• The Social Security gambit

    With Social Security inexplicably still in the news, I thought I’d release this post from my queue, in which it has been sitting for weeks.

    Frank Curmudgeon of the Bad Money Advice blog succinctly explains an amazing loophole in the rules for collecting Social Security:

    I’ve known for a while that seniors can elect to “reset” the year they start taking benefits by paying back what they got before the new start date. So a 70-year-old who started getting checks at 62 can pay back eight years of benefits and start getting much larger checks from then on. What I didn’t realize, and what stupidly never occurred to me, is that the paying back is without interest. …

    And it is more than just an interest-free loan. It is also a free option. The downside risk for waiting until age 70 to collect benefits is not subtle. You might not live that long. Kick off the day before you turn 70 and you get nothing. But start at 62 and you can have it both ways. Draw checks for eight years and if you are still in reasonably good health, pay it back interest-free and reset. If not, well, you got some money from the feds while you could.

    In case you don’t know, this matters because, as Frank explains elsewhere in the post, Social Security benefits are about 70% larger if you begin taking them at age 70 rather than than at 62. But you may not live long enough to recoup the forgone income between ages 62 and 70. With this Social Security gambit, you can have it both ways!

    Start collecting at 62. Sock the money away and earn some interest. If you’re still in good health at 70, give it back (but keep the interest) and then enjoy the 70% bigger checks. It’s a no brainer. This only works if you really don’t need the Social Security money between 62 and 70. You have to be in a position to give it all back. Also, if you’re in bad health at age 70 you may be better off keeping the money you collected since age 62. If you die too soon, you won’t recoup it. (What’s the age of death that makes this scheme just worth doing? It’s too complicated for me to bother with. You have to assume some rate of return to account for the interest earned from 62-70. Then you have to add to that the present discounted value of the stream of 70% higher checks, again assuming some rate of return. How long until that equals the total SS payments between 62 and 70? That’s the answer. Anybody want to calculate it? If you’re very persnickety you’ll also consider spousal and survivor benefits.)

    I knew all this, but I’ve never seen it so clearly explained. It sounds so simple. Why is it legal? And why doesn’t everybody try it? If it is remotely complex (a lot of paperwork?), there should be investment managers selling this as a product–offering to manage your Social Security money so you can have your cake and eat it too. Are they? If not why not?

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    • To answer the first question: It won’t work. At least, not if one has to work for a living. The problem is that one’s SS payments get reduced by $1 for every $2 one “earns” over $14,600 until one reaches “full retirement age”. So, if you start claiming SS at 62 but need $50,000 to live on, and actually has to “earn” that money, you will never receive a penny in SS payments. So, there is nothing to stash away.

      And, yes, once you finally cease working so hard, everything gets recomputed as if you started collecting at a later age.

      I kept putting “earn” in quotes, which answers the other question. If you investigate resources aimed at people who don’t have to work for a living (can live off investments, inheritances, etc.) you will find that this quirk is well known.

      • @Phil – One can start this later than 62. At what age does the “$1 for $2” reduction end? I thought 65 but I’m not confident. Start the process then.

        I can only judge if this is well known by whether my parents know about it. They didn’t. That’s almost beside the point. Why is it legal?

    • Thanks for the link.

      I wrote something of a follow-up to that post:

      http://badmoneyadvice.com/2010/08/bad-advice-at-any-price.html

      in which I discuss my horror at finding out that all of 500 people took advantage of the paying back option. Out of 37 million SS recipients.

      And of course it shouldn’t be legal. It’s a rather pointless waste of government money. But I am sure it is one of those loopholes that was unintended and unforeseen. The facts that the SSA apparently didn’t think this through, and that so few Americans have taken advantage of it, speaks volumes.

    • If I turn out to be the expert here we are all doomed! The reason I responded in the first place was … because I’ve actually seen 3 references to this oddity in the last two years. But, I can’t remember where or when. Back when I was in high school, I never had to take notes (could do it all in my head). But no longer.

      When I reviewed the SSA web site, I read that there was a limit on earnings up until one reached 66 (67 for those born after 1955). I thought I remembered something about the deduction changing to $1 for $3 earned; but I saw no reference to that. But, the SSA web site seems designed to validate all those comments about the quality of government web sites.

      As to why this ever existed, my guess is to give folks who choose to retire, then quickly discover that it was a mistake, a chance to correct that mistake (I still feel my analysis as to why this rarely makes sense as a financial planning strategy is valid). Suppose I loose my job when I turn 63. Figuring that I will never again have a decent job, I apply for Social Security. 6 months later, I stumble into a better paying job, one which pays so well that I will never collect another cent, but not so well that I can bank those missing payments until I turn 70. In this case, it would be really nice to be able to undo my earlier decision.

    • I turn 62 in few months, and I recently stopped working. I have sufficient savings so that I won’t need to draw SS until at least my full retirement age or longer. But I’m confused about whether my officially “estimated benefit” amount will actually flatten out or even decline substantially while I wait, rather than grow 8% annually vs. the age-62 amount. The SSA says the benefit amount is based on lifetime average annual earnings, so if I stop earning money for, say, eight years, how much will my declining income average affect things? Is there a rule-of-thumb or online calculator that can help compute this effect?