Crossing the Bridge: How to Fill the Income Gap Between Early Retirement and Maximum Social Security

The Story

Many retirement investors are anxious to take Social Security as soon as possible. They’ve worked hard throughout their career to accumulate assets and pay into the system. In some cases, they want to start taking what they feel they’ve earned. In other cases, they fear the stability and financial status of the system and have an urgency to get their money out before it’s gone.

The Problem

Taking Social Security early can have potentially harmful effects on retirement income. But without an income source to bridge the gap from retirement to the full retirement age (FRA) for Social Security, it can be hard for clients to delay benefits.

Client Profile

• James is 62 and ready to retire
• He has funds he can use to supplement income, but is counting on taking Social Security early
• If he takes Social Security at 62, let’s assume a benefit of $700 per month, or $8,400 per year
• If he waits to take his benefit at age 70, his monthly benefit would have grown to $1,240, or $14,880 per year

The Solution

James’s advisor offers a different strategy. Instead of using his funds for income directly, his advisor recommends purchasing a single premium immediate annuity (SPIA) that provides $700 per month, or $8,400 per year, of guaranteed income for the next eight years. The lump-sum deposit is about $57,000.

If the SPIA is purchased with nonqualified funds, only around $1,200 of the $8,400 is taxable income, due to the exclusion ratio. The SPIA includes an eight-year period certain. James will be 70 when it runs its course, and at that time he’ll turn on his Social Security benefits.

How it Works

Let’s take a closer look at this strategy. The annuity is purchased with a deposit of $57,000. It provides the $700 per month that the client would have received taking the Social Security benefits early. The hidden benefit of using this bridge strategy is that the eight-year, term-certain SPIA actually "purchases" an additional income benefit of $6,480 in year nine forward, because it allows the client to obtain a higher Social Security benefit for the rest of their life.

Today’s tax laws provide additional incentives to deploy this type of strategy for a wide segment of the American population. With the nonqualified exclusion ratio, as much as 93 percent of the income from the bridge is received tax-free.

Or, assuming the highest marginal tax bracket, the decision saves almost $2,600 per year in federal income tax, not to mention the potential savings for state and/or local taxes. It also allows clients to make as much earned income as they wish between age 62 and FRA without affecting their Social Security benefit.

The Result

By waiting to take benefits until age 70, James will be eligible to receive $1,240 per month from Social Security, or $14,880 per year. In addition, he will have reduced his taxable income each year he receives payouts from the SPIA. To continue the conversation, grab the client-facing flier that outlines why clients should wait to take Social Security.

Payout is based upon an A-rated insurance carrier as of Jan 2024 using an eight-year period certain, no life contingency.

Exclusion ratio is calculated by taking the cost basis of the contract divided by the total payments. Expressed as a fraction: (cost basis)/(total payments received from the contract) = exclusion ratio or $57,000/$67,200 = 84.9% exclusion ratio of each payment.