Some retirees can receive up to six months of back benefits
Mar
19, 2019 @ 10:08 am
Jim Perry, a financial adviser with Edward Jones in
Coral Gables, Fla., was surprised to learn that retirees who claim Social
Security benefits after their full retirement age are eligible for up to six
months of retroactive benefits paid in a lump sum.
"I had a discussion with a 69-year-old
client yesterday who will be taking Social Security when he turns 70 in
July," Mr. Perry wrote to me in an email. "He told me about his
friend who received a $25,000 lump sum payment from Social Security when he
turned 70 a few months ago in exchange for a lower benefit. Is this an option
for my client?"
"Yes, the Social Security Administration
will pay up to six months of retroactive benefits in a lump sum for benefits
claimed after full retirement age," I responded. "But there are
tradeoffs."
For every month that an individual postpones
claiming Social Security benefits beyond full retirement age up to age 70, they
earn an additional 0.66% per month or 8% per year in delayed retirement
credits. So someone who is entitled to $2,000 per month at their full
retirement age of 66 would receive $2,640 per month — a 32% increase — if they
waited until age 70 to claim benefits.
Their actual benefit amount would be even
larger as all cost-of-living adjustments, or COLAs, from the time they were
eligible for benefits at age 62 until they claimed benefits would be added to
their benefit amount. Delayed retirement credits end at age 70, so it makes no
sense to delay claiming Social Security beyond that age. Going forward, annual
cost-of-living adjustments would be applied to the bigger base amount.
For married couples, having
one spouse delay Social Security benefits until age 70 has an added benefit.
After the death of the first spouse, the remaining spouse receives the bigger
monthly amount as a survivor benefit if it's larger than their own benefit. At
that point, the smaller benefit goes away.
In the above example, the 70-year-old man
accepted a lump-sum payment of six months of retroactive payments in lieu of
six months of delayed retirement credits for that same period. So his age 70
benefits would be 28% higher than his full retirement age amount, representing
three-and-a-half years of delayed retirement credits, rather than 32% higher if
he collected the maximum four years of delayed retirement credits. That also
means his widow would receive a smaller monthly survivor benefit.
Retroactive benefits cannot be paid for
periods before an individual reaches full retirement age. For example, someone
who applied for Social Security benefits at age 66 and 3 months could request
three months of back benefits paid in a lump sum.
Accepting a lump sum payout may be appropriate
for a client who has a specific need or goal for that money, whether it's to
use it as the down payment on a second home, to fund a dream vacation or to pay
off debt. But they should be aware that the large Social Security payment will
have tax consequences and could affect future Medicare premiums.
A portion of the lump sum and monthly benefits
for the remainder of that year would be subject to federal income taxes. And
depending on their state of residence, Social Security benefits may
also be taxed at the state level.
The federal government taxes up to 85% of
Social Security benefits at ordinary income tax rates once combined income,
defined as adjusted gross income plus 50% of Social Security benefits, plus any
tax-exempt interest from municipal bonds, exceeds certain thresholds.
For an individual, up to 50% of Social
Security benefits are taxed once combined income exceeds $25,000, and up to 85%
of benefits are taxable once combined income exceeds $34,000. For married
couples, the comparable income thresholds for taxing benefits are $32,000 and
$44,000.
In addition, the lump-sum payment of
retroactive Social Security benefits could boost total income beyond certain
threshold levels that could subject future Medicare premiums
to high-income surcharges.
Since 2007, Medicare beneficiaries whose
income exceeds $85,000 for individuals and $170,000 for married couples have
been required to pay an income-related monthly adjustment amount surcharge,
known as IRMAA, in addition to their regular monthly Medicare premiums. The
IRMAA surcharges apply to both Medicare Part B, which covers outpatient
services and doctors' fees, and Medicare Part D prescription drug plans.
In 2019, most of Medicare's 60 million
beneficiaries pay the standard premium of $135.50 per month. But about 3
million high-income retirees pay additional monthly surcharges ranging from
$54.10 to $325 per month per person for Medicare Part B as well as surcharges
on their Medicare Part D prescription drug plans. IRMAA surcharges for 2019 are
based on 2017 federal income tax returns.
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