MY WIFE VICKY AND I have lately been discussing—yet again—when to claim our Social Security retirement benefits. We’re fortunate to have multiple sources of retirement income, including a defined benefit pension, traditional IRAs, Roth IRAs and two health savings accounts.
To date, we had assumed we’d both delay claiming Social Security until age 70, so we get the largest benefits possible. Until then, we’d planned to live on my pension, any consulting income I earn, and withdrawals from our retirement accounts. But we’re now rethinking that plan for a handful of reasons:
- Federal taxes. Social Security benefits are favorably taxed at the federal level. At most, 85% of benefits are considered taxable income. By contrast, withdrawals from traditional retirement accounts are fully taxable at the federal level.
- State taxes. Social Security isn’t taxed in New Jersey, where we live. Meanwhile, pension income and withdrawals from retirement accounts are potentially taxable in New Jersey. That potential tax is driven by an exclusion algorithm based on gross income.
- Retirement assets. This year’s down market has put a big dent in our retirement savings. We have a cash bucket set aside, but I’d prefer a bigger margin of safety, so I can give our stock market money plenty of time to recover.
- Interest rates. Today’s higher interest rates make holding cash more attractive.
- Maximizing Social Security. I’ve been using several tools, including Mike Piper’s excellent Open Social Security, to look at different strategies for getting the maximum lifetime benefit. Open Social Security suggests the best strategy is for my wife to claim benefits immediately and for me to wait until age 70. This maximizes our lifetime benefits, and would also provide the largest possible survivor benefit to Vicky, should I predecease her.
Collecting some Social Security income right away is also appealing from a tax point of view. As I mentioned above, Social Security income has tax advantages at the federal and state level compared to other retirement income.
I’m especially focused on New Jersey’s retirement-income exclusion provision, which includes three “cliffs”—for joint filers they’re at incomes of $100,001, $125,001 and $150,001—that can trigger a big jump in state taxes. If we claim Vicky’s benefit now, it would reduce how much other retirement income we need and potentially help us avoid stumbling over these tax cliffs.
After considering all the variables, we’ve decided to start Vicky’s Social Security benefit in 2023. She can apply for Medicare next month, at which time she’ll submit a joint application for both Medicare and Social Security. The latter will give us some inflation protection, thanks to Social Security’s annual cost-of-living adjustment, which next year will be 8.7%.
Even with Vicky’s Social Security, my pension and other income, we’ll still have a shortfall between the income we receive and what we spend. To fill this gap, I’m looking at several options. I could continue to do monthly withdrawals from our cash fund. This money is held in Vanguard’s Short-Term Bond ETF (symbol: BSV). The fund has a current yield of around 4.8% and a low expense ratio of 0.04%. Unfortunately, the fund hasn’t been immune to this year’s market woes, falling 6% year-to-date.
Another option I’ve been considering is a period certain immediate annuity. This type of annuity provides immediate income for a specified period of time. This is one way to bridge the five years between now and when I claim my Social Security at age 70. One of the benefits of a period certain annuity is you’re guaranteed to receive all the payments. Should I die within the five-year period, my wife—or her heirs—would receive the remainder of the 60 payments.
I looked at five-year annuity pricing through Fidelity Investments and ImmediateAnnuities.com. The two sites provided essentially the same result. A 65-year-old male, living in New Jersey, would get some $3,500 a month for a $190,000 investment, for a total $210,740 over the five years.
If we choose to go this route, we would fund the annuity from a traditional IRA. The income would thus be federally taxable. It would, however, be eligible for New Jersey’s retirement-income exclusion—provided we don’t end up with too much income and go over the tax cliff.
The wild card in all this is my consulting income. I intend to continue to entertain opportunities. The downside: Any significant earned income could potentially push our state income over New Jersey’s tax cliff.
Another option we have: Tap our health savings accounts (HSAs) and our Roth IRAs. Any income we generate from these accounts won’t boost our taxable income. We plan to use our HSAs to pay our Medicare premiums. The upshot: We’ve decided that our 2023 income plan will look like this:
- Traditional pension
- Vicky’s Social Security
- HSAs for Medicare premiums
- Consulting income
- Traditional IRA withdrawals
- Roth IRA withdrawals
My analysis shows this plan should cover our core and discretionary expenses, and give us a chance to minimize our tax bill. If my consulting opportunities turn out to be more lucrative than I expect, or we win the lottery, our tax bill will be what it’ll be—and we’ll view it as a nice problem to have.
There’s an old saying in finance: “Don’t let the tax tail wag the investment dog.” This is usually interpreted as, “Don’t make an investment solely based on tax considerations.” I worry a little that I’m violating this tenet with our retirement income plan.
I believe that taxes are part of our civic duty and the price we pay for being financially successful. Still, I plan to track our income throughout the year, and I may make mid-year adjustments to try to minimize our tax bill.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading
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