Deciding when to take Social Security retirement benefits is one of the more difficult retirement decisions. The decision affects lifetime monthly income of not only the recipient but also the recipient’s spouse. The choice of starting date can mean the difference of thousands of dollars over the course of retirement.
Though few people realize it, the decision is not irrevocable. The beginning date of Social Security retirements can be changed, and for many people changing benefits after they have begun might be a good idea.
Let’s take a look at the rules and some research by Laurence J. Kotlikoff, a professor of economics at Boston University.
Most of you know that the level of Social Security retirement benefits depends on the age the payments begin. The full benefit is paid to someone who begins payments at full retirement age. Traditionally FRA is age 65, but FRA is increasing on a sliding scale for those born after 1936 and eventually will settle at 67. Benefits can begin as early as age 62, and recipients will receive less than full retirement benefits for each month they begin before FRA. Those who delay receiving benefits will be paid more than full retirement benefits with the maximum benefit being paid to those who wait until age 70. Details are in my book, The New Rules of Retirement.
The procedure for changing the beginning date of benefits is very simple. At any point, a recipient of Social Security retirement benefits can have them adjusted to the level that would be paid if they initially were begun at a later age. The recipient completes Social Security Form 521, “Request for Withdrawal of Application.”
There is a price for changing the benefits. All benefits received to date must be repaid. No interest is charged, and no inflation-adjustment is made. The payments received are added, and that total must be paid to Social Security to change the benefits. In effect, the recipient has interest-free use of the money, and then can repay the benefits received and opt to receive higher benefits for life.
When does it make sense to change the amount of benefits received? After all, one must write a hefty check to the government to make the change.
Some who have enough wealth that they do not need the early Social Security benefits to pay their living expenses believe it makes sense to begin taking benefits early and invest each check received. Upon reaching age 70, they plan to complete Form 521 and send a check to the government. They keep the investment income and gains earned by the early benefits, and then they receive the higher benefits for life.
One factor not to overlook is income taxes. Someone who can pay living expenses without using the Social Security checks probably has an income level that triggers taxes on some Social Security benefits. But keep this in mind. When the benefits are repaid, either a deduction or credit might be available on taxes paid on those benefits.
Let’s look at a different situation. Max Profits uses the benefits to pay living expenses but has other liquid assets. He began receiving benefits before FRA. As he approaches age 70, he realizes how much the benefits would increase if they were started at that age. Does it make sense for Max to use his investment portfolio to repay the benefits received and buy the higher benefit stream?
Professor Kotlikoff believes that in many cases it makes sense to buy the higher benefits. He believes the way to analyze the decision is to compare the cost of higher benefits with the cost of buying a commercial annuity that would pay an amount equal to the difference between the two benefit levels. His research indicates that most of the time it costs significantly more -40% more or higher-to buy that amount of additional income through an annuity.
By returning the benefits to receive a higher benefit in effect Max would be buying an annuity for the difference between the two Social Security payment amounts. Buying that annuity from the government is likely to be cheaper than buying it from a commercial insurer.
There are a few caveats and other points to consider.
Buying higher benefits from Social Security might mean less would be available for children or other heirs. A surviving spouse will receive survivor benefits, but children will receive nothing from Social Security.
Taxes are another consideration. The Social Security benefits potentially are subject to income taxes if the recipient’s income is high enough. With an annuity, part of each payment will be a tax-free return of principal. For example, for a 70-year-old married couple 64% of the annuity payments would be excluded from gross income.
Another consideration is that if one already has passed age 70, the payoff from trading up declines. Social Security benefits do not increase after age 70, regardless of how long after age 70 one waits to begin benefits. In addition, there would be more months of early benefits to repay in order to receive the higher benefits.
Another factor to consider is how else the money could be invested. If there are investment opportunities with higher returns or more security than an annuity or higher Social Security benefits, those might be a better use of the money.
People who began receiving Social Security benefits early should re-evaluate that decision as they approach age 70. It might make sense for many of them to pay to receive higher benefits for the rest of their lives.
Suppose someone has not yet begun retirement benefits and will not need them to meet living expenses. Does it make sense for this person to begin benefits early, invest them until age 70, and then pay back the benefits in return for higher benefits? This is a more difficult decision, because assumptions must be made. Considerations include the amount of income taxes on the benefits and the investment return on the received benefits.
A final consideration: If too many people trade up for higher benefits Congress might change the law. Currently about 100,000 people annually pay for higher benefits. If Social Security reports that the number is rising and it is costing the trust fund money, Congress might change the rules. That is a risk for someone who deliberately begins benefits early with the intention of paying for higher benefits later.
Retirement does not give many second chances and “do overs.” A little-known second chance is the decision of when to begin Social Security benefits. Retirees approaching age 70 should consider whether it makes sense to apply for higher benefits.