Should you take Social Security retroactive lump sum payments?

Claiming retroactive Social Security benefits can be an attractive option for some retirees as this gives them access to a relatively large lump sum payment. But there are trade-offs involved.

In this article, InvestmentNews explains what conditions are attached to taking out a Social Security retroactive lump sum. We will discuss how the process works and who is eligible to apply for payouts.

If you’re wondering if filing for retroactive benefits is a smart financial move, you’ve come to the right place. Read on and find out the pros and cons of this retirement planning strategy.

How does Social Security retroactive lump sum work?

The Social Security Administration (SSA) allows members who delay receiving benefits past full retirement age (FRA) to file for what the agency calls a retroactive claim. This option entitles you to claim missed monthly benefits as far back as six months before you filed for retirement. Retroactive benefits are paid in a lump sum.

To qualify for the maximum benefit, you must be at least six months past your FRA. If you claim the Social Security retroactive lump sum just five months past your normal retirement age, you also get five months’ worth of payouts. If you file four months after FRA, you receive a single payment equivalent to four months of benefits, and so on.  

As mentioned, retroactive benefits max out at six months. This means that even if you retire seven months after full retirement age until age 70, you still get only six months of retroactive payments.

Members receiving survivor benefits and disability payments can also file for a retroactive claim, but the requirements are different. Social Security spousal benefits, meanwhile, don’t earn delayed retirement credits, so spouses can file for a retroactive lump sum without having their monthly payouts reduced.   

There are three factors that the SSA considers when determining how much lump sum benefits you are entitled to:

• date you became eligible for the benefit, meaning how many months past FRA you are
• date you filed your application, or how many months have passed since you qualified for retroactive payouts before filing
• type of benefits you’re eligible for as retroactive payments are available for personal retirement, spousal, survivor, and disability benefits

You can check out this guide if you want to gain a deeper understanding of how Social Security benefits work.

How does claiming retroactive lump sum impact Social Security benefits?

Based on SSA’s rules, your benefits grow 0.66% for each month past full retirement age that you delay receiving payments. This means that if you claim Social Security benefits six months after FRA, you earn an additional 4% in monthly payments.

Let’s say your monthly benefit at normal retirement age is $2,500. If you postpone retirement until six months after reaching FRA, your payments increase to $2,600 by earning delayed retirement credits.

If you choose to file for a Social Security retroactive lump sum, the SSA will write you a check worth $2,500 per month. This is equivalent to a single payment of $15,000, which can be a very enticing amount. However, there are downsides that you need to consider:

1. You lose the delayed retirement credits you have earned.

When you claim past FRA and opt to apply for retroactive Social Security benefits, your filing date gets pushed back. This effectively forfeits the retirement credits you have earned, reducing your monthly retirement payouts permanently.

So, continuing with our example above, instead of receiving $2,600 in monthly benefits for the rest of your life, your payments will drop back to $2,500. You can break even, however, if you live long enough. For the $15,000 lump sum, you can break even in around 15 years. This does not consider the tax implications and cost-of-living adjustments (COLA).

2. The benefits linked to your Social Security are also reduced.

Taking out a Social Security retroactive lump sum payment doesn’t just affect your monthly retirement payouts. It can also impact the benefits your spouse receives. Any reduction in your personal retirement payouts means smaller spousal and survivor benefits. This can leave your spouse financially vulnerable in the long term, especially if they are heavily reliant on Social Security for their retirement income.

If you’re planning on claiming your benefits before FRA instead, this guide on how early retirement affects Social Security payments can prove useful.

What are the pros and cons of claiming Social Security retroactive lump sum?

Filing a retroactive claim can have a significant impact on your retirement benefits. That’s why even though the lump sum you can receive seems very tempting, it’s best to weigh the advantages and disadvantages before making a decision.

These are the benefits and drawbacks of claiming a Social Security retroactive lump sum.

Pros of retroactive lump sum

• It provides an immediate boost to your retirement income that you can use for various expenses, including paying off debts and unexpected emergencies.
• It gives you flexibility in your retirement planning, allowing you to address pressing financial needs without dipping into your savings.
• It offers an extra layer of financial security, letting you enjoy your retirement without worrying about short-term cash flow.
• It provides additional cash that you can use now, especially if you expect to live long enough to enjoy the long-term benefits.

Cons of retroactive lump sum

• It permanently reduces your personal retirement benefits, which can also impact other benefits linked to your Social Security.
• It can push you to a higher tax bracket, increasing your tax liability.
• It can increase your Medicare premiums or subject you to high-income surcharges, especially if your income exceeds a certain threshold.

Find out if claiming retroactive Social Security benefits suits your financial goals in this guide.

What are the tax implications of retroactive Social Security benefits?

One of the biggest potential drawbacks of receiving a Social Security retroactive lump sum is the tax consequences. According to SSA’s rules, you are required to pay taxes on up to 85% of your Social Security benefits once “combined income” exceeds a certain threshold.

The agency defines combined income as adjusted gross income plus 50% of Social Security benefits. This is calculated with any tax-exempt interest from municipal bonds.

• For individuals filing a federal tax return, up to 50% of Social Security benefits are taxed once combined income exceeds $25,000 and up to 85% are taxable if combined income is more than $34,000.
• For married couples filing a joint tax return, the combined income thresholds for taxing requirement benefits are $32,000 (up to 50%) and $44,000 (up to 85%).
• For married couples filing separately, combined income is calculated as: adjusted gross income + nontaxable interest + ½ of Social Security benefits

You can pay the Internal Revenue Service (IRS) directly or withhold taxes from your payment. You may opt to withhold 7%, 10%, 12%, or 22% of your monthly payment. You will need a Form SSA-1099 to report your Social Security income on your tax return.

Find out more about Social Security lump sum benefits in this guide.

How does retroactive Social Security payment affect Medicare premiums?

Social Security retroactive lump sum payments can also boost your retirement income beyond certain thresholds that can subject you to future Medicare premiums and high-income surcharges.

High-earning Medicare beneficiaries are required to pay an income-related monthly adjustment amount surcharge (IRMAA). This is in addition to their regular monthly Medicare premiums. The IRMAA surcharges apply to:

• Medicare Part B, which covers outpatient services and doctors' fees
• Medicare Part D, which covers prescription drug plans

IRMAA charges apply to eligible Medicare beneficiaries, whether you have Original Medicare or Medicare Advantage.

The Medicare IRMAA is based on the modified adjusted gross income (MAGI) on your tax return two years ago. This means that IRMAA surcharges for 2024 are based on 2022 federal income tax returns.

• For individual filers, IRMAA surcharges apply if income exceeds $103,000.
• For married couples filing a joint return, IRMAA surcharges apply if income is more than $206,000.
• For married couples filing separately, IRMAA surcharges apply if income is over $103,000.

If you believe that there was a mistake or your circumstances have changed, you have the right to appeal your Medicare IRMAA determination. You can contact the SSA at 800-772-1213 to ask for an appeal form or fill out a Request for Reconsideration (Form SSA-561).

You don’t necessarily have to file an appeal. You can ask the SSA for a review to see if your income has declined or if your tax return was amended. You will also need to provide documents that support your claim.

Should you claim Social Security retroactive lump sum?

Claiming Social Security retroactive lump sum benefits can be an effective tool to address immediate financial needs. This strategy, however, carries long-term implications that may not suit everyone’s financial situation. That’s why it’s important to study the benefits and drawbacks carefully and seek the help of an experienced financial advisor to ensure that your decision aligns with your retirement goals.

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