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The Social Security Administration still is doing a disservice by coaxing applicants into taking the optional lump sum cash payment when they sign up. The beneficiaries more than pay for it over the long term.
The lump sum option isn’t new. But many applicants don’t know about it until the SSA offers it to them when they apply for benefits.
When you wait until full retirement age or later to claim Social Security retirement benefits, you have an option. You can receive a lump sum payment of up to six months of retirement benefits. Full retirement age is 66 for those born in 1943-1954, over age 66 on a sliding scale for those born after 1954-1959, and 67 for those born in 1960 or later. The lump sum option isn’t available to those claiming benefits before FRA.
SSA’s policy is to inform all eligible applicants about the lump sum option. Anecdotal information is that SSA employees explain the option in ways that persuade applicants to take it. The employees might say that most people take the option or that it’s a valuable benefit. They also might ask if there’s some need or want the lump sum could help with.
Applicants usually don’t expect the offer and make a decision quickly. Some say they took the lump sum because it was offered and was too much money to pass up. Others think it’s their money and if they can take it upfront they should do so instead of leaving it with Social Security.
It’s better to take the view of a friend I knew who worked with for the U.S. government. Whenever he was presented with a choice of changing benefits, his first thought was, “If they’re giving me a choice, a change probably is likely to benefit them more than me.”
Despite the impression many people have, the lump sum option isn’t free. In fact, the cost can be substantial over the years.
You receive Social Security retirement benefits based on a formula. It’s not like an IRA or 401(k) account. You don’t have money set aside that’s invested for you and from which your benefits, including a lump sum, are being paid.
When you take the lump sum option, your monthly benefits are reduced for the rest of your life.
If you take the maximum lump sum of six months of benefits, then your beginning monthly benefit will be computed as though you began receiving benefits six months earlier than you really did.
Suppose you decided to wait until age 70 to claim benefits, because you wanted to receive the maximum possible Social Security retirement benefit. If at the last minute you take the lump sum cash option, you’ll receive the equivalent of six months of benefits. But your future monthly benefit payments will be calculated as though you began receiving benefits at age 69 and six months.
For an individual who was well-paid during the working years and was planning to claim benefits at age 70, the reduction in monthly benefits is likely to be $300 to $400. That’s a permanent reduction for the rest of his or her life.
For example, Max Profits contacts Social Security and says he wants to begin benefits at age 70, receiving the maximum allowable benefit. Under his earnings history, he’s due $3,000 per month.
After hearing about the lump sum option, he chooses it. Max receives a lump sum of $17,310 (six months of his age 69½ monthly benefit). But his official beginning age for benefits is age 69½ instead of 70, and his initial monthly benefits are based on that age. He’ll receive about $2,885 per month. That’s 4% less than his maximum benefits for age 70. (Remember by delaying benefits after FRA, your benefits increase 8% annually through age 70.)
The difference in the two benefit amounts is enough to pay for the base monthly Medicare Part B premium and and then some.
Social Security benefits are indexed for inflation, so in the future Max also loses the compounded annual inflation increases on that amount.
Also consider the effects on your spouse. A major reason for the higher-income spouse to delay taking Social Security benefits is to maximize the amount paid to the surviving spouse, regardless of which spouse it is.
When one spouse passes away, one of the Social Security benefits coming to the household ends. Generally, the higher of the two benefits is paid to the survivor, so it’s important to maximize the amount paid to the surviving spouse. Taking the lump sum option, reduces the amount the surviving spouse will receive.
Another point to consider is the lump sum could push you into a higher income tax bracket for that year. It also might trigger or increase the Stealth Taxes, such as the tax on Social Security benefits, the Medicare premium surtax, and more.
You might invest the lump sum and earn good returns. I suspect few people who take the lump sum do that. If that’s your plan, keep in mind that Social Security payments and inflation increases are guaranteed, while investment returns are not.
If you made the wrong choice and did so recently, you might be able to withdraw the benefit application and start over. Visit the Social Security web site or a local office or call toll free 800-772-1213. You should have copies of your original claim forms and be prepared to explain what you want to do.
The Social Security lump sum option isn’t free money or found money. You pay for it, and the longer you and your spouse live the higher that cost is going to be.
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