Did you read last week’s blog post, Wait Until 70 to Collect Social Security?, learn that you can increase your Social Security retirement benefits by 4.5% to 8% per year for each year between your full retirement age (“FRA”) and age 70 depending upon when you were born if you delay the start date from your FRA until age 70 and say to yourself, “That sounds great, however, I’m 69, I’ve been receiving Social Security since I was 62, so that doesn’t apply to me.”? Well, not true, at least for the time being.
Using a little-publicized strategy that may be discontinued by Social Security Administration (SSA) in the near future, you can delay your Social Security start date to age 70 to obtain a higher monthly payment even though you’re already collecting benefits. Although the popular name for this strategy is a “do-over,” I like to refer to it as “pay-to-play” Social Security.
Here’s how it works. Let’s say you’re 69 and you’ve been collecting Social Security since turning 62. In order to receive a larger benefit beginning at age 70, you’re required to pay back 100% of the Social Security benefits that you’ve received from the date you began collecting your benefits. The payback is without any interest or penalties. Furthermore, to the extent that you’ve paid income tax on your Social Security benefits, you’re entitled to claim a tax credit or tax deduction for the amount of tax liability attributable to your benefits, whichever results in the most tax savings.
In order to take advantage of this strategy, you must file SSA Form 521 – Request for Withdrawal of Application at your local Social Security office. Once you do this, your retirement benefits will stop almost immediately. If your spouse is receiving a spousal benefit (See Do Your Homework Before Flipping the Social Security Switch – Part 4 of 5), his or her benefits will also stop. You will then receive a letter from SSA with the amount of your required benefit repayment, including any spousal benefits. Once you repay your benefits, you can then reapply for a higher monthly payment for you, as well as your spouse if he/she was receiving a spousal benefit, based on your current age. There will be a delay of up to several months between the date your benefits stop and they resume during which time you will be responsible for paying Medicare Part B premiums yourself.
Depending upon your tax situation in the payback year, part of the funds that you will be able to use for your payback can come from the tax savings attributable to your payback. Let’s assume this is your situation. Why would you withdraw a sizeable lump sum from existing investments in excess of the tax savings when (a) the withdrawal, assuming it isn’t from a bank account or money market fund, will be taxable, either 100% as ordinary income assuming it is coming from a taxable retirement plan, e.g., an IRA, or at capital gains rates if from a nonretirement account, (b) you will lose future income and/or appreciation on the amount of your withdrawal, and (c) you could die soon after paying back your cumulative Social Security benefits, thereby potentially negating the benefit of an increased Social Security payment?
The answer to part (a) of this question is that if you don’t have funds readily available in a bank account, money market fund, or other liquid assets, and you must instead incur a sizeable tax liability that will significantly deplete your investment portfolio, you’re probably not a good candidate for the “pay-to-play” Social Security strategy. Assuming instead that you have liquid funds readily available, then the answer to parts (b) and (c) comes down to investment alternatives. Should you use your hard-earned money to invest in a larger future Social Security benefit or are you better off investing in an alternative income-paying investment? Parts 2 and 3 will help answer this question, with the latter providing you with an illustration.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.