Monday, February 1, 2021

Social Security and Taxes and Interest

If you can keep your retirement income low, you avoid paying a lot of taxes.  How does Social Security affect this?  And are there other factors to consider when figuring out what age to collect?

In a recent posting, I opined that you don't need a lot of money to live in retirement, which is a good thing, as you likely won't have much.   Even a million dollars in your 401(k) means only a $40,000 annual income using the 4% rule.  And by the time you retire - or the time you die - forty grand will be the cost of a cup of coffee at Starbucks, given the way the government is deficit-spending.

Just an aside, that is how inflation happens.  Well, there are other ways, such as shocks in the price of commodities such as oil.  I saw that in my youth, when the price of oil doubled overnight.  As one of my professors at GMI taught us, it takes a half-a-cup of crude oil to make a cup of milk, when you factor in all the petroleum products used to make fertilizer, provide fuel for power plants (back then), fuel farm tractors and trucks and refrigeration equipment, and so on and so forth.  We were dependent on oil - fossil fuels - and still are today, we just have more sources, for the time being.   How odd that the people who pay through the nose to fuel their monster trucks are so wedded to this fuel and so against any alternatives.  But I digress.

As we saw in Wiemar Germany, and in Argentina (and many other Latin American countries), inflation is usually fueled by printing more money.  Germany tried to pay "reparations" by diluting the Deutsche Mark over and over again, until the lowest denomination note was a million Marks.  In Argentina, a similar thing happened, to the point where a major part of your day was moving money around to try to avoid having your savings wiped out by daily inflation.   And of course, usually in situations like that, governments prohibit citizens from exchanging into foreign currencies, or of they do, at a very unfavorable rate - as we see in Venezuela right now.

Inflation acts like a tax on everyone, in terms of a tax on the sale of goods, a tax on income, and a tax on wealth itself.  If you have $500 in the bank, and inflation runs at 10% a year, well, at the end of the year, you have the equivalent of only $450, unless you can earn some interest greater than the rate of inflation.   That is the real concern for the retiree on a 401(k) plan - you have this money, do you leave it in the stock market, where it could go way down in value in one of these "asset bubbles" (coming soon to an investment account near you!) or do you put it in "safe" harbors like Treasury bills, where it won't even earn as much interest as the rate of inflation?   The idea that retirees are happy-go-lucky is flawed.

So you worry about things, at a time in life when you shouldn't have to worry.  And you have to make a lot of decisions - decisions that if made wrongly, will screw you for the rest of your life.   Um, sort of like your working years, or in particularly your late teens and early 20's, when stupid decisions can ruin your life. Medicare for example.  You qualify at age 65 and then you have to decide what "supplemental insurance" to get - and you have a "window" to deciide.  Do you want "Medigap" Part B, Part C, or Part D or  Part F or "Select"?  Decide wrongly and you are kind of stuck - for the rest of your life.  And the cost of premiums for this "supplemental" insurance?  About what you paid for regular insurance before you went on Medicare.   Folks pining for "Medicare for all" might want to think about that.  It doesn't mean health care will be free.   And of course, they are expecting ordinary people to navigate these plans - folks who are at an age we used to call "senile".  Some fun!  Oh, and they recommend contacting Social Security three months before your 65th birthday to enroll in Medicare.

Since these Medicare plans will no doubt change before I hit age 65, there is little point in me making a decision now as to which supplemental plan to get - if any - or what drug plan to get or whatever.  If my blog is up and running in 2025 - maybe I will post something then.

But Social Security is starting to look me in the eye, and in a year, I will have to make my first decision about Social Security.  As I noted in an earlier posting:

The problem is, there are a number of benchmark ages you and your spouse will hit, that define when streams of income will become available, and also expire. For example:

1. Age 59-1/2: The age you can tap your 401(k) or IRA without tax penalty.

2. Age 62: The age you can start collecting Social Security.

3. Age 65: The age you qualify for medicare (cuts expenses dramatically)

4. Age 67: The present age for "full" Social Security.

5. Age 70: The present age for "enhanced" Social Security.

6. Age 89: The age your 401(k)/IRA will tap out, if spent using the 5% Rule & Draw at age 59

Note that the age 67 "full retirement" number is now a moving target depending on what year you were born.  For me, it is age 67, for people born earlier it may be earlier.  I suspect they will raise this number over time, as life expectancy increases and as the GOP keeps finding excuses to "gut" Social Security - calling it "Socialism" no doubt.

Over the years, Social Security has been tweaked.  Taxing benefits was the first step - at least part of your benefits are taxable.   And this seems only fair, as people making a million dollars a year in retirement - or even $100,000 - should not get a "tax-free" check from Uncle Sugar.   Those trying to get by on Social Security alone shouldn't have to pay any taxes, and for the most part, don't.

Tax rates for 2021 are as follows:

At first this seems unfair to those struggling to get by on Social Security - they have to pay 10% in income taxes!  But then you realize the standard deduction for a married couple is $25,100 and that pretty much wipes out all income for most folks (which is why I try to keep my retirement income around 30 grand - I pay little in the way of taxes).

Now, in the Social Security game, the question is, which age do you collect at, in order to collect the most amount of money?  And I discussed this before and the key problem is you don't know when you are going to die.   If you use standard actuarial tables, as my accountant friends suggest, collecting at age 62 makes the most "sense" as you end up collecting more money overall.

I did the analysis on this years back, and indeed, the raw amounts favor collecting early, provided you die at age 76 in accordance with the actuarial tables.  But how do taxes affect this calculation?   The entire thing is premised on the idea that "if you don't need the money" you can then bank it, and end up with that cash later on, should you outlive the actuarial table lifespan.  The problem is, if I "banked" another $21,732 in Social Security benefits (the amount they are claiming I will receive at age 62, based on this year's report) that would not only boost me into a slightly higher tax bracket, it would also boost me well beyond the standard deduction.   I would have to pay taxes, State and Federal, on the increased amount, at least in part. Oh, and it would decrease or even eliminate the Obamacare subsidy - costing me more per year than the Social Security benefit!

The alternative, of course, would be to take less out of my 401(k) and thus allow that money to grow over time.  And that might be an attractive alternative.  Again, I looked into this a decade ago, and while the numbers have changed, the conclusions are about the same - in order to collect "more" by waiting until age 70, you have to live to be at least 90.

The numbers have been updated since then, and the Social Security Administration tells me they will pay out $1811 a month at age 62, $2573 a month if I wait until age 67, and $3190 a month if I wait until age 70.  If I die at age 80, these total amounts come to $391,176, $401,388, and $382,800, respectively.  Once again, age 67 beats out age 62, just barely, and the spread between the three is trivial.

  • Age 62 - Age 80: (216 months) @ 1811/mo = $391,176
  • Age 67 - Age 80: (156 months) @ 2573/mo = $401,388
  • Age 70 - Age 80: (120 months) @ 3190/mo = $382,800

Now, suppose I take Social Security at age 62 and, as a result, leave $21,732 in my 401(k) every year over the next 8 years?  Presuming that money was invested at a 5% rate of return, after five years eight (age 70) it is worth $217,897.30.  Subtracting the base value of $173,856.00 (the amount paid over eight years) yields an additional $44,041.30 at age 70.  Doing the same for the three years between age 67 and 70 yields a lesser amount of $9,575.   Compound interest is a bitch - over time.  Assuming that additional money is allowed to grow at 5% from age 70-80, we yield $71,738.34 from age 62, and $15,596.67 from age 67:

  • Age 62 - Age 80: (216 months) @ 1811/mo = $391,176 + $ 71,738 = $462,914
  • Age 67 - Age 80: (156 months) @ 2573/mo = $401,388 + $ 15,596 = $416,9840
  • Age 70 - Age 80: (120 months) @ 3190/mo = $382,800

Hmmm....  I did factor that in, in the calculations I made ten years ago, but not the compound interest over time.  So living to age 80, you come out ahead by collecting at age 62, provided you don't just spend the excess money but instead bank it.  And therein lies the problem for most folks, who view a dollar in their pocket as a dollar to be spent.  It also assumes you get a 5% rate of return or greater, and don't lose your investment entirely.

Talking to Seniors here on Retirement Island, I get two responses to this question of "when to collect?" The first are the folks who are sucking air - they have either run out of money or have very little saved, perhaps a small pension.  They need the cash now so they collect at age 62 and spend the money.  They are not looking at "overall values" or possible interest earnings or opportunity costs - they take the money and spend it.   And later in life, as the cost of living escalates, they may regret having to do this.  But for them, it was not a choice - but a choice thrust upon them, based on circumstances and earlier poor life choices - usually the latter.

Other say, "Wait until 70! You'll get more!"  And indeed, if both Mark and I wait until age 70, our combined Social Security Income alone would be $67,200 a year.   Of course in 15 years, that would be the equivalent of the thirty grand of taxable income today, assuming inflation doesn't skyrocket.  The logic behind this argument is that you may outlive your money if you live to age 95 or so.

And from what I see here on the island, it is not atypical to kick the bucket in the 90's.   In fact, we have lost a few friends lately, in their 80's and 90's due to CoVid.  The other day at Parcheesi club, some Trumpian idiots were marching around without masks on, and it turns out they tested positive.  Sadly, some other people were there for a Parcheesi tournament, and they too thought CoVid was "fake" and now they are all exposed.   A super-spreader event, right here on our island - and we have signs up saying "masks required!" at Parcheesi club!

I digress further, but these Trumpsters are inconsistent.  First they claim it is the "China Virus" and that China is to blame for it.  Now they claim the entire thing was a hoax!  Be fucking consistent with your lies, at least!   But I digress.

But not by much.  CoVid will throw a wrench into these calculations, as it may shorten life expectancy, which already has dropped in the last few years, due to the Opioid epidemic (which neatly erased part of the surplus population).  But let's suppose I live to be age 90?  Seems unlikely to me, given my current health, but let's crank the numbers.

  • Age 62 - Age 90: (336 months) @ 1811/mo = $608,496 + $116,854 = $725,350
  • Age 67 - Age 90: (296 months) @ 2573/mo = $761608 + $  25,405 = $787,013
  • Age 70 - Age 90: (240 months) @ 3190/mo = $765,600

Interesting - it is pretty much a wash either way.  If all you calculate is the base amount received, then waiting until age 70 works out - provided you live until age 90.  But if you can really "bank the difference" in terms of not taking a corresponding amount of your 401(k) plan, then that money, if it earns even a 5% rate of return in the market, will add up to about the same as the overall return from waiting until age 70.

What does this mean?  Well it could mean you could choose any of the three ages and end up about the same.  But death is not an even thing.  Some live long, some live short.  Mark's stepmother was T-boned on the way to her dialysis treatment.  She might not have lived much longer in any event, but an unlicensed, uninsured, illegal immigrant sort of forced the issue.  Life is like that.

So what is my decision?   Still undecided.  It seems a lot of people pick the middle ground of waiting until the "full retirement" age, as a compromise.  But again, if you die at age 66, this kind of sucks, although as a reader points out, your spouse may get survivor benefits - which is a whole other calculation, as you can take these as early as age 60, and then delay your own benefit collection until later.  There are so many ways to work the system.  Some have been shut down, such as "claim and suspend" where a retiree claims benefits and then suspends, so the spouse can collect in the interim. Even though that door is closed, spousal benefits are still available and that gets complicated as well - as the laws have been recently changed.

Oh, geez, does this get complicated!   I guess that is one reason we have a local Social Security office.  I went there once to get a Social Security card (my parents never gave me mine - or my birth certificate!  Identity abuse!).  Most of the people in the office were there to file for benefits, and the folks behind the counter can advise people the best way to go about this - hopefully.  

The spousal benefit thing is maybe one reason I would wait to collect later.  If Mr. See is entitled to 50% of my benefit, perhaps it is better to wait until he is at least 62 (and I am then 67) to collect.  Damn!  Now I have to do a whole different set of calculations!  The Social Security Administration does provide a set of calculators which are helpful, to some extent. I downloaded the detailed calculator which was clearly written by a government employee - it generates all sorts of numbers, few of which are useful to the average citizen.

This information was not very helpful - at least to me.  I think it is in Fortran.

What is interesting to me is that I thought I had more time to think about this, but I will be 61 this year - next month.  That means in about 12 months, I will qualify for Social Security and will have to make my first decision about whether to collect or not.  At the very least, I should visit the Social Security office and talk to someone about it before next March.

I am still undecided..... after all of that!