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Facts to Know Before Taking the Social Security Lump Sum Cash Option

Published on: Jun 30 2023

The Social Security Administration still is doing a disservice by coaxing applicants into taking the optional lump sum cash payment when they sign up. The beneficiaries more than pay for it over the long term.

The lump sum option isn’t new. But many applicants don’t know about it until the SSA offers it to them when they apply for benefits.

When you wait until full retirement age or later to claim Social Security retirement benefits, you have an option. You can receive a lump sum payment of up to six months of retirement benefits. Full retirement age (FRA) is 66 for those born in 1943-1954, over age 66 on a sliding scale for those born after 1954-1959, and 67 for those born in 1960 or later. The lump sum option isn’t available to those claiming benefits before FRA.

SSA’s policy is to inform all eligible applicants about the lump sum option. Anecdotal information is that SSA employees explain the option in ways that persuade applicants to take it. The employees might say that most people take the option or that it’s a valuable benefit. They also might ask if there’s some need or want the lump sum could help with.

Applicants usually don’t expect the offer and make a decision quickly. Some say they took the lump sum because it was offered and was too much money to pass up. Others think it’s their money and if they can take it now, they should do so instead of leaving it with Social Security.

It is better to take the view of a friend I knew who worked for the U.S. government. Whenever he was presented with a choice of changing benefits, his first thought was, “If they’re giving me a choice, a change probably is likely to benefit them more than me.”

Despite the impression many people have, the lump sum option isn’t free. In fact, the cost can be substantial over the years. You receive Social Security retirement benefits based on a formula. It is not like an IRA or 401(k) account. You don’t have money set aside that’s invested for you and from which your benefits, including a lump sum, are being paid.

A more important point is the cost of the lump sum. Your monthly benefits are reduced for the rest of your life. You waited until full retirement age or later to claim benefits so the monthly benefit would be higher. You partly reverse that by taking the lump sum.

If you take the maximum lump sum of six months of benefits, then your beginning monthly benefit will be computed as though you began benefits six months earlier than you really did.

For an individual who was well-paid during the working years and was planning to claim benefits at age 70, the reduction in monthly benefits is likely to be $300 to $400. That’s a permanent reduction for the rest of his or her life.

For example, Max Profits contacts Social Security and says he wants to begin benefits at age 70, receiving the maximum allowable benefit. Under his earnings history, he’s due $3,000 per month.

After hearing about the lump sum option, he chooses it. Max receives a lump sum of $17,310 (six months of his age 69½ monthly benefit). But his official beginning age for benefits is 69½ instead of 70, and his initial monthly benefits are based on that age. He’ll receive $2,885 per month. That’s 4% less than his maximum benefits for age 70. (Remember by delaying benefits after FRA, your benefits increase 8% annually through age 70.)

The difference in the two benefits amounts is enough to pay for the base monthly Medicare Part B premium and more.

Social Security benefits are indexed for inflation, so in the future Max loses the compounded annual inflation increases on that amount.

Also consider the effects on your spouse. As I’ve emphasized in the past, a major reason for the higher-income spouse to delay taking Social Security benefits is to maximize the amount paid to the surviving spouse, regardless of which spouse it is.

When one spouse passes away, one of the Social Security benefits coming to the household ends. Generally, the higher of the two benefits is paid to the survivor, so it’s important to maximize the amount paid to the surviving spouse. Taking the lump sum option reduces the amount the surviving spouse will receive.

Another point to consider is the lump sum could push you into a higher income tax bracket. It also might trigger or increase the Stealth Taxes, such as the tax on Social Security benefits, the Medicare premium surtax and more.

You might invest the lump sum and earn good returns. I suspect few people who take the lump sum do that. If that’s your plan, keep in mind that Social Security payments and inflation increases are guaranteed, while investment returns are not.

If you made the wrong choice and did so recently, you might be able to withdraw the benefit application and start over. Visit the Social Security website or a local office or call toll free: 800-772- 1213. You should have copies of your original claim forms and be prepared to explain what you want to do.

The Social Security lump sum option isn’t free money or found money. You pay for it, and the longer you and your spouse live the higher that cost is going to be. The SSA reps make this point, but they don’t emphasize it or give the applicants projections that show how much the lump sum costs them over time.

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