When taking steps toward early retirement, it’s easy to get confused and frustrated with the sheer amount of contradictory information out there. In this article, we are going to break down social security early retirement options that could benefit you. While it’s tempting to go ahead and say yes to taking social security early, just to start that money flow, it may not be the best choice for you. Read on to learn why dipping into your IRA might be a better option.
Social Security Early Retirement
The Difference Between Partial and Full Social Security Benefits
First of all, it’s important to understand what it means to “take social security.” Retirement age varies for most people, but most start thinking about it around age 62. This is also when you have the option to start getting social security payments. The problem is the payment you’d get at age 62 is much less than what you can expect if you wait longer to start to take payments. Full retirement also allows you to take advantage of inflation increases, something you lose if you start taking your cut early.
To put this in perspective, a person entitled to $12,000 a year, in full social security payments at age 66, will only get around $9,000 if they took at age 62. Working an additional four years means you invest that much more into the social security system, which will increase your payments and give you a more impressive full-age benefit.
If you can hold off until age 70, you are increasing the value of your social security even more. A woman expecting to get $1,200 a month at age 62 will get 33 percent more if she waits until her full retirement age of 66. If she puts it off four more years, and files for social security age 70, she gets another 32 percent more each month. That delay bumps her monthly social security payment from $1,200 to $2,112.
None of that necessarily means you have to continue to work full time until age 70, though. It is worth considering cashing in on your other retirement assets like your IRA, to see more savings.
What is an IRA?
If you are not familiar with the term IRA, it stands for Individual Retirement Account and the sooner you get one, the better. There are a number of formats for IRAs, but they all have one purpose — to provide supplemental funds for retirement. One thing to consider for an IRA, though, is deferred use. They are literally designed for retirement, and taking money out early comes with penalties.
However, these penalties may be justifiable considering the benefits when held up against using partial social security as an alternative.
So what are the differences in IRAs?
Traditional and Roth IRAs are established by an individual. SEP and SIMPLE IRAs are set up by a small business owner, or self-employed person. With the majority of these, an issue of taxable income comes into play. However, Roth IRA contributions are after-tax; so the distributions are tax-free.
It’s always best to consult a tax professional, but for many people, withdrawing from your IRA is the better choice if you want to retire prior to Social Security Full Retirement Age (FRA). Depending on when you plan on retiring, taxes and penalties are not incurred when withdrawing from your Individual Retirement Account (check out this infographic for the types of IRA’s and withdrawal rules). There will be tax issues to consider, but this is where you can make the system to work for you.
Again, before making any decision about this, please be sure to consult a tax professional, who can guide you based on your personal situation.
Converting to a Roth IRA
As of 2010, people can opt to convert any pre-tax IRA to a Roth IRA, paying the taxes early. There are two key advantages to this plan. One, it gives you control over when you pay the taxes on this money. If you’ve taken early retirement, your taxable income is based on your pension, investment earnings and, maybe, some part-time work. That is likely to put you in a lower tax bracket; so the amount of taxes you pay for IRA distributions is less overall.
Ideally, you convert it to small amounts for better effect, too. For example, converting a third of your traditional IRA to a Roth IRA in one year allows you to stay in a lower tax bracket. Whereas, converting the whole thing at once might push you up one or two tax brackets, and cost you money. By putting the money from a Traditional IRA into a Roth, it continues to work for you by adding more investment incomes to your portfolio.
Distributions from Traditional IRAs are seen as taxable income, even if you get social security. That’s the other good reason to consider drawing from your IRA before taking social security. The income from the IRA can push you up to a level where you have to pay federal taxes on the social security income.
It may be hard to wait, but it could offer you the best opportunities for income, and to pay fewer taxes. So ask a tax professional if it makes sense for you to withdraw from your IRA’s first, and let social security age get you more benefits.
What do you think about taking a social security early retirement option? Let us know in the comments section below.