Close Close
ThinkAdvisor

Retirement Planning > Social Security > Claiming Strategies

The Hidden Hazards of Taking a Social Security Lump Sum

X
Your article was successfully shared with the contacts you provided.

What You Need to Know

  • Welcome to Connecting the Dots, the column where Marcia Mantell discusses real-life decisions around Social Security claiming and retirement.
  • Working after full retirement age and then taking a lump-sum Social Security payment doesn't work for everyone.
  • A lump-sum payment puts the retiree at risk of a bigger tax bill and a potential Medicare surcharge.

An advisor called me with a question from a client. The client, “Jerry,” called Social Security to explore his claiming options.  Jerry reaches full retirement age (FRA) in January. He wanted information about when to claim since he will work until the end of June. He doesn’t need the money but wonders if he should tap his benefit at FRA or wait to receive some delayed retirement credits (DRCs).

Confusing Information From Social Security

Jerry was confused after the conversation with the Social Security agent and relayed his conversation to his financial advisor. The agent told Jerry it didn’t matter when he claimed —either in January or July. With either claiming date, Jerry’s payments will be the same. How can that be?

While we often talk about DRCs as getting a boost of 8% per year up to age 70, the calculation is applied monthly. Waiting six months should permanently boost Jerry’s monthly payment by 4%.

Why would the Social Security agent tell him he would get the exact same payment? Does Jerry need to claim a full year after FRA to “turn on DRCs?”

Nuances of Claiming After FRA

There are advantages to claiming at or after FRA. There are also technical and often misunderstood rules that apply. One of the lesser-known rules is when a client claims after FRA, Social Security will let them know they can get up to a six-month retroactive payment as a lump sum.

However, what the agents often miss is explaining the consequences of the lump sum: Your client’s benefit amount gets recalculated back six months. And, the ongoing monthly payments will not include the full DRCs as expected.

In Jerry’s case, the agent was technically correct. If he claims in January at his FRA, he would get $3,000 per month (as an example). If he claims in July, Jerry can choose a lump-sum retroactive payment and reset his ongoing monthly payments as if he had claimed in January. So, $3,000 per month.

What’s the Harm in That Strategy?

There are several consequences to consider, including the three below, and Jerry’s looking to his advisor to connect the dots.

For one, a potentially higher tax payment.

Social Security benefits are taxable for many clients. Because Jerry is working through June, his income will likely exceed the threshold for combined income of $44,000 for those married filing jointly.

More on this topic

Therefore, he may owe more in taxes if he takes the lump sum payout than if he collects benefits for only half the year. He also could jump up a tax bracket, so that would need to be considered as well.

Another danger: IRMAA.

Once Jerry retires, he’ll start Medicare Parts A and B. Part B comes with a monthly premium. In 2022, the standard premium is $170.10 per month. But, if Jerry’s income is above $182,000 married filing jointly, his premium will increase due to income-related monthly adjustment amounts, or IRMAA. He could pay monthly premiums of $238.10 or $340.20 or more.

Technically, Jerry’s 2022 Part B premium will be based on his income from two years ago. His 2022 income will impact his 2024 Part B premium. He can file an appeal each year until his lower retirement income catches up with Part B premium determinations. But, based on his entire financial picture, his premium may or may not get reduced.

Also, the six-month retroactive payment lowers the survivor benefit.

Probably the most consequential result of taking the lump-sum payment is that Jerry’s wife will receive a smaller survivor benefit if she becomes a widow.

Waiting six months to claim yields a 4% increase for DRCs. His initial benefit of $3,000 per month at FRA increases to $3,120. If he dies 20 years later, his benefit would be approximately $4,545 (assuming a straight-line COLA of 2%). But, if he chooses the lump-sum retroactive payment, his approximate monthly benefit is $4,370 in 20 years and his wife would receive $175 less per month.

While the numbers aren’t huge, they do make a difference when clients are in their 80s and 90s. Every dollar extra from Social Security helps them offset their Part B premiums, meet their expenses, and stretch their own savings.

The 6-month retroactive lump sum may sound like a win, but all the dots need to be connected first for each individual client to see where there are hidden consequences.


Marcia Mantell is the founder and president of Mantell Retirement Consulting, Inc., a retirement business development, marketing & communications, and education company supporting the financial services industry, advisors, and their clients.  She is author of “What’s the Deal with Retirement Planning for Women?,” “What’s the Deal with Social Security for Women?” and blogs at BoomerRetirementBriefs.com.