From the October 2008 issue of Investment Advisor • Subscribe!

October 1, 2008

Legal Double Dipping

A new study reveals a loophole in Social Security by Kara P. Stapleton

What if you could tell a client that they can retire early and still get their full retirement benefits? Well, in fact, you can. "It's not a new concept, but a lot of people don't know that you can do it," notes Pam Villarreal, senior policy analyst at the National Center for Policy Analysis (NCPA). "It's not something that's advertised."

The current Social Security system allows individuals to claim reduced, early retirement benefits beginning at age 62. Individuals who wait until their full retirement age to collect receive about 30% more in monthly benefits. If they wait until age 70 to collect, their benefits will be about 60% larger than at age 62. So what should you suggest your clients do? Laurence Kotlikoff, senior fellow with NCPA and a professor of economics at Boston University, recently released a study with NCPA outlining this very question.

According to Kotlikoff, assuming a normal life expectancy and using the interest rate on government bonds, the actuarial present value of lifetime benefits are the same for those taking early retirement as for those waiting to take benefits at a later age. Of course, if one's life expectancy is not normal--due to illness or bad luck or particularly good genes or good luck--one retirement age will look more attractive than another. Kotlikoff suggests going for the best of both worlds: retire at age 62, then pay back and reapply for Social Security benefits at age 70 if you come to regret your earlier decision.

"He ran a simulation with sample household couples," explains Villarreal. Kotlikoff uses the scenario of Peter and Kate, both of whom are now 70, to demonstrate. The couple claimed their Social Security benefits at age 62 and now they each receive a reduced benefit of $13,250 annually (in 2008 dollars). If they had waited until their normal retirement age (65) to collect benefits, Peter and Kate would each receive $18,928 a year. If they waited until age 70 (this year) to apply, their benefit in 2008 would have been $20,693, thanks to the delayed benefit credit.

Kotlikoff goes on to explain the choice Peter and Kate now have. If they choose to pay back the Social Security benefits they have received over the past eight years, they will each receive the much higher benefit for the rest of their lives. If they take this option, each would repay $94,556 to Social Security. They would then each begin receiving $20,693 a year (the same as if they had waited until age 70 to begin receiving benefits); and as a result, they would have approximately 56% more in real Social Security benefits every year for the rest of their lives. "Essentially, the government has given them an interest-free loan," Villarreal says. "When you pay the benefits back you don't have to adjust for inflation or pay interest."

Kotlikoff's company's financial planning software, Economic Security Planner (ESPlanner) can be used to determine a client's standard of living in terms of discretionary spending power. If Peter and Kate don't repay their benefits and continue receiving their reduced benefits, their annual consumption (discretionary spending) will be $42,774. However, if Peter and Kate pay back and reapply for retirement at age 70 (this year), their sustainable consumption rises by 21.7%, Kotlikoff's study reveals.

To show how those in their mid-60s to mid-70s would reap substantial benefits, Kotlikoff uses a table based on age when an individual reapplies in 2008. For example, at age 68, the increase in living standard is 18.2%, compared to early retirement benefits from age 62 without repayment. By age 76, however, the increase in living standard is only 9%--households have to pay back more benefits and have fewer remaining years to enjoy the higher level of benefits when they reapply. Anyone now age 63 to about age 75 who took Social Security benefits early is likely to be able to raise his sustainable living standard, Kotlifkoff argues, though how much depends on the individual's other economic resources--some households will not have the liquidity to repay and reapply for benefits.

Repaying Social Security and reapplying for a higher benefit does entail the risk of not living long enough to recover the amount of the benefit repayment, of course. Should younger retirees consider taking their benefits early, banking the money, repaying at age 70, and then reapply for benefits at age 70? Villarreal suggests that there is some advantage to doing so, provided your client has the liquidity to pay the extra income taxes they'll be assessed from ages 62 to 69 because of the receipt of benefits during these years.


Staff Editor Kara P. Stapleton can be reached at kstapleton@investmentadvisor.com.

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