Executive Summary
An interesting article in the syndicated column of Scott Burns suggests that it may be a wise strategy for those at or around age 70 to withdraw from Social Security and reapply to increase their benefit. Is this a Social Security loophole, a great deal, a trap, or just another good arrow in the financial planner's quiver?
The basics of the strategy, which can be viewed in the article here, are relatively straightforward. Assume an individual was receiving a Social Security benefit of $1,000/month at age 62 (which would be 75% of the Primary Insurance Amount {PIA} that they would have received as a full benefit at Normal Retirement Age), and is now age 70. The individual can withdraw their application for Social Security, and reapply as a 70 year old, instead receiving $1,760/month (which would be 132% of the PIA, after allowing for the increase in benefits for someone who "deferred" and took Social Security benefits late). In order to do this, the individual must pay back $96,000 of benefits received ($1,000/month x 12 months/year x 8 years), but ultimately receives an increase of $760/month ($9,120/year). This is the equivalent of buying an immediate annuity of $9,120/year for $96,000 - a 9.5% starting payment - AND the annuity is inflation-adjusted and is backed by the Federal government, which the article points out is FAR better than any other commercial annuity available on the market!
Does it really work this way? Yes, and it's completely legal and allowable under the Social Security Administration's rules. However, there are a few minor math errors worth noting in the example above (which came from Burns' article). First of all, it's important to remember that the benefits of $1,000/month at age 62 would have been adjusted for inflation all along, which means the amount to pay back is more like $121,909, not $96,000. However, the payment increase would actually be $963/month ($11,553/year) due to the same inflation adjustment, which means the ratio $11,553/year for a $121,909 lump sum investment, remains the same 9.5%. Secondly, the reality is that this math only works for someone who turns age 62 in 2005 or later because the bonus credit you receive for delayed retirement, along with the normal retirement age at which you receive full benefits, has been shifting for several decades due to various changes in the Social Security program over the years. So if you're actually turning 70 this year in 2008 (and thus would have been 62 in 2000), your normal retirement age would have been earlier and your benefit for delayed Social Security would have been smaller, so an original benefit of $1,000/month would have increased to only $1,659/month by resetting. This represents a "reset" value of only an 8.2% Social Security "annuity" rate, not the 9.5% of the original example. Also, the value of the annuity can slip 0.5% to 1%, or even 2%, from the original 9.5% if someone's individual fact pattern doesn't quite fit the example details (e.g., retired a year or two later than 62, and is already a year or two off from being age 70). Nonetheless, that's still a pretty good rate, and so as long as someone has sufficient liquidity available to pay the higher lump sum (after also accounting for inflation adjustments), the "deal" is still available.
However, the article fails to point out one of the most significant risks to the approach, which was correctly addressed in what I believe was the original source of this article, this case study by Laurence Kotlikoff of ESPlanner. It is the same risk that applies to anyone who purchases an immediate annuity - the danger of dying early and losing the principal investment. Thus, to say the least, this strategy does involve managing a trade-off between retirement income goals and legacy goals. On the other hand, this risk is somewhat mitigated for married couples by the fact that if only the spouse with the higher initial benefit chooses this path, then at least if that spouse dies first the survivor will receive an even higher Social Security survivor's benefit.
The article also fails to point out that the Social Security approach may be less favorable from a tax perspective, because Social Security is 85% taxable for many individuals, while the purchase of a commercial immediate annuity for a 70-year-old is typically only 25%-35% taxable, after application of the exclusion ratio at that age. This tax effect doesn't undo the entire benefit, but it does reduce the value somewhat.
Nonetheless, there appears to be a lot of value to this strategy. To say the least, if someone is around age 70, had elected early Social Security, and is considering an immediate annuity purchase anyway, he/she should start by withdrawing and reapplying for Social Security and using their available lump sum for the process. Beyond that, for an individual who is in very good health and is either confident about living past the breakeven period for the Social Security "annuity" to be a good deal (about 7-10 years depending on assumptions) or can manage the mortality risk, this still appears to be a pretty good investment. For instance, assuming a 3% inflation rate on Social Security benefits after reapplication, the internal rate of return on your "annuity" purchase, which depends on how long you live and continue to receive payments, is:
| Years until death | Return |
| 5 | -19.0% |
| 10 | 1.5% |
| 15 | 7.5% |
| 20 | 9.9% |
| 25 | 11.0% |
Does that mean you should just plan to apply for Social Security at 62 and reapply at 70 from the start? Not necessarily. For the individual who anticipates a long life, the deal may still be better to simply delay Social Security in the first place. The reason is that Social Security payments will be taxable for most individuals along the way, which means they only effectively have the NET amount after taxes available to save or spend. The Social Security payback requirements of the withdrawal and reapplication process are based on the GROSS amount, which means you might pay back at age 70 more than you accumulated (after taxes) just by taking early benefits to start! You can partially recover the lost value of these taxes by taking an itemized deduction for the amount of the benefits repaid, or by actually refiguring your taxes for the preceding years without the Social Security income and claiming a credit for the amount of taxes "overpaid" through the years (see IRS Publication 14, Part 2, Section 11 for more details; thanks to reader Charlie Ryan for pointing this out!). But even with the ability to seek a recovery of "excess" taxes paid on taxable Social Security benefits repaid, the IRS will not give you back any interest for all those years you gave them advance tax payments on your Social Security, and for some that can be a material amount of interest that reduces the value of taking benefits early if you plan to withdraw-and-reapply anyway. And of course, if someone elects early with the plan to withdraw and reapply later, there is a risk (as the Kotlikoff article points out) that the option may not be available in the future, and in that case the individual should have just delayed until 70 from the start if he/she wanted to plan for longevity.
So in the end, for those who wish to elect Social Security early to manage cash flow needs or because they are not confident they can live past the breakeven point for delaying, it will still be a good deal to elect benefits early. For most of those individuals, if their health was a concern or they had limited assets in the first place, it will unlikely be desirable to withdraw and reapply, as assets will probably still be limited at age 70 and health is likely to be worse, not better. For those who are healthy and have confidence in their longevity, they will still be best served by simply delaying benefits in the first place, and starting at age 70. But for those in the middle - who may have ALREADY elected benefits early, but are now age 70 and are now realizing that their good health may mean two or more decades of retirement remaining, there is definitely some good value to withdrawing Social Security benefits and reapplying to receive the higher cash flow and hope to live beyond the breakeven point.
The withdrawal and reapplication process for Social Security isn't a panacea, by any means, but it is a great arrow for the financial planner's quiver in the right situation!
Footnote: The days may be numbered for this strategy. See the recent Nerd's Eye View discussion!
Thanks for you’re analysis. This topic was recently raised on a financial planners’ forum that I frequent, and you have added some great food for thought. I agree that this a great arrow to have for the right case. Nice job.
Hi Mike,
I’ve been looking into this and I’m not sure I understand you here.
You wrote: “However, the Social Security payback requirements of the withdrawal and reapplication process are based on the GROSS amount, which means you might pay back at age 70 more than you accumulated (after taxes) just by taking early benefits to start.”
My understanding is that you can take a deduction for the amount paid back or a credit for the taxes paid to date. So you are reset to ground zero save for interest lost on the tax payments.
IRS pub 17 “For information on how to deduct your repayments of certain social security benefits, see Repayments More Than Gross Benefits in chapter 11.”
Charlie
Hi, Charlie.
I think that the idea behind the comment that you refer to is that the amount of the net benefit after taxes at age 70 might not be enough to make the repayment if the investment experience in the intervening years had been negative.
This would necessitate dipping into other assets to make the repayment.
Rita Brown
IF A PERSON DID NOT HAVE THE TOTAL AMOUNT TO PAY BACK ,WILL SOCIAL SECURITY ACCEPT A LOWER AMOUNT,KNOWING YOUR GRAND TOTAL MONTHLY WOULD BE LOWER.THE 96,000 TO 110,000 IS ALOT OF MONEY FOR ANYONE RETIRED,PLEASE RESPOND ,,
Thanks for the good analysis. Note: your reference to the IRS publication is incorrect, it is 17, not 14).
My wife was diagnosed with breast cancer when she was 59, so we decided she should start drawing benefits at 62. Now 5 years later, with a clean bill of health, it looks like the payback option may be a good idea. Now that I know we can recover most of the taxes we have paid on the benefits, it looks even better.
A very interesting idea, but there are lots of variables and assumptions for individuals, including the loss of investment potential of the paid-back lump sum, the rates of return one might achieve on the “annuity”, the timing of inflation over one’s remaining life, etc.
I constructed a spreadsheet to deal explore the first two mentioned, and assumed a $60K Reset payback with a 9% investment return and a 4% annual SS adjustment. I get a breakeven at age 82-83 (I am almost 69). If one lives longer than that, staying with the early retirement option provides a greater return. I did not take taxes into account, which would reduce the increased annual benefit from the Reset option.
Again, the assumptions make all the difference. Two considerations if one lives longer: Higher medical costs then; and, how much one wishes to leave to family (not choosing the Reset provides a greater inheritance amount if one lives longer than the breakeven age).
On the other hand, with the Reset, one gets to spend more now on fun stuff while one is able. Alas, doing this also affects the breakeven point, as it influences the return one receives on the “annuity” differential.
That PDF doesn’t open. Here’s the case study on the esplanner site:
http://www.esplanner.com/case-reapply-social-security
No one mentions whether you should do this reap if you took benefits at 62, in 2005, and then now, at 67 decided to pay back. They always mention 70.
Also, if you take the money to pay back out of an IRA, is the money taxed.
This is such an interesting article. Well. Yes,I should withdraw and reapply for social security benefits. As I am above 90 but I want these benefits as my whole life. Thanks.