Creative use of Social Security timing strategies can be key to securing comfort throughout a long retirement. This seldom discussed strategy can possibly ensure longevity protection by delaying benefits and accessing a chunk of cash when needs become a reality.

The Social Security Lump Sum Strategy

Much of the accumulation phase of retirement income planning is a guessing game as a person may attempt to invest in products structured to meet their needs during retirement, but have no way of definitively know what those needs will be ahead of time. The Social Security lump sum strategy can give people access to the extra funds needed to purchase products that more accurately reflect reality at a time when they may not be ready to sell off current investments and are not yet required to take minimum distributions from traditional retirement accounts.

To be eligible for the lump sum payment, a person must first delay claiming Social Security retirement benefits for at least six months past the normal retirement age — currently 66 — but this figure will increase over time. Once the person ages past full retirement age, he or she is eligible to claim both retirement benefits and a lump sum payment.

The lump sum payment represents up to six months’ worth of retroactive benefits that were not paid between full retirement age and the date the person actually began claiming benefits. Note that retroactive benefits are only paid for time that elapses after full retirement age up until benefits are actually claimed — so that if the person claims benefits at age 66 and four months, he or she is only eligible for four months’ worth of retroactive benefits.

A simplified example can illustrate. Assume a person is eligible for a $2,400 monthly benefit if he or she begins claiming benefits at age 67 and six months, but waits until age 68 to actually begin claiming (when the monthly benefit has increased to $2,500). At this point, he or she can elect to take a lump sum payment equal to $14,400 — or what the person would have been entitled to receive had he or she claimed benefits six months prior to the date of the actual claim.

The person can then take these funds and roll them over into a product that can meet his or her needs as they exist at the time — such as a deferred annuity that begins payouts when the person reaches age 80 or a product with a long-term care rider to fund care after an accident.

Potential Pitfalls

In the example, it is important to note that the lump sum payment is based on the person’s monthly benefit level as it existed at age 67 and six months — not the level of entitlement at age 68. This is because the retroactive benefit claim is designed to put the person in the same position as he or she would have been in had the claim been made six months earlier.

This means that, going forward, the person in the example will be treated as though the initial claim was made at age 67 and six months, so that the permanent monthly benefit is reduced from $2,500 to $2,400. As a result, the strategy is often recommended for people who are in need of emergency funds or anticipate a shortened lifespan.

Further, the entire lump sum payment is taxable in the year it is received. The percentage of benefits that are taxed depends on the person’s total income for the year, so for people who have other income sources — including amounts drawn from traditional retirement accounts — in the year that the lump sum is received may wish to consider pushing that income into a subsequent tax year, if possible.

Conclusion

The Social Security lump sum strategy can give older people access to the funds they need to plan for contingencies arising late in life. Despite this, it is important to examine the potential pitfalls in order to evaluate the strategy’s effectiveness for each particular individual.