My wife would like to retire at 62. Would it be better for to use the funds from her 401(k) first to get to the age of 65 before filing for Social Security?
— James Baker, Missoula, Mont.
Every situation is different. But it can be beneficial for many individuals to consider waiting to at least full retirement age (FRA) before starting Social Security and using 401(k) or IRA distributions to fund the "bridge period" between the time retirement starts and Social Security is claimed, says James Mahaney, a vice president with Prudential Financial.
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The reasons are two-fold. One, if your wife starts Social Security at age 62, she'll lock in a permanent "real" reduction of 25%. "I say 'real' because the lower benefit will provide a smaller base on which cost-of-living-adjustments will apply into the future," says Mahaney.
How much your wife's benefit will be reduced will depend on her age. If your wife was born in 1952, for example, she'd receive a monthly benefit of $750 by claiming at age 62 instead of $1,000 had she waited to claim at age 66, or FRA.
Also consider delaying beyond FRA. Why so? Social Security benefits are increased by a certain percentage (depending on year of birth) if your wife and you delay claiming Social Security beyond FRA. The yearly increase is 8% for those born in 1943 or later. Or put another way, instead of getting $1,000 per month from Social Security if she claims at FRA, she stands to get up to $1,320 per month if she waits to claim at age 70, the oldest age for which you can earn delayed retirement credits.
"A Social Security benefit starting at age 66 or later would provide a higher lifetime income stream to your wife and earn higher cost-of-living-adjustments," says Mahaney.
By contrast, let's say your wife has $100,000 in her 401(k) and she withdraws what she would have received had she taken Social Security early; say $9,000 per year for three years. So, her 401(k) would be worth, not including investment gains, $73,000. To be sure, that sounds painful on the surface, but the second reason why the "bridge" tactic works is this: By drawing down your retirement account, you potentially reduce your future required minimum distributions (RMDs), which she would have to take after age 70½. Having a large RMD can often put you into a higher-than-expected tax bracket, as well as cause your Social Security income to become taxable.
Yes, her future investment returns in her 401(k) will be off a smaller base. But consider what your wife gains in the tradeoff. One, a higher guaranteed for life, adjusted-for-inflation monthly Social Security benefit. She can't get that kind of guarantee from her 401(k) or IRA. Or put another way: You can't guarantee that you won't outlive your assets, but you can guarantee that you won't outlive your Social Security benefit. "Keep in mind that today's low interest rate environment makes it challenging for retirees to generate a dependable lifetime income stream similar to what Social Security provides," says Mahaney.
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