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Timing Retirement: Balancing Social Security and Retirement Plan Distributions

If early retirement is your goal, you may consider withdrawing from your tax-deferred retirement plan to cover your income needs and delaying taking social security until you reach full or late retirement age.

You can retire as early as 62 (with Social Security Benefits), but this is considered “early,” and your benefits will be reduced from the total benefit amount by as much as 25% per year. The Social Security Administration (SSA) calls these “early benefits”. Delaying social security until after age 66* qualifies you for the “late benefit,” which provides for an increase over the maximum amount you would otherwise qualify for. The growth is 8% for every year you delay, up to age 70. The reward for delaying claiming social security can be considerable – in 2022, the maximum monthly benefit for retiring at age 66 is $3,345, and the maximum monthly benefit for those retiring at age 70 is $4,194.

By funding the delay in claiming social security with withdrawals from your retirement plan assets, you’ll be able to maximize your lifetime income, and an additional advantage is that it reduces your retirement plan balance before required minimum distributions (RMD)s kick in at age 72. This will lower the amount of the annual RMD, which preserves your retirement assets and decreases your tax bill.

Retirement investments in a Traditional 401(k) or IRA are made with pre-tax dollars, and taxes are paid when the money is withdrawn in retirement. However, the IRS mandates that beginning at age 72; you must take the required minimum distributions from your retirement plan. This is to ensure that the money will at some point be taxed and will not be left in an estate and potentially avoid taxation.

The Strategy

The general rule of thumb is a 3-4% annual withdrawal rate once you are in retirement. However, increasing this by an additional 2-3% may provide enough to live on. Sample scenarios below model two options for retiring at 62.

Option 1 utilizes higher withdrawals from retirement plan assets to postpone claiming social security until age 70, and

Option 2 models taking social security at the early retirement age of 62.

At age 70, Option 1 shows that the income from the late retirement benefit exceeds the early by a significant amount, and at age 72, the RMD is lower.

Temporarily increasing the number of withdrawals from your retirement plan to make up the difference between your retirement age and the age at which you begin to claim social security benefits can have multiple benefits. For example, you may maximize the amount of social security, decrease your RMD, which preserves plan value, and reduce your tax liability.

While your own situation will be particular to you, and there are other considerations, employing some creativity in how you build your retirement income picture can pay off. Thinking of it as a series of choices you control and can manipulate to your best advantage rather than an inflexible series of milestones you meet can help you plan a retirement that gives you flexibility.

Bottom Line

Starting your retirement journey is as big a decision as any of your other life milestones – and it requires thoughtful careful analysis. Working together, Hampton Park Financial Planning can map out a plan that incorporates your lifestyle and your goals and makes sound financial sense.

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