A spirit of giving usually pervades most activities during this time of year. But the Social Security Administration must not have a calendar, as they seem to be in the mood for taking away.
Thanks to the surprising and sudden prohibition of an increasingly-popular maneuver, retirees searching for more money each month have one less place to put liquid assets to work.
Here's a recap of the strategy, why it's been virtually revoked, and some alternative ideas for clients to consider.
Doing a “Do Over”
As was discussed in this space earlier this year, until recently, recipients of Social Security retirement benefits could legally halt their monthly checks, repay previously-received benefits with a lump sum, and start over with the new, higher check they would have received if they had waited to initiate the benefits.
Since there was no interest charged on the repaid benefits, those who took advantage of this option ended up receiving an interest-free loan in the form of their original payments. Plus, calculating recipients were eager to take their checks sooner rather than later, since there was always an option to repay and restart if the circumstances dictated.
The do-over strategy became more popular as retirees sought out prudent methods to boost income during a near-zero interest rate environment.
The actual rate of return on the money used to repay benefits depended on many factors, including lifespan, taxes and inflation. But conservative hypothetical projections usually produced an annualized rate of return in the mid-to-high single digits — far ahead of most other alternatives.
The Window's Almost Closed
With little advance notice and less fanfare, on Dec. 8 the Social Security Administration announced that “effective immediately” the opportunity to repay and redo retirement benefits would be severely curtailed.
In restricting the activity, the SSA cited the interest-free repayments as being a significant cost to the Trust Fund, as well as the amount of paperwork and personnel hours required to process a withdrawal and subsequent restarting of the benefits.
Now those who wish to stop and start over must do so within 12 months of originally initiating their retirement benefits, and can only perform the tactic once (rather than the unlimited number of repeats recipients could previously perform).
The closing of the loophole may be understandable, but it adds one more layer of urgency to the decision of when and how clients should initiate Social Security retirement benefits.
But even without the strategy, you can help Social Security recipients make the most of their monthly checks, plus use extra cash to enhance income in a conservative manner.
Wait For It?
Now that the repay-and-reapply option has disappeared, clients might be tempted to delay taking benefits as long as possible. From a purely financial standpoint, waiting usually makes sense, as long as the client lives to 80 or so.
But if the alternative to taking Social Security benefits now is to live off of (and deplete) liquid assets while awaiting a higher check down the road, clients are probably better off taking less money sooner.
The eventual higher regular payment awarded to those who wait won't be much consolation if the clients don't have larger sums of money left to cover unexpected financial emergencies, or to take advantage of other investment opportunities that might arise.
Back To The Basics
Clients with a surplus of liquid assets still have a couple of options to modestly augment their retirement income. The most similar alternative to the newly-prohibited strategy is an immediate annuity.
However, clients familiar with the Social Security payback option will be disappointed with the paltry internal rate of return offered by immediate annuities, compared to the prospective yield on paying back benefits.
Still, the relatively-smaller yield is offset by a much greater degree of flexibility. Immediate annuity buyers have dozens of different payout permutations from which to choose, especially if they want to include a continuation of benefits for surviving spouses.
According to the calculator at www.immediateannuities.com, a 65-year-old client with $100,000 who desires a guaranteed payment for as long as he and his spouse live could get about $500 per month.
The same calculator says that the client could get almost the same monthly amount even if he added a “period certain” payment of 20 years — meaning that the payments will continue that long even if the couple's lifespan doesn't.
Clients who aren't comfortable handing over their nest egg to an insurance company might like the safety and certainty of a laddered portfolio of federally-insured certificates of deposit.
A $100,000 deposit averaging just 2.5 percent annually over 20 years should provide about $528 per month before the funds would be exhausted. Plus, the clients would get access to a small portion of their original deposit with each maturing CD, and what's not needed for expenses could be reinvested elsewhere.
Finally, this option is an improvement over the Social Security payback strategy in that if the clients pass away before the 20 years are up, the remaining CDs will still be there for any heirs.
More Income, Less Taxes
High-income clients who are feeling philanthropic and are comfortable with the idea of making a large deposit today in return for a higher income in the long run, might want to consider the virtues of a charitable gift annuity (CGA).
According to the calculator at www.giftlaw.com, if a 65-year-old couple were in a 28-percent federal tax bracket and deposited $100,000 into a CGA, their donation would cut $11,635 from this year's federal taxable income.
They would then receive about $400 per month as long as either is alive, only about $100 of which would be taxable. The predictability of the payment stream might be a step below that of a CD or insurance product, but the upfront and ongoing tax advantages might be too tempting for clients to pass up.
Because no matter how generous the clients are, it's certain that the name “Uncle Sam” is not on their gift list.
Kevin McKinley CFP is Principal/Owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of the book Make Your Kid A Millionaire (Simon & Schuster), and provides speaking and consulting services on family financial planning topics. Find out more at www.mckinleymoney.com.