You have waited to file your Social Security benefits to raise the amount of benefits that you receive. At the time of filing, you are offered retroactive Social Security benefits for up to six months. Why would you not take the Social Security Administration up on that offer?
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There is one huge reason not to take the retroactive benefits. Doing so also sets back your filing date to determine your lifetime benefits by six months, costing you up to 4% of your total benefits for the rest of your life in return for six months’ worth of benefits.
Remember that you can receive Social Security benefits starting at age 62, but benefits are significantly reduced when you file that early. To receive your maximum benefit, you must file when you reach the full retirement age (FRA), of 66. (For those of you born in 1955-1959, the FRA scales up in two-month increments until reaching age 67 for those born in 1960 or later)
Retroactive filings are only relevant once you reach FRA or beyond. By law, once you reach FRA, you are able to file for retroactive benefits for up to six months, but cannot extend the benefits beyond your FRA. For example, if you turned 66 in March but held off filing until June, you could only claim the four months of retroactive benefits extending back to your FRA in March.
The reason the retroactivity is harmful is that if you do not file, your benefits continue to build until age seventy when the maximum benefits can be claimed. For each year that you defer filing until age seventy, your annual benefits increase by 8%, including any cost-of-living adjustments.
However, the benefits are accumulated throughout the year after your birth month. Should you file halfway through that year, you would receive around half of the benefit you would receive compared to waiting until the end of the year, thus receiving a 4% increase instead of an 8% increase. If you compound that by taking retroactive benefits for another six months, that effectively wipes out the benefit increases you could have received for that year.
In that scenario, you have traded an extra six months’ worth of lump sum benefits for 4% in extra annual benefits over the rest of your life. Just to get a simplistic feel for the tradeoff — without any tax or investment considerations or the time value of money, the extra monthly payments from filing early would equal the lump sum value in 12.5 years.
You could calculate a cost-benefit of taking the extra benefits depending on your tax situation. Keep in mind that a lump sum payment will almost certainly be taxed higher than your regular payments. You could feasibly invest the retroactive benefits and come out ahead, but is that really what you plan to do with the money?
Retroactivity rules also apply to disability and spousal benefits, although there are some differences depending on specific situations. Consult your local Social Security office or check out the information available at www.ssa.gov if you have further questions.
In the meantime, we suggest laying out your Social Security filing strategy before you reach retirement age and avoiding retroactive benefits unless you really do need the money upfront for emergencies. Otherwise, without carefully investing the lump sum benefits, you are likely to have less money available later in life when you really need it. Sure, you could come out ahead if you die relatively soon after you retire — but what kind of victory is that?