When to Pull From Your IRA Before Claiming Social Security

Christine Benz: Hi I'm Christine Benz from Morningstar.com. Many retirees tap their Social Security benefits at their full retirement age or even earlier, while leaving their IRAs until later in retirement. But IRA expert Ed Slott believes that the opposite sequence can make more sense in certain situations. He's here to discuss that topic; he is the author of the newly revised Retirement Decisions Guide.

Ed thank you so much for being here.

Ed Slott: Great to be here, thanks.

Benz: In your newly updated Retirement Decisions Guide, which factors in all of the new tax code, you have a section about Social Security and IRAs and how the two work together. A point you made resonated with me, which was that a lot of investors kind of flip this, where they take Social Security at full retirement age or a lot of them take it even earlier when they are first eligible, and they delay tapping their IRAs. You think there is a reason to consider the opposite sequence, where you delay Social Security receipt and potentially pull from the IRA sooner. Why would that be?

Slott: You have to integrate. When the paychecks stop you have basically these two sources left that people don't work together on, they look at them as separate issues. I have my IRA, and I have my Social Security. I think by now everybody knows with Social Security if you hold off to age 70 you get more. You have the cost of living increases--say 8%--it's like having an account that's growing 8% plus cost of living increases about another 2%, 3%. You could be talking about 10% guaranteed higher checks for the rest of your life if you hold off to age 70. I say if you need the money, take from the IRA during your 60s, if that's enough. If you do need the money it means you are probably in a lower tax bracket, so it won't cost you that much, plus you are bringing down that taxable money, and you'll get a bigger check with Social Security starting at age 70 1/2. I use the 70 1/2 retirement age, for Social Security it's 70, two different things.

Benz: Right.

Slott: At age 70 with Social Security you'll get the higher check for the rest of your life, that's locked in. Now don't wait past 70 because you can't get any more after that. But that's a big deal, because now you have that guaranteed highest check for the rest of your life, and at worst Social Security is only taxed--I say only--85%, it sounds like a lot. But IRAs are taxed 100%. I'd rather have the money that's less taxed, more of that going into retirement.

Benz: Are there any obvious situations though where that sequence of potentially tapping the IRA first and delaying Social Security receipt, where that doesn't make sense. Any sort of profiles of individuals?

Slott: I think it's more psychological. Once you are eligible, people want that money. I know people in my own family, I have said don't do that. No but why would I give that up, that's another year I didn't have money for that. It's just why would I give up something I could have now to have more later. Remember when you are talking about retirement planning you are talking about even at age 70, people live to 90, 100 years old. The great thing about Social Security benefits other than savings account, like an IRA, I call Social Security like renewable resource--it never runs out. You spend it, it comes right back next month, you spend it, it comes right back next month. It's guaranteed income for life. Not, so with a savings account. Sure, you could draw from a savings account, but you could draw it down. Also if you draw from a savings accounts--and I include retirement account--you have the tax of course. If you are withdrawing in a declining market then you have what's called that sequence of returns risk where you really start losing boatloads of money, that you can't make back in retirement because you have no more paychecks. If you need money in those years in the 60s once you reach full retirement age or even before you could take it, there are penalties, but then take the money. You don't think you are going to live that long. You have health issues. There are reasons, everybody has a different situation. But all things being equal--you are healthy, you can live on the IRA during your 60s--you are generally better off waiting till age 70 to start drawing on the highest Social Security check for the rest of your life.

Benz: You mentioned sequence of return risk which is such an important concept in the retirement planning space, and that basically means that you encounter that lousy market environment right out of the box when you retire. Is there potentially a risk for retirees today? We don't want to get into market timing, but the market has been going up for the better part of 10 years.

Slott: There is something called gravity.

Benz: Right. So realistically this …

Slott: It's all timing, nobody knows. Look at people who chose to retire, because it was their time in 2008. They retired at the worst possible time, when the market was in free-fall. That is not the time you want to start drawing from investments in a market you can never recover. So yes, then that equation shifts. You might be better off leaving that money, the money invested in the market, leave it there to rebound and take the Social Security if you need it. Just so you don't have to touch money in a falling market.

Benz: Or at a minimum perhaps line up some more conservative investments within that IRA so that you are leaving your equity holdings to recover.

Slott: Right.

Benz: Ed, thank you so much for being here. An important topic, thanks for discussing it with us.

Slott: Thanks.

Benz: Thanks for watching. I'm Christine Benz from Morningstar.com.