In response to questions sent in by readers, we’ve been discussing the strategy of retirees waiting to take Social Security as long as possible, and instead living off of any savings, IRAs, and pension payments. The benefits are many, but the drawbacks can still be enough to give a person pause. ## Know the code
One of the most effective ways you can increase your net income is by reducing your taxes. And no, we’re not talking about declaring yourself to be a sovereign nation, exempt from the auspices of the Internal Revenue Service.
Instead, you should monitor and manipulate your taxable income so that, overall, you stay in the lowest possible rate. Workers can employ some tactics along these lines, but it’s much easier when you’re retired, and can (in theory) decide how much money to take from where, and when.
Assume for a moment that you’re retired, but not yet taking Social Security. Since you still need income, start your planning with any earnings or pension checks, and include interest and capital gains earned on non-retirement accounts.
Then take distributions from IRA accounts, until you have enough to cover your living expenses for the tax/calendar year.
Hopefully, you’ll get what you need without exceeding the top of the 15% federal income tax bracket. As both of the regular readers of this column are aware, that’s the figure on Line 43 of your 1040 tax return.
For 2015 that figure is $74,800 for married couples filing jointly, and $37,450 for single filers.
When you don’t need it all
In an ideal situation, you not only have enough to support yourself via this strategy, but maybe even have some room between your income needs and the top of the 15% federal income tax bracket.
If that’s the case in any year of your retirement (especially before you initiate Social Security), you should consider converting a portion of your IRAs to Roth IRAs, again to the point of hitting the top of the 15% federal income tax bracket.
Yes, it may bump up that year’s tax bill a bit. But once that tab has been paid, the Roth IRA offers lots of tax advantages to retirees.
First, there is no required minimum distribution (RMD) on your Roth IRA while you’re alive. So the funds can remain in the account as long as you’re around.
Second, any distributions from the Roth IRA in retirement are tax-free; meaning if you need to withdraw the money you won’t increase your tax bill or tax rate.
Last and certainly not least, under the current laws distributions from Roth IRAs are not included in the formula that determines if your Social Security benefits are taxable.
How this might work
Let’s say we have a retired couple in their 60s who are contemplating whether to take Social Security sooner, or live off of their savings and retirement accounts.
If they decide to take the latter option, they would draw down their IRAs now, spending the money and/or converting a portion of their IRAs to Roth IRAs each year.
Then at 70 or sooner, they would initiate their Social Security payments. Not only will their monthly checks be higher as a benefit of delaying the payments, but since income from Social Security is taxed at a lower rate than most other forms income, their taxes will be lower as well.
After turning 70 ½, the couple will have to initiate required minimum distributions (RMDs) form whatever is left in their IRAs. But because they have already spent money from the IRAs and/or converted some of the money in the IRAs to Roth IRAs, the RMDs will be smaller, and therefore less likely to make their Social Security taxable.
That said, there are of course some negatives to this strategy that you should first consider. Next week we’ll tell you why you may not want to wait to take Social Security, even if it could eventually mean a bigger check and a smaller tax bill.