Fidelity and Schwab recommend proportional withdrawal strategies in retirement. Proportional withdrawal strategies ignore the rising and falling pattern of marginal tax rates due to the taxation of Social Security benefits and income-based Medicare premiums. We present several cases that demonstrate that multi-phase withdrawal strategies that navigate this marginal-tax-rates pattern can add substantial additional value to retirees’ portfolios compared to proportional withdrawal strategies.

The spike in marginal tax rates associated with the taxation of up to 85% of an individual’s Social Security benefit is termed the “tax torpedo.” In How Social Security Coordination Can Add Value to a Tax-Efficient Withdrawal Strategy, from the Fall 2021 issue of The Journal of Retirement,William Reichenstein and William Meyer, principals at Social Security Solutions, Inc., demonstrate how marginal tax rates can spike when a retiree collects both Social Security benefits and income drawn from tax-deferred accounts in the same year. The authors use a series of case studies to model how financial advisors can identify optimal tax-efficient strategies for clients who are able to delay the start of Social Security benefits. In the early years of retirement, income is drawn from tax-deferred accounts, and additional tax-deferred funds are converted to Roth accounts. When Social Security benefits later begin, the Roth accounts can be drawn upon tax-free as needed. This strategy can add significant value to portfolios by reducing income taxes and Medicare premiums.

This study describes a tax-efficient withdrawal strategy that can add substantial value to many clients of financial advisors with financial portfolios worth up to $2 million. In early retirement years, these households can delay the start of their Social Security benefits and make Roth conversions to fill relatively low tax brackets, which are generally also their marginal tax rates. Once Social Security benefits begin, they can make tax-free Roth withdrawals to minimize the amount of tax-deferred account (e.g., 401(k)) withdrawals that are taxed at 185% of their tax bracket, due to the taxation of Social Security benefits. With a series of cases, we show that a financial advisor can add substantial value to many of their clients’ financial portfolios by recommending such a withdrawal strategy. Key Findings • Due to the taxation of Social Security benefits, there is a wide range of income where a household will have a marginal tax rate of 150% or 185% of their tax bracket, where marginal tax rate denotes the additional taxes paid on the next dollar of income. • This study presents a general tax-efficient withdrawal strategy that will help many singles and married couples with financial portfolios worth up to $2 million substantially reduce the present value of their lifetime income taxes. In addition, these withdrawal strategies can greatly reduce the percentage of these households’ lifetime Social Security benefits that will be taxable. • In the general tax-efficient withdrawal strategies, in early retirement years, these households should delay the start of their Social Security benefits and make Roth conversions to fill relatively low tax brackets, which are generally also their marginal tax rates. Once Social Security benefits begin, they can make tax-free Roth withdrawals to minimize the amount of tax-deferred account (e.g., 401(k)) withdrawals that are taxed at 185% of their tax bracket, due to the taxation of Social Security benefits.

Practical Applications Summary In Investment Implications of the Rising and Falling Pattern of Marginal Tax Rates for Retirees, from the Summer 2020 issue of The Journal of Retirement, authors William Reichenstein (of Social Security Solutions, Inc. and Retiree, Inc.) and William Meyer (also of Retiree, Inc.) explore strategies for optimizing Medicare premiums and taxes. Medicare premiums are based on one’s income from two years earlier, and they rise sharply at certain income thresholds. Meanwhile, taxes on Social Security benefits cause marginal tax rates for middle-income retirees also to rise sharply on a wide range of income, and then drop sharply at still higher incomes. This humplike rise and fall in rates is called the tax torpedo. Reichenstein and Meyer argue that some retirees should convert assets in their tax-deferred accounts (TDAs) into Roth IRAs if their income is at or beyond the end of the tax torpedo, thus allowing them to achieve a lower tax rate on the converted assets. However, those who will be on Medicare two years hence may need to limit their Roth conversions to avoid increasing their future Medicare premiums. TOPICS: Wealth management, retirement, social security

Practical Applications Summary In Medicare and Tax Planning for Higher-Income Households, from the Winter 2019 issue of The Journal of Wealth Management, authors William Reichenstein and William Meyer (both of Social Security Solutions, Inc. and Retiree, Inc. in Overland Park, KS) warn high-income retirees that they may owe more taxes than expected if their income exceeds certain levels. Most people know that income tax rates go up as income rises. However, many do not know that higher-income individuals pay higher Medicare premiums; each time their income exceeds one of several threshold levels set by the Affordable Care Act (ACA), their Medicare premium jumps. Since Medicare is a government program, these premium spikes are effectively tax rate increases. The authors offer strategies that take advantage of the current tax laws to help people avoid Medicare premium spikes and generally lower their lifetime income taxes. The authors’ key recommendations are to report life-changing events that reduce income, make Roth IRA conversions before tax rates are scheduled to increase in 2026, and satisfy charitable giving plans by making qualified charitable distributions from IRAs after age 70½. The authors say these measures can reduce retirees’ taxable income and thus reduce their lifetime income taxes and Medicare premiums. TOPICS:Wealth management, retirement

The Bipartisan Budget Act of 2015 made significant changes to the rules affecting Social Security benefits. Some people think that these rule changes made it relatively easy to determine when someone should claim their Social Security benefits. In this article, the authors explain the rule changes and provide 10 reasons why making an optimal Social Security claiming decision is still complicated, even if we knew how long the single claimant or each partner in a married couple will live. Deciding when to claim Social Security benefits remains a complex decision. TOPICS:Retirement, legal/regulatory/public policy, social security

Practical Applications Summary In Optimizing Social Security Benefits Is Still Complicated, which appeared in the Winter 2019 issue of The Journal of Retirement, William Reichenstein and William Meyer (both of Social Security Solutions, Inc.) explain that despite recent legislative changes to Social Security, deciding when to begin receiving benefits remains a complicated issue. The authors provide 10 scenarios illustrating the complexity of this decision for retirees; these can be categorized as complications regarding oddities of the Social Security system itself, complications regarding simple retirement benefits, and complications regarding additional benefits (e.g., spousal, survivor). The authors detail how each aspect adds to the intricacy of determining when to file for benefits, and provide advice on how to optimize Social Security benefits in each scenario. TOPICS:Retirement, legal/regulatory/public policy, social security

This article explains how Medicare Part B and D premiums vary with a household’s modified adjusted gross income. Each time MAGI increases by $1 above several income threshold levels, a couple’s Medicare premiums two years hence can rise by more than $2,400. These premium hikes represent spikes in the marginal tax rate exceeding 240,000%. It then explains how certain life-changing events can affect a household’s level of Medicare premiums. Next, it presents two cases that illustrate the value that financial advisors can add to clients’ portfolios by helping them coordinate a smart Social Security claiming strategy with a tax-efficient withdrawal strategy. These cases demonstrate that higher-income households should consider making Roth conversions from 2019 through 2025, when tax rates are scheduled to be temporarily lower, and before required minimum distributions begin. These Roth conversions may allow these households to greatly reduce the size of both their lifetime income taxes and their lifetime Medicare premiums. Finally, it explains the advantages for households with someone at least age 70.5 of making charitable contributions through qualified charitable distributions from individual retirement accounts. TOPICS:Wealth management, retirement Key Findings • As a household’s income increases, it can cause spikes in Medicare premiums due two years hence. These spikes in Medicare premiums are effectively spikes in marginal tax rates. • Higher-income households younger than 70.5 should consider Roth conversions before tax rates are scheduled to increase in 2026 to reduce both their lifetime income taxes and their lifetime Medicare premiums. • Making a qualified charitable distribution from an IRA is a more tax-efficient method of donating funds, especially for higher-income households.

This study presents rules governing survivor benefits and provides several cases to illustrate these rules. It then presents guidelines to help financial advisors quickly determine the best strategy for a widow or widower who is eligible for survivor benefits. The authors present separate advice for four groups of clients who differ in terms of the age of the surviving spouse. In addition, they present examples that illustrate the logic of the recommended strategies for each group of survivors. As seen in several examples, there are many times when a widow or widower should not simply take the larger of his or her own retirement benefit or his or her survivor benefits. TOPICS: Retirement, legal/regulatory/public policy, social security

The authors considered an individual investor who holds a financial portfolio with funds in at least two of the following accounts: a taxable account, a tax-deferred account, and a tax-exempt account. They examined various strategies for withdrawing these funds in retirement. Conventional wisdom suggests that the investor should withdraw funds first from the taxable account, then from the tax-deferred account, and finally from the tax-exempt account. The authors provide the underlying intuition for more tax-efficient withdrawal strategies and demonstrate that these strategies can add more than three years to the portfolio's longevity relative to the strategy suggested by the conventional wisdom.

This article’s aim is to help the more than 6 million people with a pension from work that is not covered by Social Security decide when they, or they and their spouse, should claim Social Security benefits. When there is a noncovered pension, Social Security benefits will likely be reduced, if not eliminated, by the windfall elimination provision (WEP) or government pension offset (GPO). One of the authors’ examples illustrates a present-value-maximizing claiming strategy for a married couple. For convenience, assume that the higher-primary insurance amount (PIA) spouse is the husband and that he will predecease his wife. The key issue is whether his delaying his retirement benefits would meaningfully affect his wife’s survivor benefits. If so, he should base his starting date on the age he would be when she is expected to die (i.e., defer if she has a long life expectancy). If her survivor benefits will not increase meaningfully, then each spouse should base the claiming decision on his or her own life expectancy. TOPICS:Social security, legal/regulatory/public policy, retirement

Suppose a client just retired and has funds in a tax-deferred account like a 401(k), a tax-exempt account like a Roth IRA, and a taxable account. She needs to withdraw sufficient funds to finance her spending plans in retirement. This study explains how, just using the tax code, she can tax-efficiently withdraw funds from her financial portfolio to meet her spending goal while allowing her financial portfolio to last several years longer.

The Social Security Administration set the reduction in benefits for beginning benefits before full retirement age (FRA) and delayed retirement credits for delaying benefits until after FRA to be approximately actuarially fair for someone with an average life expectancy of 84 years, assuming a real risk-free rate of 3%. Consequently, given a 3% real rate and life expectancy of 84, the present values of Social Security benefits are approximately the same no matter what age benefits begin. Given today’s 0% real rate, the present values are approximately the same if a single individual lives to 80. Today, a single individual with average life expectancy of 84 will maximize the present value of benefits by delaying benefits until about 69. Furthermore, the authors explain why today’s low real rate should influence the starting date for each partner of a married couple.

As people approach retirement age, they should ask, “What is the best strategy for claiming Social Security benefits?” That is, at what age should an individual begin to receive retirement benefits? Or at what age should a married couple begin to receive retirement benefits, and if applicable, which spouse should file for spousal benefits and when? These complex questions are nicely addressed in this gem of a book for every investor, CFA, CFP, lawyer, financial planner, and retiree. The authors demystify the technical and quantitative jargon, as well as the complex Social Security system rules.