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Should Clients Take a Lump-Sum Social Security Payment?

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Advice from many experts today is that people should delay claiming their Social Security benefits for as long as possible, or until age 70, when they have to claim them. But what do advisors tell clients who have delayed taking Social Security even after reaching full retirement age (FRA), and when they make the claim, the government offers them a lump-sum retroactive payment up to six months? Should they take it or not, and what’s the downside, if there is one?

We asked several financial advisors via email how they would advise clients on this choice. Keep in mind that the six-month, one-time lump sum offer isn’t available to those who haven’t reached FRA. Also, the lump sum retroactively resets the benefit amount. For example, after full retirement age, the Social Security benefit is increased by 2/3 of 1%, or .667% per month, and if the lump sum is taken, the monthly Social security payment would be set back by 4% of that payout.

“With the benefit of hindsight after the client is long gone, the ‘right’ answer could be identified,” said Rob Greenman, partner and lead advisor with Vista Capital Partners in Portland, Oregon. “Since that’s not possible — it’s more about understanding the trade-offs. There’s a lot there — including what implications it has on the surviving spouse benefit if the client in question predeceases his spouse.”

Danilo Kawasaki, vice president and chief operating officer of Gerber Kawasaki in Santa Monica, California, agrees. “The answer really depends on a few factors. The main one being longevity. By opting to take the lump-sum option, one rolls back the clock six months for when benefits are calculated. Depending on longevity factors (which are hard to predict) one needs to determine the breakeven point for that to make sense,” he explains.

Although this lump sum may be a tempting choice for clients in need, it isn’t always the right one.

“Most folks are not running numbers on the ‘best’ age(s) to draw their Social Security benefit(s). Winging it leads to bad decisions that can cost the client(s) tens of thousands of dollars over their lifetime,” says Mark Wilson, whose firm is Mile Wealth Management in Irvine, California. “Once you run the numbers and make a decision about when is a great time to begin [Social Security] benefits, then we can answer the question about taking the lump sum offer.

“For example, assume George and Linda have decided (based on their specific situation) to delay George’s Social Security until he turns 70, but draw Linda’s at 66. If Linda were 66 1/2 today, I would encourage her to make an appointment, apply to begin her retirement benefits and ask for her retroactive lump sum (effectively starting her benefit at 66). If Linda’s ‘best’ retirement age is instead 68, I would recommend she make an appointment just before her birthdate (in 1 1/2 years) and not take the lump sum offer. I’d also recommend George not take the offer when he starts his benefit.”

Spending Ideas

Kawasaki adds that plans for the lump sum also make a difference. “If you are using it to buy a boat because you can’t wait six months for it, then it doesn’t make sense. If you are using it to make an investment that can grow over time, then that could work in your favor. One last consideration is if you are married and your spouse is much younger than you with a lower Social Security benefit amount, you may not want to lock in a lower social security benefit over both lives.”

David “Trey” Bizé of Oklahoma City, Oklahoma, notes that “a retroactive lump sum reduces the monthly benefit with a 10- to 12-year catch-up period, so generally [it’s] not prudent if you think you will live another 10-12 years.

“However, if you have bills, debt or having trouble making ends meet and the choice is retroactive lump sum or retirement account withdrawal, the retroactive lump sum may be better, even in the long run, because the retroactive lump sum creates less income tax than the retirement account withdrawal. The retirement account withdrawal is taxed dollar-for-dollar, and the retroactive lump sum is taxed at most $0.85 on the dollar, possibly $0.50 on the dollar or maybe even tax-free depending on the family’s other taxable income,” he says.

Death and Taxes

John R. “Dick” Power, principal of Power Plans in Wapole, Massachusetts, agrees that it depends on the circumstances, but adds, “Remember that taking a lump sum sets the start date back to an earlier age and therefore discounts all future benefit checks. So if one can anticipate a long life, perhaps an inflation-indexed annuity is the best choice. On the other hand, if one has been diagnosed with a disease that doesn’t have great longevity indicators, taking a lump sum now may well be the best choice. It tends to be situation specific.”

Yet there are those who heartily reject the idea of taking a lump sum. Says C.J. Miller, financial planning analyst with Sensible Money in Scottsdale, Arizona, “It is almost never in the best interest of the client to take the lump sum. The payment eliminates the monthly benefit increase gained by delaying in the first place, which is usually 8% a year,” he says.

“Additionally, taking the lump sum is a taxable event. Many people that elect the lump sum end up paying a higher tax rate and getting less for the benefit than they would have if they had claimed earlier. Most people that delay benefits do it for a reason, and the lump sum eliminates that. It’s in the government’s best interest to push for the lump sum option, not the average claimant’s.”

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