House Downsizing and the Social Security Claim Decision


The Situation:  Many people claim Social Security benefits as soon as they reach age 62 even though large financial gains can be obtained by delaying claiming benefits until the full retirement age.  Some people choose to claim Social Security benefits early because they have little or no liquid assets and they do not want to remove money from their 401(k) plans.  Moreover, disbursements from 401(k) plans will increase tax bills.

One way to finance living expenses between age 62 and 67 is to downsize to a smaller home and live off the proceeds from the house sale until reaching the full retirement age.

This post considers the potential tax advantages of using proceeds from a house sale rather than disbursements from a 401(k) plan to fund living expenses prior to reaching the full retirement age.

Question:   A person aged 62 with $35,000 in wages needs to supplement his salary for five years prior to claiming the full Social Security benefit.  The first strategy involves a $40,000 annual disbursement from a 401(k) plan.   The second strategy involves annual disbursements of $40,000 obtained from the proceeds of a sale of a home.  How much income tax will the person pay under the two strategies?

Answer:  I have assumed the person is single and takes the standard deduction.  Based on the 2013 tax rate schedule the person who disburses funds from the 401(k) plan will pay $13,728 in taxes.  The person who lives off the capital gain from housing will pay $4,233 in income taxes. The tax savings obtained from living off the capital gain on housing rather than disbursing funds from the 401(k) is $9,495 per year.  Over the course of five years this amounts to $47,475.

Concluding thoughts:   The decision to delay claiming Socials Security benefits until reaching the full-retirement age is one of the best financial decisions a person can make.  This decision  protects a retiree from poor returns, unexpected inflation, and from living too long.  The authors in the article linked below does a much better job in explaining these benefits than I can.

Unfortunately, many people either do not fully understand the benefits obtained by delaying Social Security claims or due to lack of liquidity or tax consideration feel they must claim benefits as soon as they turn 62.

Often short term tax considerations tend to dictate financial strategies.  For example,  people tend to choose 401(k) plans over Roth IRAs because they value the immediate tax savings.   Note, had the person in this example allocated some resources towards a Roth IRA taxes could have been  avoided by disbursing funds from a Roth rather the 401(k).

House downsizing may be one way to fix tax problems for retirees who are 401(k) rich and liquid asset poor.

For more information on the Social Security claim decision go the following post.

For more information on Roth IRAS consider:

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