Lump sum payouts for Social Security? Yep

I received an e-mail from a reader the other day asking if I was aware of the bonus lump sum payment available for those who wait until after their full retirement age to claim their Social Security benefits. I was, of course, aware of the 8% per year delayed retirement credit available to those who postpone collecting benefits beyond their full retirement age up to age 70. Those people whose normal retirement age for full benefits is 66 can collect 132% of their primary insurance amount—plus the intervening annual cost-of-living adjustments—if they wait until age 70 to claim benefits. So if someone was entitled to $2,000 per month at 66, for example, he could collect $2,640 per month starting at age 70. The actual amount would be higher as annual cost-of-living adjustments in effect between age 62, when the worker first became eligible for benefits, and age 70 when he first applied for benefits, would be applied to the primary insurance amount before adding the delayed retirement credits. As an added bonus, the resulting larger monthly checks would serve as a bigger base amount for future annual cost of living adjustments. No, the reader insisted. She was talking about the lump sum bonus. She said she used her $15,000 bonus to pay for a long-planned European vacation. Hmm. It took some investigating to figure out what she meant.

Retroactive payments

It turns out that if you are older than your full retirement age when you first claim Social Security benefits, you may be entitled to up to six months of retroactive benefits paid as a lump sum. “Let's say a person reached full retirement age in March 2011 and meets all the employment requirements to receive benefits,” Kia Green Anderson, a spokesperson for the Social Security Administration, wrote in an e-mail. “If the person decides to file for retirement benefits in March 2012, he or she is entitled retroactively beginning in September 2011 (six months before filing the application).” So it is possible to receive a lump sum payment of up to six month of retroactive Social Security retirement benefits. The Social Security Handbook goes on to say that retroactive benefits for months prior to attainment of full retirement age are not payable to a retired worker, spouse, widow or widower if this results in a permanent reduction of the monthly benefit amount. In other words, if you claimed benefits at 66 and three months, you would not be entitled to a full six months of retroactive benefits because you reached your full retirement age only three months before. Any time you claim benefits before your full retirement age, it results in a permanently reduced benefit amount. But you could request a lump sum payment for three months of retroactive benefits.

Don't forget taxes

Keep in mind that Social Security benefits may be taxable, and a lump sum payment could boost the amount of benefits that are taxed. You must include the taxable part of a lump-sum retroactive payment of benefits received in 2012 in your 2012 income, even if the payment includes benefits for an earlier year, according to IRS Publication 915 Social Security and Equivalent Railroad Retirement Benefits (http://www.irs.gov/pub/irs-pdf/p915.pdf ). Up to 50% of Social Security benefits are taxable if total “provisional income” (which includes adjusted gross income, tax-exempt interest and one half of Social Security benefits) exceeds a base amount: $25,000 for single taxpayers and $32,000 for married taxpayers filing jointly. A second tier of income tax–reaching up to 85% of Social Security benefits received – kicks in for single taxpayers with provisional income over $34,000 or for married taxpayers filing jointly with provisional income over $44,000. Generally, you use your 2012 income to figure the taxable part of the total benefits received in 2012. However, you may be able to figure the taxable part of a lump-sum payment for an earlier year separately, using your income for the earlier year, the IRS publication explains. That way, you can take advantage of the exemption amount in the provisional income formula for both years. You can elect this method if it lowers your taxable benefits. The IRS publication cautions that because the earlier year's taxable benefits are included in your 2012 income, no adjustment is made to the earlier year's return. You should not file an amended return for the earlier year. So if you have clients who have surpassed their normal retirement age but who have not yet collected their Social Security benefits, you might suggest the lump sum Social Security retroactive benefit option. It may be appropriate for those who don't intend to wait to collect the maximum benefit amount at age 70, but who haven't gotten around to claiming yet. And it could be a better alternative than dipping into savings or taking out a home equity loan to finance that retirement celebration cruise or kitchen update. But don't forget to warn them about the possible tax bite.