Social Security payments and withdrawals from tax-deferred accounts can be coordinated throughout retirement to lower an individual’s taxes, according to authors William Reichenstein and William Meyer.

The strategy involves drawing down from tax-deferred accounts to achieve the lowest tax rate in retirement years, they said. The taxation of Social Security benefits can cause a person’s marginal tax rates to dramatically rise, something the authors call the “tax torpedo.”

Reichenstein is professor emeritus of investments at Baylor University and head of research at Social Security Solutions, a firm that developed software to help individuals decide when to begin taking Social Security benefits. Meyer is CEO of Social Security Solutions. Both men have written extensively about Social Security strategies and how to maximize benefits.

The latest strategies unveiled by the two in a recent white paper show how advisors can help clients use tax brackets to determine withdrawals, which can add substantial value to many retired clients’ financial portfolios. The paper is called “How Social Security Coordination Can Add Value to a Tax-Efficient Withdrawal Strategy.” It appears in the fall 2021 issue of The Journal of Retirement.

“Advisors need to incorporate withdrawal strategies that minimize Social Security taxes. Showing how to keep more of their Social Security by paying less in taxes adds a significant amount of value,” Meyer said in an email. “Many advisors think Social Security taxation does not apply to their clients. We show that coordinating a smart Social Security claiming decision with a tax-efficient withdrawal strategy can add value to mass affluent clients who have savings of up to $2 million.”

The strategy also can enable many retirees with financial portfolios to pay taxes on less than 85% of their Social Security benefits, he added.

The first step of the strategy is for the retiree to delay receiving Social Security benefits until age 70, when payments achieve the highest rate possible for the rest of the beneficiary’s life. Instead of relying on Social Security benefits for the first few years of retirement, before the person reaches age 70, withdrawals should be taken from Roth accounts, where the taxes have already been paid, until the Social Security is taken.

Second, in later retirement years, retirees should withdraw from their tax-deferred accounts either the required minimum distribution or enough to fill in lower tax brackets, whichever is higher, the pair said. The Roth balances provide the additional spending money that can be used without raising the tax rate.

Reichenstein and Meyer developed various scenarios in the paper to show how retirees with portfolios worth between $1 million and $2 million can save on taxes. The optimal withdrawal strategy varies depending on whether the client is single or married, the size of the client’s financial portfolio, and the client’s spending goals. In some instances, depending on the size of the portfolio, the amount to be paid for Medicare benefits can also be reduced.

“All advisors need to include these analyses for many of their retired clients and not be fooled into thinking that these clients are not impacted by a potential tax torpedo,” they said in the paper.

“Compared to the conventional wisdom withdrawal strategy, each of these retired households that follow this version of the withdrawals from tax-deferred accounts, combined with delaying Social Security benefits, can substantially reduce lifetime income taxes, reduce the amount of Social Security benefits that are taxable, and lengthen the projected longevity of their financial portfolio,” they continued.