A big question for people in retirement is: “When To Start Social Security?” If Roth conversions are a priority, you may want to delay until age 70. Here’s why.
The decision about when to take Social Security benefits might be one of the most important ones you’ll ever take. According to the Center on Budget & Policy Priorities, over 64 million people took Social Security benefits in June 2020.
Most people can start collecting benefits as early as age 62, delay taking benefits (in exchange for a larger monthly amount) until age 70, or chose an option in between. As with most financial planning questions, there is no universal right answer, although you might want to take some time to consider an answer that is most correct for your specific situation.
For the purposes of this article, we’ll steer clear of making a blanket recommendation. Instead, we’ll focus on how delaying Social Security benefits could help your Roth conversion strategy.
What is a Roth conversion strategy?
A Roth conversion strategy is a strategy that allows you to make periodic Roth conversions, over time, at a desirable tax bracket. Roth conversions are a common focus point for recent retirees, as they start looking towards tax-related events like required minimum distributions (RMDs) and income-related medical adjustment amounts (also known as IRMAA) on their Medicare premiums.
Many Roth conversion strategies involve making decisions that are designed to keep taxable income at a lower level. By doing this, the taxpayer hopes to pay less in taxes now than they would in the future. They also hope to minimize or eliminate RMDs, which begin at age 72.
Why Does Deferral of Social Security Matter in a Roth conversion strategy?
Roth conversion strategies aren’t a part of Social Security planning (or vice versa), but they can intersect in two ways:
Taking Social Security lowers the amount of Roth conversions that a taxpayer can make in a year and remain in the same tax bracket. Conversely, delaying Social Security allows more Roth conversions in a given year.
The amount of taxable income a taxpayer has impacts how much of that Social Security is actually taxed.
Let’s imagine that you want to convert as much into a Roth IRA as you can while remaining in the 22% tax bracket. All of your income would first fill up the 10% bucket, then the 12% bucket, then the 22% bucket. It doesn’t necessarily matter what type of income (pension, IRA distributions, Roth conversions, capital gains, or Social Security), since it all is counted towards the same bucket.
With that understanding, it’s easy to assume that not taking Social Security simply leaves more room in the tax bucket for Roth conversions.
But what about the second point—the amount of income impacting how much Social Security is taxed? That one needs a little more explanation.
How Is Social Security Income Treated For Tax Purposes?
Simply put, Social Security is treated differently from ordinary income. While it’s taxed similarly to ordinary income, the difference is in how much of your Social Security pension is subject to taxation.
No matter how rich you are, you will find that not 100% of your Social Security is taxed. Social Security is taxed based on how much your combined income is, which the Social Security Administration calculates as follows:
Adjusted gross income (line 7 of your 1040)
Nontaxable interest (line 2a of your 1040)
½ of your Social Security benefits
If you are an individual, and your combined income is less than $25,000, then your Social Security income is tax-free. If it is between $25,000 and $34,000, then 50% of your Social Security is taxed. If it’s above $34,000, then 85% is taxed. But never 100%.
For married couples filing a joint return, these income figures are as follows:
0%: Combined income less than $32,000
50%: Between $32,000 and $44,000
85%: Above $44,000
While these income numbers might seem ridiculously low to some people, they might be achievable to others. Let’s imagine that your entire net worth is in retirement accounts (pre-tax) and that you retired early enough to do systematic Roth conversions before you had to start taking RMDs. If your entire portfolio is in a Roth IRA, then
You never have to take the money out during your lifetime
If you do take money out, anything you take out is tax-free (you already paid the taxes on it).
And if you were fortunate enough to be able to cover your living expenses without taking Social Security, then when you finally do take it, your monthly checks will be that much larger.
Delaying Social Security is not for everyone. There are definitely circumstances that warrant taking Social Security earlier than age 70. However, if you’re considering a systematic Roth conversion strategy designed to keep your lifetime taxes as low as possible, then delaying Social Security might be worth considering.
Interested in reading more about Roth conversions? Check out Lawrence Financial Planning’s Roth conversions articles page. Here you’ll find lots of articles that we’ve written about Roth conversions.
And if you’re ready to take the next step and work with a financial planner, you can learn more about how we work with clients right here.