Here’s What Happens When You Draw Down Your 401k To Increase Social Security (Surprising)
The allure of a bigger Social Security check is understandable. For many, it’s a crucial component of retirement income. But is it a smart move to dip into your 401k early to delay claiming Social Security and potentially boost your monthly benefits? The answer, as with most financial decisions, is: it depends. And the consequences can be surprising.
Before you start strategizing a 401k withdrawal to bolster your future Social Security income, let’s break down the potential upsides, downsides, and the unexpected realities you might encounter.
The Basic Premise: Delaying Social Security = Bigger Checks
The core idea behind this strategy is straightforward. For every year you delay claiming Social Security benefits past your full retirement age (FRA), up to age 70, you earn an 8% delayed retirement credit. This translates to a significant boost in your monthly benefit amount for the rest of your life.
So, if you’re considering claiming at 62, the earliest possible age, you’ll receive significantly less than your FRA benefit. Delaying until 70 could potentially increase your benefit by as much as 77% compared to claiming at 62.
The Potential Appeal: More Guaranteed Income Later
Drawing down your 401k to bridge the income gap while delaying Social Security allows you to tap into retirement savings now for a potentially larger, guaranteed income stream later. This can provide peace of mind, especially for those worried about outliving their savings or facing unexpected healthcare expenses.
The Harsh Reality: The Tax Man Cometh (and Other Drawbacks)
This strategy isn’t without its significant drawbacks:
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Taxes, Taxes, Taxes: This is perhaps the most surprising and often overlooked consequence. Withdrawing from a traditional 401k triggers income taxes. Depending on the amount you withdraw and your overall income, you could be pushed into a higher tax bracket. This means you’re not only losing a portion of your retirement savings, but also paying a chunk of it to the government. This can severely diminish the long-term benefits.
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Early Withdrawal Penalties (If Applicable): If you’re under age 59 ½, you’ll likely face a 10% penalty on top of income taxes when withdrawing from your 401k. This further erodes your savings and makes the strategy even less appealing.
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Opportunity Cost: Think of your 401k as a growing tree. By withdrawing from it, you’re cutting off a branch. This means you’re forfeiting potential future investment growth, which could have a substantial impact on your overall retirement wealth. Compounding is a powerful force, and even a small withdrawal can have a significant long-term effect.
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Running Out of Money: Relying heavily on 401k withdrawals to delay Social Security can be risky if you underestimate your expenses or encounter unforeseen circumstances. You could deplete your retirement savings faster than anticipated, leaving you with fewer resources later in life.
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Inflation’s Impact: While a larger Social Security check provides a guaranteed income stream adjusted for inflation, you need to consider the eroding power of inflation on the withdrawals you’re making now. The purchasing power of the money you withdraw today might be significantly higher than the value of the increased Social Security benefit in the future.
Is It Ever a Good Idea? The “It Depends” Factor
There are specific situations where drawing down your 401k to delay Social Security might be a viable option:
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You’re in a Low Tax Bracket: If you’re currently in a very low tax bracket and anticipate being in a higher one in the future, withdrawing a smaller amount to delay Social Security might make sense, provided you carefully consider the long-term implications.
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You Have a Short Life Expectancy: While morbid to consider, if you have reason to believe you won’t live much beyond your life expectancy, maximizing your Social Security benefit for a shorter period might be beneficial.
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You Have Other Substantial Assets: If your 401k represents only a small portion of your overall retirement savings, and you have other significant assets that will continue to grow, the potential impact of withdrawing from your 401k might be less significant.
The Bottom Line: Do Your Homework and Seek Professional Advice
Drawing down your 401k to increase Social Security is a complex financial decision with potentially surprising consequences. It’s crucial to:
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Calculate the Break-Even Point: Determine how long it will take for the increased Social Security benefit to offset the cost of the withdrawals, including taxes and lost investment growth.
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Factor in Inflation: Account for the eroding power of inflation on both your withdrawals and your future Social Security benefits.
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Consider Your Personal Circumstances: Evaluate your tax bracket, life expectancy, overall financial situation, and risk tolerance.
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Consult a Qualified Financial Advisor: A financial advisor can help you analyze your specific situation and determine whether this strategy is appropriate for your needs and goals. They can also help you explore alternative strategies that might be more beneficial.
Don’t be lured by the seemingly simple appeal of a larger Social Security check without carefully considering the potential pitfalls and hidden costs. A well-informed decision, guided by professional advice, is the key to maximizing your retirement security.
LEARN MORE ABOUT: Qualified Retirement Plans
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I retired at 61 6 years ago got a large severance check and left with a pension just under 100k annually no cola. We drew my wife's SS at 65 last year she had limited time in the system and it wasn't much. I wanted to keep my income down and continue to do some annual Roth conversions to at least 70 1/2 when I may start drawing SS, I may look at the DRC's to continue Roth conversions at least until our rmd's start at 73. We don't owe anybody anything other than insurance, food, utilities, and maintenance items. Currently the pension has taken care of our expenses for the last 6 years. We are down to about 1.4 m in IRA's still so rmd's will be manageable, but I still want to get as much as possible into Roth as early as possible. As we get older we will start gifting the grandkids (all will be 18 and older this year) primarily with a combination of rmd's and maybe some Roth money, our adult kids are sitting pretty good but if things go well we will cut them in for smaller portions. The Roth is pretty good sized and I believe I have one more double at least left in me. My parents lived into their 90's, My wife's mother passed at 72 but her dad went into his 90's. We have a good size pension, SS between the two of us will be 5600 a month if I draw at 70.5, a good size Roth, 2 IRA's, large brokerage account, small HSA, a house and personal property. Our 4 kids are just 19 to 26 years younger than us but well established with good jobs and homes, we want that to continue with their kids all between 18 and 26. It's our life that's where we're headed, so that is the plan for now, right wrong or indifferent.
I've been saying exactly this for years. James, a couple of things not mentioned:
Only 85% of the social security $$ are taxed for most.
And SS isn't taxed in most states (including mine).
As compared to IRA withdrawals being 100% taxed at the Federal level
and by most states in a reduced form.
A win for fed taxes in the early retirement years, bonus for state taxes.
Since my taxable income is thus less, it gives me a little more $$ leeway for my Roth conversion.
Another win.
I can't leave SS to my heirs.
And taking it earlier leaves more in my IRA in almost every scenario,
including all the most likely ones.
Another win.
Present day $$ are worth more than future $$ due to inflation.
Another win.
Other than survivor's benefit, I see nothing but wins by taking at 62.
Bird in the hand, etc.
After watching numerous example videos, I bought the software. I was surprised that every scenario I ran resulted in a better outcome if I take SS at 63 when I retire next year. I thought I was inputting something wrong, but was sure I hadn't. This video confirms what I already had discovered as this video is more or less similar to our situation. As for Roth conversions to avoid RMD issues, I've looked at the charts and it's about what I'd probably want to take out anyway. And, if I didn't need the money, I feel sure my children, grandchildren, and my church could use it.
This is a great explanation of combining social security early as part of your overall retirement financial plan. The stress relief of including SS early is amazing. This strategy coupled with spending less overall as you grow older makes it even more valuable.
Social security is insurance. Insurance is to protect yourself against the unknown. If you need it between 67 and 70 you can always activate it. Also who cares about maximizing your benefit if you’re dead.
This all makes sense to me. The other wrinkle I would add is the possibility that SS benefits may be reduced about year 2033 when the Trust Fund is expected to be depleted (assuming Congress does nothing between now and then). Some say benefits could be cut 24% to balance the benefits paid out with the SS taxes coming in. On this basis, my own simple break-even analysis (SS payments only) shows that a 24% reduction in SS benefits in 2033 increases the break-even age by three years, from age 84 to age 87, when comparing taking SS at full retirement vs taking SS at age 70. My thinking is to not delay SS until age 70. What advice do you give clients regarding potential future cuts to SS benefits?
Great video, thanks for the example of a single person, I'd love to see the same example but with someone who also has a monthly pension.
Good Lord you took a long time to get to the point.
Why would you want to "maximise" your monthly benefit when not considering maximising their LIFETIME benefit?
Another outstanding video James! For my situation, with a conservative asset allocation, 65 years old is optimum filing. Additionally, since my wife is younger, she will file a few months after me at 62.
This results in the best results in low, median and upper quartile montecarlo analysis.
I like the way you approach this. It is not a simple match problem. It’s more like three dimensional chess.
To me, it's not about how much I accumulated from ss on a return basis over the years once I get old and retired, but how much steady cash flow I will have to live off of each month in the old age years and the income is fixed!
All of the SSI collection advice is completely flawed.
Yes, the payment does increase by 8% each year… HOWEVER…
The COLA to SSI is based on that 8% increased amount.
So if I take $1000 per month at 62, vs $1500 at 70, the COLA is given to the amount you are receiving…
So 5% COLA to $1000 will be a bit different than 5% COLA to $1500.
I’ve never seen anyone point this problem out for early SSI collection.
You failed to mention SS has COLA.
Sounds good if your portfolio allows it. I lost a lot being self employed and some bad decisions. I’m 63 and still working as a company employed truck driver. I am building from scratch my 401k so wouldn’t make sense to collect and pay a penalty on Social Security. Whether I live long enough to break even or not, for the years I likely have, I will need the maximum Social Security.
A max of 85% of SS is subject to taxation. Taxes and RMDs weren’t figured into the break even analysis.
I’m waiting until 70 for SS because I will have 4 years where I will live off my high yield savings account and have zero earned income for a period of robust ROTH conversions. It also gives me higher probability of receiving my inherited brokerage account with step up in basis in time to use these funds to pay conversion taxes. Waiting until 70 also gives my wife higher survivor benefits.
whats an extra 100K doing for you at age 76? nothing unless you are in the top 10% shape of all 76 year olds. But 100K extra in the decade before 76? thats 10 really nice vacations even for an elderly couple
Yet another good video
If how much you need SS is the primary driver in your retirement plan, you probably need it as early as possible or you can't even afford to retire yet.
Good video. Even though my average return on my portfolio is 10%+ I use a more conservative growth number when calculating SS breakeven. That is because in a diversified portfolio you have some assets in liquid accounts such as high yield savings or T Bills. Let’s say they are getting 4% pre tax. When I delay 1 year I can withdraw from these assets allowing the higher growth assets to remain untouched. Also I withdraw equally throughout the year so I am only losing 2% pre tax in year 1 and 3% in year 2 of delaying.
I started drawing at 62. I'm diabetic and you never know. 2 friends died of heart attack before 62 and another one at 62 died of kidney failure
I’m 57 with $600K in retirement accounts but my wife is 65 with only $300K. The longest living male in my family for the last 400 years lived until 68. Bad genes I guess. At 57 I’M TIRED and stressed out. I don’t know if I have another 2.5 years left in me to wait to retire. I have have $750K life ins so if I die anytime soon she’s taken care of so our question is what should she or I do? She’s not taking SS yet, just not working whereas I’m working 9-10hr days M-F.
Social Security is important for many seniors, but it’s also crucial to plan for retirement with smart investments. Diversifying your investments helps grow wealth over time. It’s never too early to start saving and investing for a secure future. I'm 63 and my husband is 65. We’re both retired with over $3 million in net worth and no debt. We live frugally and earn monthly passive income, which makes our early retirement possible.
I'm not saying you'll get 9% return, but just want to illustrate to you as an example! LOL…well don't use it as an example if it's not even accurate! Geeeez! Overall, what I am getting is that you are squabbling over about $10,000 ultimately? In the end, I"m going to retire and begin drawing SS at 62 because to be frank, I have no faith it will even be there by the time I hit 70. The Scoial Security trust will be flat broke by 2032 and I have NO FAITH that Congress will fix it! They never do! They continue to just kick it down the road! We will hit a brick wall in 2032 and I fully expect the Feds to cut Social Security benefits by 30%! Yes, you heard that right! They will cut SS by 30% (not just people who haven't retirned, but people alreeady drawing SS). They may devise some sneaky "phase in" program where it will be only 10% for existing retired people initially and then eventually cap out at whatever number it is they finally decide on. But otherwise, we are all screwed and if you don't have an alternative source of income when you retire, you are up Schitz creek without a dollar! So, the best advice that ANYONE can receive is take it as early as you can, because there is no guarantee it will even be there come 20 years from now!
When you show portfolio value by year with investment returns, are you also factoring in withdrawals each year after a certain point?
I am 65. I am planning on working to 68 and husband to 70. SS would only be a fraction of what we make from work plus health benefits. I don't want to live on a low salary for the rest of my life. Now our salary is at its highest. I hope to maximize all of our earnings.
401k is YOUR money… SS is the government's money. When you die, your family can get your 401k… they can't get your SS in most cases.
Good video. I agree with your analysis with one tweak related to tax rates which improves the answer for delaying. At least 15% of SS is not federally taxable and zero in many states. I will pay 50% more combined fed and state tax on my ordinary investment income vs SS (30% vs 20%). By delaying and drawing down my investments I will have a larger % of my income in lower taxable SS.