Q: My husband and I are in our mid-60s. We are planning to retire very soon. We are having a bit of a disagreement about when we should file for our Social Security benefits. I want to wait and he wants to collect right away! Who is right?
A: Congratulations! Of course, I can’t tell you who is right without all the facts. But, I can tell you that your decision may open up interesting opportunities during the “gap years” marked by the end of your work life and the start of your Social Security. Given that you’re the one who asked the question, I have to give you the preliminary nod!
To start, most people know the advantages of delaying Social Security. The boost in benefits can be big, if you can afford to wait. That decision, of course, depends on good genes, good health and good luck, too!
Delaying Social Security not only boosts your future benefits, but it also widens the length of your “gap years” and, with it, it also opens a nice tax planning window.
First, there’s a little-known wrinkle in the tax law that’s been around for about 15 years. For people who pay tax in the 12% federal bracket, realized capital gains are afforded a special 0% federal tax rate. If you are able to live off of your already-taxed savings during your gap years, you might be able to strategically sell some of your highly-appreciated stock without taking any federal tax hit at all.
To be clear, selling that stock doesn’t mean you aren’t allowed to immediately re-buy it for your portfolio. You are just getting a tax-free shot to effectively “step-up” the cost basis to today’s price. That’s a shot that usually only happens when you die. This way is much more satisfying!
Next, you might consider doing some strategic Roth conversions during your gap years. A Roth conversion is just a fancy term for taking some of your pre-tax, regular IRA money and moving it over into a tax-free, Roth IRA. Of course, the income tax you’ll owe with any Roth conversion should always be paid with money that’s outside your regular IRA.
The main motivator for doing a Roth conversion is when your current tax rate is the same, or preferably less, than your expected future tax rate. During your gap years, when you might choose to draw down your already-taxed savings to cover your needs, you can purposely look much poorer to Uncle Sam and sneakily squeeze Roth conversions into your tax return at a temporarily low tax rate.
While recently traveling around London during a very special visit to my older brother, I got very used to the constant warning to not fall through the absurdly wide crack between the subway and the platform. So, as the English like to say, as you make your Social Security timing decision, be sure to “Mind the Gap!”