04/17/09 - Get An Income Makeover Courtesy of Uncle Sam
By: Robert J. Gordon, MBA, CFP®, AIFA®
A few folks might benefit from a little known provision in the Social Security code - the Request for Withdrawal of Application. Many early retirees find themselves with a smaller nest egg but with the same monthly expenses to cover. In most cases they have two options: continue to take a steady amount from their reduced investment portfolio or reduce their withdrawal in line with the decline in portfolio value. Continuing their withdrawal at a constant dollar amount threatens the survivability of their assets - a scary prospect for most. Reducing the withdrawal percentage makes sense; however, typically, it is difficult to imagine a significant reduction in income even for a short period of time. The Social Security Administration offers an option which may help in replacing lost income; it's called the Request for Withdrawal of Application.
The SSA's Request for Withdrawal of Application
The Request for Withdrawal of Application (SSA Form 521) is not right for everyone; in fact, it probably only makes sense for a small percentage of early retirees. Depending on the age of the individual, this tactic allows persons who retired before their full retirement age to reset their income to either the income they would have received at the full retirement age or at the bonus credit amount up to age 70. Filing the form is easy enough; however, one of the deterrents is the fact that you will have to return 100% of the benefits paid to you since filing the original application. Fortunately, the amount you will be paying back does not include any growth or interest. Once the Social Security accepts your application, you receive the stepped-up amount for the rest of your life and your spouse's survivor benefits will be based on the now higher benefit amount. The IRS even allows you to take either a tax credit or tax deduction to recapture any federal income taxes you've paid on your Social Security benefit. Clearly, the biggest obstacle for someone of limited means is paying back 100% of the benefits received.
Increasing Your Social Security Benefit
Let's take an individual named Phyllis, age 70, who has been receiving a Social Security benefit of $1,000 a month since age 62. Phyllis worked as a registered nurse for many years and retired early to travel the world and volunteer with Doctors Without Borders. During her working years, she saved religiously in her company retirement plan and her account's value got as high as $500,000 in 2007. Since then, it has declined substantially. To date, Phyllis has received $121,909 (assuming a 3% annual inflation adjustment) in Social Security benefits. Born in 1938, her normal retirement age was 65 and 2 months and, upon taking the early retirement benefit amount, her retirement benefit was reduced by 25.82% to $1,000 from $1,348 (her Primary Insurance Amount or PIA.) Had she waited until age 70, she would have received a delayed retirement credit of 6.5%. All in all, her Social Security benefit at age 70 would have been 132.5% of her PIA or $1,786. That is a $519 difference or a 41% increase in benefits versus the inflation-adjusted benefit she now receives (her inflation-adjusted benefit today is $1,267 assuming a 3% per annum inflation adjustment.) The difference certainly goes a long way in the developing world. To realize this increase, she has to hand over $121,909. Of course, before handing over this significant percentage of her lifetime savings, she should seek advice and do her own analysis of the many options available in addition to the Request for Withdrawal of Application. The Request for Withdrawal of Application is an all or nothing proposition so she can't send half the money back and hope to get half of the increased benefit. However, she could use the money to buy an immediate annuity of any amount. Phyllis could also decide to change her lifestyle and even go back to work on a part time or full time basis to build up her travel warchest. That option will most likely affect taxation of her benefits.
Ultimately, while the Social Security Administration has made allowances for changing circumstances, proper planning is required to make sound, long term decisions.
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