THE TAX ATTIC with Jerry Coon

Jerry Coon

To draw or not to draw 

Baby boomers and when to begin drawing Social Security benefits; to draw or not to draw—it’s a prime time discussion topic for millions of baby boomers. To draw benefits at the age of 62 or wait to draw until reaching full retirement age—calculating a break-even point at which it would pay to wait would help in making that decision, but there are many variables that go into the calculation. Some of those variables are numerical and calculable. Other variables are not so black and white. Let’s look at the numbers-related variables first.

The penalty for drawing early is the largest factor and is a good place at which to start. For taxpayers with a full retirement age of 65, the penalty for drawing at age 62 is a 20% reduction in benefits. For taxpayers with a full retirement age of 66, the penalty is a 25% reduction and for those with a full retirement age of 67, the penalty is a 30% reduction.

For example, a taxpayer born in 1952 has a full retirement age of 66 and would incur a 25% penalty for drawing at age 62. The taxpayer’s benefit at age 66 would be $1,500. The reduced benefit at age 62 would be $1,125. At age 77 and 11 months, the taxpayer would have drawn $216,000 using either monthly benefit amount, so that is the black-and-white break-even point. If the taxpayer lives beyond age 77 and 11 months, it would have paid him to wait until drawing because he could then be drawing $1,500 instead of $1,125. However, if he leaves this world sooner than 77 and 11 months, he would have benefited by drawing early. A large number of these calculators are available on the Internet. Google “Social Security breakeven point” and you will have a variety of choices.

There are other factors that are harder to put a finger on. For example, Social Security benefits are increased by a cost-of-living allowance (COLA). The COLA for 2010 and 2011 was 0.00%, but for 2009 it was 5.8%. What will that factor be going forward? Your guess is as good as any of the experts, but I think it’s a foregone conclusion that it won’t be 0.00% without some real manipulating going on by the government.

In our earlier example, the $1,125 is increased each year by this unknown COLA figure while the $1,500 would not necessarily be increased until the benefit begins to be drawn at age 66. Plugging that figure into the equation could make the break-even point go a little past that age 77 and 11 months point.

A second factor to consider is this: Where can the taxpayer get the money to replace the Social Security benefit if he doesn’t begin to draw at age 62? If 60% of all taxpayers get 50% of their retirement income from Social Security, then I would say that most likely 60% of all taxpayers need the Social Security benefit to survive in retirement. That money has to come from somewhere. Is the taxpayer able to work? Does the taxpayer have a job even if he is willing and able? If there is no job, can the $1,125 per month come from retirement monies or savings? Are those retirement or savings amounts even available?

Multiply $1,125 times 12 months, and it equals $13,500. According to many experts, in order to not deplete your savings, you should take a distribution of not more than 4% of savings. In order to take $13,500 per year, our taxpayer would have to have about $337,500 put aside in savings. Multiply $337,500 times 4%, and it equals $13,500. Let’s think for a moment about how many taxpayers have $337,500 in a savings and/or retirement account. Again, according to the experts, it’s a pretty slim percentage. The 60% depending upon Social Security for 50% of their retirement income most likely won’t have $337,500.

A third factor is: What would the $13,500 allow a taxpayer to do at the ages of 62-66 that he wouldn’t be able to do at a later age? That’s an unknown variable, but all of us slow down as we get older. None of us like to admit slowing down, but it’s a fact of life. Waiting until age 66 would mean getting a $1,500 monthly benefit or $18,000 per year. What good is that extra $4,500 if your health has deteriorated or you have just slowed down enough that things aren’t as much fun as they used to be? That’s one of those variables that you can’t put a dollar amount on, but it’s just as important as the money factors.

Whether or not to draw at the early age and take the penalty is an important decision. Don’t take it lightly. Talking to an expert who is aware of the options available and looking at the whole story is important. This is Jerry Coon signing off.

Jerry Coon is an Enrolled Agent. He owns Action Tax Service in Rockford. Contact Jerry at www.actiontaxservice.com.

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