Social Security Lump Sums & The Start-Stop-Start Strategy

Social Security Lump Sum & Start-Stop-Start Strategy

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# YOU NEED GUIDANCE, STRATEGIES TO USE, YEAH. I’M GONNA SHOW YOU HOW TO DO THIS. INVESTING AND TAX, STATE TIPS YOU NEED, YEAH. I'M GONNA GIVE YOU MY HELP. I'M GONNA GIVE YOU MY HELP. OH!

Welcome to Retired-ish. A podcast produced for those exploring retirement and those currently in retirement. I'm your host, Cameron Valadez, and today I'm talking about a couple of social security strategies that many people don't know exist.
The first is the retroactive social security payment election which seems to have become more and more common these days with the lack of the average American's retirement savings. In a nutshell, it's a sizeable lump sum payment made directly to you just before beginning your ongoing monthly benefits. To make that clear, you get a lump sum amount, and you also continue to receive ongoing monthly payments for life.

Sounds great, right? Well, not so fast. The government, of course, isn't just gifting you extra money for every gimme, there's a gotcha, and we'll get into that later. While this has been around for what seems like forever, I believe more people are tempted to make this election these days due to the massive decrease in private company pensions and, therefore, the overall retirement nest egg for the hardworking American. The option has a purpose, of course, but most people are being told about it for the first time by social security representatives when they go to officially file for benefits, and they want to quickly make a decision on the spot since they waited a month or so for their callback from the administration. This is why people are tempted to bite so quickly. But are these retroactive lump sums a good thing or a bad thing? The short answer is, of course, it depends. A for short.

The second strategy is what is called the voluntary suspension of Social Security payments, or what I call the "Start-Stop-Start" strategy. In this strategy, you can essentially file a claim to begin receiving reduced monthly benefits early between the age of 62 and your full retirement age, or FRA for short. Which will be sometime between age 66 and 67, depending on the year you were born. And then you stop receiving the payment at any time after you've reached your FRA up until age 70.

This allows you to let the benefit marinade and accumulate an 8% increase per year after full retirement age up to age 70. This can allow you to access your benefits early, but at a reduction, then pause them a little later to then earn some of your reduced benefits back.

Let's dive into the details of the retroactive election of benefits strategy. First, we need to have a basic understanding of full retirement age or FRA and delayed retirement credits, aka DRCs. Full retirement age, or FRA for short, as previously mentioned, is age 66 for those born between 1943 and 1954. After that, it rises in two-month increments until age 67, which is currently the highest full retirement age for anyone born in 1960 and later.

For example, if you were born in 1955, your FRA is 66 and two months. If you were born in 1959, your FRA is 66 and 10 months. Your FRA is important to know because that is the age you are entitled to a hundred percent of the benefits you should receive based on your work history. If you delay taking your benefits beyond your full retirement age, that is, you choose not to start taking them, you get what is called delayed retirement credits or DRCs, and these come at the tune of 8% each year until age 70. At age 70, the 8% increases stop because that is the longest you can wait to claim social security, period. Now I want you to note that technically these DRCs apply each month at a rate of 0.67%, which equates roughly to our 8% a year.

Now let's get to the meat of the retroactive lump sum election. The max amount of retroactive payments you can get in one lump sum is limited to six months or your full retirement age, whichever is later. Therefore, theoretically, the largest lump sum can be received if you file and asked for retroactive benefits at least six months after you've reached your full retirement age.

For example, let's say your FRA is 67 because you were born in 1961. If you ask for a retroactive filing at least six months after your 67th birthday, you will get a full six months of back pay all at once. If you try to do it any earlier, you can only get paid lump sum benefits back to the attainment of your full retirement age.
If you claim and ask for retroactive benefits three months after you turn 67 in this example, then you can only get three months’ worth of back pay in a lump sum, not six. Now, of course, there are always exceptions. In this case, it's that there's an exception to the six months. In certain cases involving disability payments and what are called certificates of election of reduced spouses benefits.

I know that's a mouthful. Or reduced widow and surviving divorced spouses, those can be retroactive for up to 12 months. Now, there are very unique qualifications for these, so that it won't apply to most. But just know this before you call or apply with the administration. They should be able to identify this and notify you if this applies to your situation, but at least you'll know what to ask about when you get that valuable time on the phone with them.

The big question is, does this make sense to do? It sounds great, right? You do the math and think of all the wonderful things you could do with that money. But as I said, for every gimme, there's a gotcha.

The key thing to note when electing to receive the retroactive payment is that it comes at a future cost. The reason is that by doing so, you are technically filing in the month that the retroactive payments go back to. Therefore, and this is the important part, you will lose any of those delayed retirement credits that you earned past your full retirement age.

Remember those 8% per year bumps? You could lose those, and this will permanently reduce your ongoing social security payments forever. For example, if your benefit at your full retirement age is, say, $2,000 a month and your full retirement age is 67, and you actually file for benefits at age 70, you would receive three years of those 8% increases.

This would actually equate to a 24% increase in your benefit. That's huge! Therefore, your benefit at age 70 could be around $2,480 a month. What's more, is that your future cost of living adjustments that Social Security provides will be based off the larger number of $2,480 versus $2,000 in this example.
This has more powerful growth potential because of the compounding effect. What's the delayed retirement credit boost if you don't claim retroactively? Well, if we take the max of six months in the earlier example, that is 4%, half of the 8% per year increase beyond your full retirement age. This doesn't sound like a lot, but when compounded over many years, it's much larger than you think.

This is likely a big reason why the Social Security representatives have recently begun bringing this up to claimants. The Social Security Administration understands the time value of money and presents future value calculations. The more people take the lump sums, the less strain on the overall retirement fund itself.
Why would someone make this election, to begin with? It's not always a bad idea to disregard the lump sum. There can be situations where this actually makes good financial sense, but there aren't too many. One might be health reasons. If you have a family history of health issues that have already started to pop up and you have a good inclination that your life expectancy likely won't beat the averages, then it may make sense to take the lump sum.

The reason is that the amount of time that would need to go by for you to break even on your decision may be past the age at which you're likely to live. Maybe you have a terminal illness. This might easily be the case for taking a lump sum and accepting a decrease in those future payments. Another scenario might be that if you have a significant amount of other financial assets or a private pension income, the social security benefits you are due to receive may not make that big of a difference in your day-to-day finances. They're more like icing on the cake.

In cases like this, maybe taking a retroactive lump sum sounds more appealing in order to save for another family member or make that big retirement purchase you never made because your frugal, of course. In these cases, the reduction in future payments doesn't look so bad since you don't really need it anyways. To each his own.

Now it is important to consider a few more things before making a decision. How about how will taking the retroactive social security benefits affect your spouse? Your spouse is able to receive what are called survivor benefits should something happen to you. This is true even if they have never worked or have their own social security benefits. You just had to have been married for at least nine months before they passed or for ten years if they were an ex-spouse that passed. And yes, you heard that right, you can collect on an ex's social security record. You also have to be at least age 60 or have a child in your care. And this is actually age 50 if you are disabled.

As it pertains to retroactive benefits, the key to understanding is that the survivor or widower's benefit is equal to 100% of whatever the deceased was receiving if the widower makes the claim at or after their full retirement age. Again, likely between age 66 and 67. The minimum survivor benefit that would be available at age 60 is 71 and a half percent of the deceased's benefit.

This means that if you file retroactively to receive a lump sum, you would be reducing the future payments not only for yourself but also your spouse, should you pre-decease them. Basically, the greater the deceased benefit was, the greater the survivor's benefit. This is definitely something to take into consideration, even if you have other assets or pensions.

What about taxes? How will taking the retroactive social security benefit affect my tax return? As you can imagine, a lump sum is going to bump up the numbers on your tax return, and this could do a number of things. The most obvious effect is that a chunk of that nice-looking lump sum will likely go to the IRS simply because part of that is taxable income. How much? Well, that depends. 0%, 50%, or 85% of your Social Security payments are subject to taxation at whatever tax bracket you fall into. This ultimately depends on your other income sources other than social security. It is fairly complicated to determine which, but just know that the more other income you have, likely the more of your social security is going to be subject to taxation.

If you collect social security in the same year you retire, for example, you could have a really high income compared to the following year when you won't be getting that paycheck or a bonus from an employer. Taking a lump sum could definitely bump you up from having, say, 50% of your social security benefits subject to tax to 85% subject to tax, which makes the bite even worse, of course.

However, there is a bright side to Social Security, and that is at least 15% of your benefits is always tax-free, and most states do not tax social security income at the state level. Increasing your income will also increase what is called your adjusted gross income, or AGI for short. This AGI is used to determine how much and whether or not you will receive certain deductions.

Having a larger AGI can reduce or eliminate potential deductions, medical expenses being a big example. Most retirees will have certain years where medical-related expenses are higher than normal. For example, you may have a year where you have multiple medical procedures done. Add that to your medical insurance premiums, and you may have a hefty amount in medical expenses.

You are allowed to deduct some of these to the extent that they exceed 7.5% of your AGI or seven and a half. And you have to do what is called itemize your deductions to get that. Having a higher AGI might limit this deduction or phase you out of it completely. This is just one example. There are several.
Having a higher income from a lump sum may also subject you to what is called IRMAA or I R M A A, which is a hefty surtax that is tacked onto your Medicare part B and part D premiums. The point is to be careful and make sure you or your advisors have done some analysis before making these decisions. Oh, and one more thing, the Social Security Administration doesn't care about your tax situation and likely won't give you any guidance either because they can't. They’re not tax professionals. If you don't fill out form W4V before you get your payments, they aren't going to withhold anything for taxes. Be aware of that. Otherwise, you'll be in for a nasty surprise come tax time. The social security withholding options are currently 7%, 10%, 12%, or 22%.

Let's discuss the second strategy, which is not so well known, and this is the Start-Stop-Start strategy, or in other words, the voluntary suspension of social security payments. As I mentioned at the beginning of the show, this lesser-known yet useful strategy allows you to start receiving some reduced benefits early, then pause them later when your finances are more in order. This allows you to “earn some of those benefits back.” The Start-Stop-Start strategy allows an individual who collected social security prior to their full retirement age to submit a request to the administration to suspend the benefit once full retirement age is attained. While suspended or while your benefits are marinating, remember that your benefit earns those 8% per year delayed retirement credits, which you can earn each year up until age 70 or any age before then if you decide to resume benefits again sooner. Anytime between full retirement age and 70.

And also, remember that technically you earn those delayed retirement credits on a monthly basis at a rate of 0.67% per month. So it's not an all-or-nothing 8% on an annual basis. In addition, because you will earn the DRCs each month you wait, the higher income amount you will eventually receive will also result in a bigger cost of living adjustment in the future once you begin taking benefits for the long haul. Notice there’s a lot of powerful factors that are at play here.

Here's an example. Let's say your full social security benefit at your full retirement age of 67 is $2,000 a month. You become eligible to take your benefits early at age 62 and decide to do so. This means you will get roughly a 30% reduction in benefits and end up with about a $1,400 a month gross benefit. You collect that benefit until age 67 and then file to suspend it and let it marinade. You then receive an 8% increase per year until age 70 on that $1,400 reduced benefit. That brings you to roughly $1,764 a month at age 70, and that's not accounting for cost of living adjustments, which you would get.

Now that $1,764 isn't the $2,000 a month you would've received if you waited until your FRA initially, but at least it is partially restored by about 26%. If you included the cost of living adjustments you would have received during those years, it would be even closer to the $2,000.
Here’s a few important things to keep in mind with this strategy. One is that you cannot change your mind and get a retroactive payment, like we discussed earlier, of all of those suspended payments under this strategy. That would ultimately defeat its purpose of it. Another is that if other members of the family are receiving a benefit that is directly contingent on that of the recipient, this could be the spouse or a dependent child, for example. Suspending your benefits will also discontinue the benefit for them.

The exception to this rule is that divorced spouse payments will actually still continue since this has no effect on your benefits anyways. A lot of people seem to think that if their ex collects based on their social security, it will take away from their own benefit, and I'm here to tell you that that is just false. It doesn't.
That brings me to another point I want to make, and that is that you can only suspend your own benefits. You can't suspend a spousal benefit or ex-spousal benefit you may be receiving. Medicare premiums which are taken or withheld directly from your social security if your benefit is being received.

Therefore, remember that if you suspend your benefits, you will need to make direct quarterly payments to Medicare to pay your premiums. And for legacy planning purposes, the spouse with the highest social security benefit should generally try to delay taking it as long as possible because their amount will essentially serve as the survivor benefit for both. Meaning no matter who pre-deceases who, the survivor will end up receiving the larger benefit amount for the rest of their life.

Why would you use this strategy? Well, there are a few reasons why you might consider it. Maybe you are in a desperate need of income at an earlier age due to temporary life circumstances, and you know for a fact that your financial situation is going to improve by the time you are at your full retirement age.
Or maybe you filed early, say at age 62, and took a huge reduction in benefits at age 66 or 67. You are in good health and active and are wishing you never would've filed so early. You could technically stop the benefits, possibly go work at a part-time job you enjoy, or operate a small business related to your passions, then start the benefits later once the benefit has had some time to grow. Or let's say you come into some money from an inheritance or something at a later age after you started collecting. If you are at or over your full retirement age, you can stop your benefits, live off of your inheritance, then start them again later.

Now, why would you do this? Well, because you are essentially getting a guaranteed 8% per year increase on your benefits while they are suspended. You can't really get that anywhere else. You may use it simply because other income streams are available to you that will pay out later but not soon enough to provide you with what you need in the early years of retirement.

This could be an annuity, for example. You could utilize a TAG team approach when a meaningful age difference exists between you and your spouse. For example, the older spouse's benefit could be started early and then stopped at their full retirement age. The younger spouse then starts their benefit early, once eligible, and then suspends theirs at full retirement age.

Both spouses could then restart collecting benefits when each one reaches age 70 or sooner if needed. And last but not least, as I mentioned, a delayed higher benefit could be important for a survivor in the case of an early death of either spouse. A survivor is entitled to 100% of a deceased worker's benefit, including any of those delayed retirement credits if they had accumulated any.

Maximizing the retirement benefit of one spouse also creates the maximum survivor benefit for the remaining spouse. Claiming social security early surely reduces future survivor benefits, but with this strategy, you can help restore some of that potential survivor benefit. The bottom line is that social security decisions shouldn't be taken lightly. As you can see, there are many factors that play into when and how to take your benefits. It is not a black-and-white answer, and everyone's situation is different.

If you would like to learn about these rules discussed and want to find more information to help you retire on your terms, you can find the links to the resources we have provided in the show notes on your podcast app, or you can visit us at retiredishpodcast.com/3.

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# YOU NEED GUIDANCE, STRATEGIES TO USE, YEAH. I’M GONNA SHOW YOU HOW TO DO THIS. INVESTING AND TAX, STATE TIPS YOU NEED, YEAH. I'M GONNA GIVE YOU MY HELP. I'M GONNA GIVE YOU MY HELP. OH!

Securities and advisory services are offered through LPL Financial, a registered investment advisor, member FINRA, SIPC. The opinions voiced in this podcast are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.