Which Comes First: Social Security Optimization or Tax Minimization?

"Hey Mike, which should be done first, social security optimization or tax minimization planning?"

Discover why tax planning should be done before you optimize your social security benefits.

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Episode Transcript

Mike (00:05):
Welcome to How to Retire On Time, a show that answers
your retirement questions. We'rehere to move past that
oversimplified advice you'veheard hundreds of times.
Instead, we're gonna dive intothat nitty gritty. So as always,
text your questions to [phone] anytime during the
week, and we'll feature them onthe show. Just remember, not
financial advice.
This is an educational show.David, what do we got today?

David (00:28):
Hey, Mike. Which should be done first? Social Security
optimization or tax minimizationplanning?
Chicken or egg here?

Mike (00:37):
Or No. I'm No? I was trying to think of a prices
right quote.

David (00:41):
Like Bob Barker prices right or Drew Carey prices
right?

Mike (00:44):
Either. Okay. So the the answer is taxes first.

David (00:47):
Okay.

Mike (00:48):
And the reason is you don't wanna jump over dimes to
pick up pennies. So if you lookat Social Security as an
isolated optimization strategy,as in how can I get the most out
of Social Security, you maysignificantly hurt or lower the

(01:09):
amount of money you're gettingfrom other resources?

David (01:12):
Okay.

Mike (01:12):
So for example, if you have a significant amount of
your assets in pretax accounts

David (01:19):
Four zero one k, IRA?

Mike (01:20):
IRA. Yep. Anything that if you take it out, you're gonna
pay taxes. Okay? And you'regoing to, based on projections,
run into issues with your RMD.
Required minimum distribution.Happens all the time. People run
into the problems. And let's sayyou know that's coming, but you
still wanna get the most out ofSocial Security, so you're gonna
file at 62 or 63 years old.

David (01:42):
Okay. So that's filing early.

Mike (01:44):
You're filing early. That's a part of your adjusted
gross income. Let's say 85% ofSocial Security is a part of
your adjusted gross income atthat point.

David (01:52):
Okay.

Mike (01:53):
All of that money is now taking up room where you could
more strategically take moneyout of your IRA either as income
or as an IRA to Roth conversion.Because RMDs are only as
difficult or only as tricky asthe amount of money that's still
in the IRA. So if you delayedSocial Security, let's say, a

(02:18):
couple of years, that opens upmore room to either spend or
convert your IRA assets to Rothor just spend it.

David (02:26):
Oh, okay.

Mike (02:27):
Which then allows you to lower the amount, which then
would allow your RMDs topotentially be a part of your
income. That was a lot. Let mebreak down each step. Okay?
Okay.
Let's say that your taxableincome each year is a 150,000.
Alright. And for easy math,let's say your combined Social

(02:48):
Security, if you filed at 62 ina month, is 50,000. So a 150,000
is your total target taxableadjusted gross income. That's
all of your taxes you're gonnatake out.
And 50,000 of that is now yourSocial Security benefit for the
household, two people.

David (03:05):
Alright.

Mike (03:06):
That means you've got a $100,000 that's leaving your IRA
each year when you're 62, 63, or64 years old, 65, and so on and
so forth. Whereas you coulddelay your Social Security, that
50,000, and delay it till 67 or70 years old. Okay? And now
you're taking out a 150,000 fromyour IRA. You're paying the same

(03:30):
taxes, but you're getting moreout at a faster rate so that
alleviates the burden so thatwhen RMD start, maybe your RMD
is and I'm just throwing out anumber.
Let's say your RMD you can doenough IRA to Roth conversions
so that your IRA balance lowersenough that your RMD is, let's
say, 30,000.

David (03:51):
Okay.

Mike (03:52):
Well, guess what your standard deduction is? 30,000.
So now you've got a higherSocial Security benefit that's
being taxed efficiently becauseonly up to 85% is subject to
tax, plus your RMD, all you needto take out from your IRAs at
that point is your standarddeduction. So that's basically
tax free, and then the rest ofyour income comes from Roth.

David (04:13):
Okay.

Mike (04:13):
There are many moving parts when it comes to your tax
planning. The last thing youwanna do is to arbitrarily give
yourself something that's gonnagive you resistance to your
goals, something that's going toget in the way, something that's
gonna push up your tax rates.Because tax planning really, in
my opinion, is not about justmoving funds over as quickly as

(04:37):
you can. It's not even about taxbrackets. Everyone, especially
all the CPAs who just heard thatgasped.
It's not about tax brackets.That's what we're told. That's
the indoctrination. We've beenmanipulated to think it's all
about tax brackets. Well, why?
Why not look at it from aneffective tax rate? The total
amount of taxes you've paidversus the total taxable events

(05:00):
that that have occurred. Thatseems more appropriate to me
because what if you're in themiddle of a bracket, but your
modified adjusted gross incomepushes a certain limit that then
helps your IRMA or keep yourMedicare charges under a certain
level here? What if you're let'ssee. 150,000 modified adjusted
gross income, you get an extra$6,000.

(05:21):
Oh, but that's not a taxbracket. It's about 200,000 or
so for the 22% tax bracket. Orit's like it's all these nuances
that people get hung up on. Theywant a simple singular thought
process and ignore all of theother factors. That's not how it
works.
And here's the reality. If yougo a couple of dollars into a

(05:43):
new tax bracket, it doesn'treally change your overall tax
situation that much. You don'twanna what's an expression?
You're very articulate withexpressions, where you're
looking at the micro, like, datapoint and you forget the entire
picture.

David (06:01):
Maybe you're looking beyond the mark or you can't see
the forest for the trees.

Mike (06:05):
I feel like there's a camel expression. Oh. I don't
know. Anyway Straw that brokethe camel's back. No.
But that's a good one.

David (06:12):
A rich man can't get into I let's see. I don't know. I'm
I'm going through

Mike (06:16):
just gonna go the Yeah. There's something there.

David (06:19):
A camel has a better chance getting through the eye
of a needle than a rich

Mike (06:21):
man in heaven. I don't know.

David (06:22):
Yeah. We we've exhausted all of our idioms and sayings
here.

Mike (06:25):
But the point being is don't get hung up on tax
brackets. Look at your effectivetax rate. And here's my point.
Do you do your tax withholdingsin January saying, okay. Well,
this first month, every dollar Ispend, only 10% of this is going
to federal taxes.

(06:46):
And then in February, you'regoing, well, this is 12%. So,
you know, 12%, a little bitmore. And then by the end of the
year, you're going, well, youknow, 22%. So Mhmm. That's not
how anyone does their taxes.
I don't know a single personactually counts that way. I'm
sure someone there exists. Yeah.There's someone out there for
everything.

David (07:06):
Yeah.

Mike (07:07):
But the point being is that's not how you do your
taxes. You're focused on youreffective tax rate. How much do
you have to pay? And so if yougo a couple of dollars over, it
might not be the end of theworld. People are manipulated by
this next dollar tax situation,which I get, but it's just the
next tax dollar.

David (07:27):
Yeah. Everything under that dollar stays in that in
that bracket, in that bucket.Your whole thing doesn't It's
get progressive. Yeah. It'sprogressive.
Your whole income isn't in the22% bracket. Right? You graduate
up. Yeah. Is that right?
Yeah. So we shouldn't lose sightof that is what you're saying.

Mike (07:42):
Yeah. If you go $10,000 into the twenty four percent tax
bracket or in the 30 whatever itis in the future tax bracket,
it's not the end of the worldfor arguments sake.
Optimistically. Yeah. They gottacome up with a better expression
than that.
What could be a problem in thefuture Yeah. Is if your RMDs are
pushing you into a higher taxbracket than the income you

(08:05):
already want, and taxes were tohave gone, sound like a
Shakespeare thing. Oh. Were tohave gone, hidden to Yeah. It
is.
Were they if they went up in thefuture. Yeah. So we don't know
what future tax rates are in thefuture. There's currently no
sunset to current tax brackets,but the tax code is written in
pencil. So mindfully, at aeffective tax rate that you're

(08:26):
comfortable with, doing IRA toRoth conversions, figuring out
the long term tax strategy,because taxes will likely be
your largest expense inretirement, health care is the
next, Then you can start to seehow does my Social Security fit
in for my lifestyle and legacygoals.
And maybe filing early makessense. Maybe filing later makes

(08:49):
sense. Maybe having one spousefile earlier and one spouse
filing later for a spousalsurvivorship makes sense. But
the point is you start with yourbiggest problems first. And if
you think that Social Securitybenefits are going away, let me
give you your prescription.

David (09:08):
Alright.

Mike (09:08):
Okay? Yeah. Not a doctor. Whatever news source you're
watching, watch the oppositenews source. I've actually told
many clients this.
If you're left leaning, watchleft and right news sources. If
you're right leaning, watchright and left news sources. I'm
not trying to convert you to theother side of the aisle. Right.
I want you to see how much salesthere is in the news.

(09:33):
The news wins when they give youfear, when they keep you
compelled to keep watchingbecause you're scared to death.
Clickbait isn't really clickbaitanymore. It's now rage bait.
They want you to get upset. Theywant you to get angry.
And on a biological level, bythe way, when they get you angry

(09:54):
you know what this does? This isa bit of a rabbit hole. Alright.
Let's go down it. When you getangry or in a flooded state,
fight, flight, freeze, or faint.
Oh, you know, it's the crazyuncle or aunts at Thanksgiving
that no one wants to hear that'svery political, and they're just
just rage all over, whatever.They're upset all the time, and
they have something to complainabout. They're constantly on
Facebook just complaining aboutstuff. What's really going on is

(10:19):
there could be an addiction, notlike its traditional definition,
but this need to self medicate,get a little psychological here,
based on norepinephrine oradrenaline and cortisol are the
two big drugs that when we feelpain, our body produces it, and
you can have an addictive likebehavior to it. So if the news,

(10:40):
if other media outlets can getyou angry, you're going to
experience these drugs that yourbody produces, which then gets
you more in there.
Watch it more. Stay tunedlonger. Click on more of their
articles. There's a reason whythey do it, in my opinion.
That's my get out of jail freecard.

David (10:56):
Yeah.

Mike (10:57):
But the point being is if you're very fearful of the
markets, of trade wars, ofinflation, of politics, of
whatever it is, consider for amoment that maybe that's not the
full picture, and you're beingsold a story on either side of
the aisle, and then that allowsyou to maybe see a little bit
more clearly, maybe see a littlebit more objectively. Because

(11:19):
when everyone says, oh, SocialSecurity is going bankrupt,
there's usually a politicalangle or a marketing angle to
that statement. Social Security,80 plus percent of it is paid
for by last year's taxes. Maybethere's a slight reduction.
Maybe.
There are so many ways. If youread the laws and how they could
fix Social Security, there aremany ways they can save it. It's

(11:40):
just no politician yet haswanted to really do that because
it would be difficultpolitically speaking. Is it
going away? Well, the largestvoting bloc is the retiree.
Yeah. It's not going away. Butthe point being is don't file
early out of fear. Look at thetaxes, your bigger potential

(12:02):
issue, then look at your healthcare, the second biggest
potential issue, and then seehow Social Security supports
your overall objectives. At theend of the day, if I had to to
kind of summarize this, thequestion is, how do you get the
most out of your money?
And that requires a morecomprehensive position with more

(12:26):
strategies looked at andwatching how they all connect
and work together so that you'reable to enjoy your lifestyle and
legacy goals so you canaccomplish the purpose of the
money. Your entire life, youworked for something. Do you
wanna be a good steward overthat and get the most out of it,
or do you wanna just put it incash, live off the dividend
because it's safe? That's not ahealthy relationship. No.

(12:48):
That's not a healthyrelationship with money. So what
is right for you? That's a veryimportant conversation, but it
does require a morecomprehensive discussion. That's
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(13:11):
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(13:36):
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