Q. I attended a seminar on Social Security benefits and learned something that sounds intriguing. I am currently working as a consultant on a project that will end in a few months so my cash flow meets my expenses. My plan before attending this seminar was to wait until later this year to begin my benefit at age 68. The presenter said that anyone over full retirement age can get a lump sum benefit for up to 6 months from Social Security. My lump sum would be around $14,000, and the guy giving the seminar suggests that I use that money to fund a special type of deferred annuity that would provide me with $144/month for 12 years beginning at age 80. None of my friends had heard of this option either, what are your thoughts?
A. Once you reach full retirement age, you can request to begin receiving benefits for the months prior to your application. But you can’t receive retroactive benefits for any month before you’ve reached full retirement age or more than six months in the past. The lump sum benefit may be requested for up to six months retroactive between full retirement age and the date of actually receiving benefits. There are some situations where this makes sense, but I wouldn’t do this solely to fund the suggested deferred annuity. A retroactive lump sum may be helpful if you become in need of some emergency funds. It may also be a prudent action if you have been delaying your benefits with the assumption that you will collect more if you live to a certain age but because of unanticipated health concerns you determine that you will have a shortened life span. Taking retroactive benefits will reduce your monthly benefit. You would need to consider the implications on any survivor benefits as well as taxes owed on the lump sum for the year in which it is received.
Example: If at 68 your monthly benefit was $2,500 and your monthly benefit at age 67 and 6 months was $2,400, a request for a 6-month retroactive lump sum will provide you with $14,400 and make your future benefit base $2,400. If earnings from your consultant work are significant, 50 percent to 85 percent of your Social Security benefits, including the lump sum, may be subject to tax. If your combined income – which means your adjusted gross income plus tax exempt interest plus one half of your Social Security benefits – is below $25,000 if filing single and $32,000 if filing jointly, none of your benefits will be subject to tax. If filing single and combined income is between $25,000 and $34,000, 50 percent of your benefits will be subject to tax. And if over $34,000, 85 percent of your benefits will be subject to tax. If married filing jointly and your combined income amounts are $32,000 to $44,000, 50 percent of benefits are subject to tax. And if over $44,000, 85 percent of benefits will be subject to tax. North Carolina does not tax Social Security benefits, but some other states do.
You could create your own version of the annuity. If you decide to request the retroactive benefits and invest the lump sum of $14,500 at a 2 percent after-tax rate of return until age 80, this will allow you to withdraw $144/month for 12 years. If you don’t request retroactive benefits, delay taking your benefits until age 68 and invest the extra $100/month at a 3 percent after-tax rate of return, you will have accumulated enough money to generate $144/month for over 12 years beginning at age 80. The extra $100/month benefit will also increase with any Social Security cost of living adjustments. The COLA for 2014 is 1.5 percent. These “do it yourself” options offer more flexibility than the annuity. The money is accessible if you should need funds sooner than age 80, and you can keep them invested if you end up not needing the funds at age 80. You also have the potential of generating a higher rate of return on your investment. If you decide to purchase the annuity, make sure you understand what happens to the monthly payments if you should die before age 92.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624