Tax Considerations When Delaying Social Security

Wade Pfau, Ph.D., CFA

by Wade Pfau, Ph.D., CFA

November 24, 2015

Tax Considerations when Delaying Social Security

Click here to download Wade’s latest ebook, “When Should You Claim Social Security?”

Originally published at Forbes

Delaying Social Security can potentially contribute to an overall tax strategy for retirement. Every case is different, but generally speaking, when you add taxes to the mix, the case for delaying Social Security becomes even stronger than usual.

Delaying Social Security gives you an ability to better management tax brackets when you are no longer working and earning a salary.

Consider a 62-year-old couple who are married and file jointly on their taxes. They have both stopped working and have not claimed Social Security benefits yet. They could potentially spend $20,600 from their tax-qualified accounts to meet their standard deduction and personal exemption. They could also realize $74,900 of additional long-term capital gains and qualified dividends from their brokerage accounts and still have their federal tax bill be $0.

If they would like to spend more than this $95,500, they could also include distributions from Roth accounts, spend the cost-basis on taxable investments, tapp into the line of credit from a HECM reverse mortgage, use a Health Savings Account (for medical expenses), and potentially spend from permanent life insurance cash values to keep their federal income tax bill at $0.

Depending on how wealthy this couple is and how much they actually wish to spend each year, the objective may not necessarily be to keep the tax bill at $0. It may be advantageous to use these years with no salary and no Social Security benefits to make additional Roth conversions from their IRAs to their Roth IRA. Doing so would require paying higher taxes in the short run in order to potentially pay much less later on. The concept is referred to as tax bracket management, and it is possible to take greater advantage of this strategy before Social Security benefits begin.

For instance, if the couple used the $74,900 for Roth conversions instead of realizing capital gains, their marginal tax rate on these funds would be 10% and 15%. If making the Roth conversions now at these lower tax rates helps to avoid being pushed into the 25% or 28% marginal tax rates later on when Required Minimum Distributions (RMDs) begin, it can be a worthwhile endeavor for enhancing the long-term plan. Wealthier couples might find that taking full advantage of the taxable space within the 28% tax bracket can help keep them from paying taxes at 33% later in retirement, and so on.

Social Security Benefits Taxation
Provisional Income Taxable Benefits
Single Filers Married Filing Jointly
Under $25,000 Under $32,000 0%
$25,000 – $34,000 $32,000 – $44,000 up to 50%
Over $34,000 Over $44,000 up to 85%
Provisional Income = AGI + 1/2 Benefit + tax-exempt interest

Tax bracket management is relevant as well because Social Security benefits may also be taxable. Those who are married and filing jointly, as shown in the table, may pay income tax on up to 85% of their Social Security benefits if their provisional income exceeds $44,000.

These numbers are not adjusted for inflation, which means that over time more and more Americans will pay income tax on their Social Security benefits unless they have built up large reserves of nontaxable resources. Provisional income is defined as the adjusted gross income plus half of the Social Security benefits plus any tax-exempt interest from investments such as municipal bonds.

The rules for benefit taxation can create what is known as the “tax torpedo.” Wealthier individuals may find that avoiding the tax torpedo is impossible, but those with relatively more modest resources might be able to set into motion a plan that can avoid the tax torpedo for life. Once benefits have begun, each $1 of additional income from qualified plan distributions and the like will require taxes on that income, plus taxes up on to 85% of a corresponding $1 of Social Security. Effectively, the marginal tax rate can be increased dramatically once benefits have begun, which can serve as an additional benefit for delay.

If Social Security is delayed until 70, then pre-70 taxable income is reduced. If you are able to wait until 70, you can can provide more space for Roth conversions and realizing long-term capital gains on taxable accounts. Subsequent Roth distributions do not count when determining how much of Social Security is taxable, and if you have the capacity to get a large portion of your IRAs converted to Roth accounts prior to reaching 70, you can enjoy substantial improvements to your tax situation.

You can pay taxes at lower marginal tax rates, and you may also be able to better avoid the Social Security tax torpedo. These strategies may also help in later retirement to lower the amount of RMDs, to increase the cost-basis for taxable accounts, and to create less pressure to make taxable withdrawals to meet retirement spending needs. Social Security delay complements strategies to support the most after-tax spending power from your savings.


Retirement Researcher is owned by McLean Asset Management Corporation (MAMC), which is a SEC registered investment adviser. The content of this publication reflects the views of McLean Asset Management Corporation (MAMC) and sources deemed by MAMC to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.
The information throughout this presentation, whether stock quotes, charts, articles, or any other statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither our information providers nor we shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission there of to the user. MAMC only transacts business in states where it is properly registered, or excluded or exempted from registration requirements. It does not provide tax, legal, or accounting advice. The information contained in this presentation does not take into account your particular investment objectives, financial situation, or needs, and you should, in considering this material, discuss your individual circumstances with professionals in those areas before making any decisions.