For those individuals who have waited past their full retirement age (FRA) (age 65 to 67, depending in which year an individual was born) to apply to start receiving their Social Security monthly retirement benefit, there is the option that allows an individual to cease their delay, apply for their monthly benefit, and then receive up to six months’ worth of retroactive benefits in a lump-sum payment.
While this option sounds very enticing for someone older than his or her FRA who perhaps recently retired and in need of an infusion of cash as they start their retirement years, the option has a downside. In recent months, the Social Security Administration (SSA) has in fact made this option even less attractive. This column explains the lump-sum retroactive Social Security benefits payment option, including its downside and what has recently happened – a result of the COVID-19 pandemic – to further decrease the attractiveness of a lump-sum Social Security retroactive payment.
How the Lump-Sum Retroactive Social Security Payment Option Works
It is important to first explain how in general the lump-sum retroactive Social Security payment option works. The purpose of giving an individual a lump sum payment of retroactive Social Security retirement benefits is to allow this individual who had previously missed his or her planned Social Security filing date to “push back” their retirement date by up to six months. Retroactive benefits comprise a one-time payment the SSA will send an individual when the individual delays filing for their retirement benefits beyond his or her FRA.
In other words, if an individual files for Social Security benefits after his or her FRA, the individual can choose to be paid a lump-sum for a maximum of six months’ worth of Social Security retirement benefits preceding the month the individual files. That is, the month the individual elects to start receiving Social Security retirement benefits. Note that there is a limit of six months of retroactive benefits. But if there is less than six months between the month that FRA occurred and the individual’s filing date, then the retroactive lump-sum payment will be only for the actual number of months. Consider the following examples:
Annie, age 66, became age 66 in January 2020. Her intention was to start receiving her Social Security in February 2021. But Anne has incurred some major expenses over the last few months and could benefit from an infusion of cash. So, Annie contacts the SSA in August 2020 for a retroactive lump-sum payment equal to six months of Social Security monthly payments going back to February, March, April, May, June and July. But Annie’s payment will not include any delayed retirement credits (DRCs) that permanently increases one’s Social Security retirement benefit (DRCs are equal to 2/3 of one percent for every month past FRA an individual delays the start of Social Security retirement benefit).
Barry, age 66, became age 66 in May 2020. His intention was to start receiving his Social Security in May 2021 right after his 67rd birthday. But Barry in July 2020 incurred some major health care-related expenses and needed some liquid cash. Barry contacts the SSA in August 2020 for a retroactive lump-sum payment equal to three months (May, June, July) of Social Security payments. The payments will not include any DRCs that Barry would have benefited from had he started receiving his monthly Social Security retirement benefits after May 2020.
Perhaps the most significant thing that an individual who elects this lump-sum retroactive Social Security payment should understand is that the individual could lose up to six months of DRCs. The DRC is equal to 2/3 of one percent per month of the individual’s FRA monthly benefit amount. If an individual agrees to take the retroactive lump-sum payment, the individual then agrees to a smaller monthly payment. Multiply 2/3 of one percent per month by 6 months results in a 4 percent reduction on the amount the individual was eligible to receive. This reduction is not only permanent for the individual’s benefit amount but also for the surviving spouse’s survivor benefit
Returning to example 1 above with Annie: Suppose Annie’s monthly benefit in January 2020 (the month she became FRA) was $2,000 per month. Six months later, in July 2020 she is six months past her FRA and her monthly benefit is increased by: Six months times 2/3 of one percent per month, or 4 percent, of $2,000, or $80, to $2,080 per month. If Annie opts for the lump-sum retroactive benefit, the SSA will send her six months times $2,000/month, or a total of $12,000. Instead of receiving a monthly payment of $2,080 per month (subject to future cost-of-living adjustments or COLAs) had she started receiving her retirement benefit in July 2020, Annie will receive $2,000 per month starting in August 2020, as if she started drawing her retirement benefit in January 2020. The questions now become: In that case, what is Annie’s breakeven age? Answer:
$12,000 (lump-sum payment)/$80/month (extra amount each month with no lump-sum payment)
= 150 months (12.5 years)
In other words, if Annie dies before she, and if applicable, a surviving spouse, become age 78.5, then Annie made the right decision in choosing the lump-sum retroactive payment.
One of the biggest fears for retirees is that they will outlive their savings. Many retirees determine when they will start taking their Social Security benefits based on the fear that they will die young. But that strategy is not realistic. A retiree’s biggest fear should be living too long, not dying too young. In fact, based on Social Security data, a man who reaches age 65 is expected, on average, to live to age 84.3. A woman who has reached age 65 can expect to live on average, to 86.6.
Another point to consider: The lump-sum retroactive payment will create somewhat more work when it comes to filing one’s federal income taxes if the lump-sum amount includes monthly benefits that were from the previous tax year. The IRS gives an individual two options for calculating any tax due on the portion of the lump-sum that would apply to another tax year, namely; (1) use the current year’s income to determine the taxable portion of the lump-sum; or (2) elect to determine the taxable portion of the lump-sum based on one’s income for the earlier year, using the worksheet in IRS Publication 915 (Social Security and Equivalent Railroad Retirement Benefits) (download at https://www.irs.gov/pub/irs-pdf/p915.pdf) .
COVID-19 Pandemic Causes Problems for Six Months Retroactive Payments
Since March 17, 2020, when Social Security field offices closed as a result of the COVID-19 pandemic, there have been instances of individual’s being denied retroactive lump-sum Social Security payments. These individuals were all eligible for those payments, namely they were past their FRA and waiting to take their Social Security retirement benefits. In one instance, an individual, due to become age 70 in June 2020 with an enhanced benefit of 32 percent (eight percent DRC per year for four years) decided in March 2020 to ask retroactively for two months of benefits (January 2020 and February 2020) in a lump-sum payment and to start his monthly benefit at age 69 and 6 months as if he filed to start his benefit in December 2019 (42 months of DRC’s rather than 48 months). But the person was denied the lump-sum payment for the January and February 2020 monthly payments.
The SSA explained in its denial letter to the individual that the SSA cannot pay this lump-sum because the SSA “needs additional income.” Perhaps the shutdown of businesses resulting from the COVID-19 Pandemic resulting in less Social Security (FICA) taxes being collected and remitted to the US Treasury has resulted in the SSA not being able to meet its financial obligations to pay lump-sum retroactive payments.
Sticking to One’s Plan When to Start Receiving Social Security
Any federal annuitant older than his or her FRA who initially decided to delay the receipt of Social Security retirement benefits needs to ponder a few points before opting for the lump-sum retroactive payment.
First, if the original plan were to wait until age 70 to start receiving benefits and the individual is between age 69 and age 70, why change one’s mind now, receiving a less than maximum possible retirement benefit check? By starting to take the benefits before the month one becomes age 70, is this not giving the US government an interest free loan for six months?
Second, the individual needs to think about the tax consequences of a lump-sum payment as well as the possibility that by receiving this lump sum payment, this may in the year of receipt, result in the individual’s exceeding the Medicare Pat B modified adjusted gross income (MAGI) bracket limitation. For Medicare Part B monthly premium purposes, this could mean an Income-Related Monthly Adjustment Amount (IRMAA) and higher Medicare Part B monthly premiums two years in the future.
It is important to understand that anyone past his or her FRA (and younger than age 70) who has delayed the start of Social Security benefits is automatically eligible for retroactive benefits and will therefore be given the lump-sum retroactive payment automatically.
To avoid receiving the lump-sum payment, an individual has to specifically tell the SSA that the individual does not want a lump sum of retroactive benefits. The individual would then avoid the lump sum payment by filing a “restricted application” – specifically saying that the he or she wants his or her monthly retirement benefit to begin in a particular month and that the monthly benefit check will include all earned DRCs to-date. By not electing the retroactive lump sum retroactive payments option, an individual will therefore receive the full benefit of the delayed retirement credits he or she has rightfully earned.