A client reaching age 66 now is at “full retirement age,” according to the Social Security rules. Such seniors can claim their retirement benefits without any reduction, no matter how much they continue to earn.

Most seniors claim Social Security at age 66 or earlier but they don’t have to do so. “I typically recommend that clients wait until age 70 to take benefits,” says Mark Lumia, CEO of True Wealth Group in Lady Lake, Fla.

The obvious reason to wait is an 8% annual increase in benefits for up to four years, for those who wait past 66 to begin. Yet Lumia points to still another advantage of being patient: in his new book, Thinking Outside the Money Box, Lumia asserts that seniors can gain by employing a “reverse tax torpedo” tactic.

'TAX TORPEDO'

According to Lumia, many people who need retirement income in their 60s claim Social Security then, supplementing those benefits with IRA withdrawals if necessary. A double tax on Social Security benefits and IRA withdrawals has been called the tax torpedo; to reverse the process, seniors can delay Social Security until age 70 while using IRA funds for spending money until then. The later a client starts Social Security the larger the benefit will be, so smaller IRA withdrawals can generate the total required for retirement income.

“The formula for determining the tax on Social Security benefits includes IRA distributions in full but only half of Social Security benefits,” says Lumia. Thus, increasing Social Security by waiting until age 70 and consequently reducing the desired IRA withdrawals can dramatically lower the tax on Social Security benefits. Lumia calculates that a retired couple with $97,000 of income ($70,411 in Social Security after delaying benefits to age 70 plus $26,589 from their IRA) would owe $6,492 less in federal income tax than a retired couple with the same $97,000 income receiving $40,006 in Social Security benefits after starting early plus $56,994 in IRA distributions. Over an extended retirement, such tax savings can be substantial.

WHEN TO CLAIM AT 66

Nevertheless, Lumia does recommend claiming Social Security earlier than age 70 in some situations. “For a married couple,” he says, “one spouse can take the spousal benefit at age 66 while they both delay until age 70 for maximum benefits.”

With this strategy John Smith might claim benefits at 66, his wife Ann would claim a spousal benefit at 66 that’s equal to 50% of John’s benefit, and John would suspend his full benefit to as late as age 70. Meanwhile, Ann’s own benefit continues to grow by 8% a year, plus cost-of-living adjustments, until Ann claims her own benefits at age 70.

“In addition,” says Lumia, “some people have very large pensions and don’t need Social Security for retirement income. They may take Social Security early and use the money to purchase a properly-structured permanent life insurance policy.” Such a policy might eventually accumulate substantial cash value that can be accessed tax-free, via loans and withdrawals, while also providing an increased estate to the client’s beneficiaries.

Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.

Donald Jay Korn

Donald Jay Korn is a New York-based financial writer who contributes to Financial Planning and On Wall Street.