security benefits based on someone else’s earning history without undertaking a sophisticated identity theft operation. There are several variables involved, but the main requirement is that the client is currently (or was once) married to someone else.

First, a client can file for her spousal benefits (typically half of the spouse’s actual benefit) if she is at least 62, and her spouse has reached full retirement age and filed for his own benefit.

If the client is divorced she might still be eligible to receive spousal benefits based on her ex’s earnings as long as she was married for at least 10 years, reached age 62, and not remarried since.

Finally, a widow or widower who has reached at least age 60 (age 50 if disabled) may file for survivor’s spousal Social Security benefits, allowing him to collect on his deceased spouse’s earning history.

5. Wait another year
Delaying taking benefits certainly allows you and your clients more time and flexibility to evaluate and complete the aforementioned moves. An even bigger benefit will come from the higher check the clients eventually receive.

Clients who initiate Social Security benefits at full retirement age (again, 66 for those born between 1943 and 1954) get a check that’s 33 percent higher than what they would receive if they were to file at 62 years old.

If they wait until 70, they’ll get a whopping 76 percent increase over the amount they would have received at age 62, all other factors being equal.

Of course, waiting another year to start getting Social Security means the client would miss out on twelve slightly-smaller checks, and have to live long enough to get enough larger checks to make up for the year’s delay.

The breakeven age depends on several factors, including taxes, interest rates, and investment returns. But the usual rule of thumb is that if the client lives past 80, it was smarter to delay taking Social Security as long as possible.

Plus, if the client in question is both married and the higher-income member of the couple, delaying his way to a higher monthly check means that his surviving spouse may continue to receive that higher figure even after he dies, and for as long as she lives.

A step to take at 65
Retired clients who are able to delay taking Social Security benefits until full retirement age and beyond still have an important task to complete right before turning 65 years old: applying for Medicare. If a client opts to receive Social Security benefits before or at age 65, she is automatically enrolled in Medicare Parts A and B. Part A covers hospital insurance, and Part B covers medical insurance.

But if she delays Social Security past the age of 65 and doesn’t proactively enroll in Medicare in the appropriate window (starting three months before turning 65, and ending four months after), she will have to wait until January 1st of the following year to enroll, and be covered. Plus, she may incur an ongoing 10 percent additional penalty to her Medicare Part B premiums for each year past age 65 that she fails to enroll (perhaps that penalty is a nudge toward action for those who can’t accept their new status as “senior citizens.”)

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