Considering a lump sum from Social Security?

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| By Dan Rafter, MoneyRates.com

Here are the pros and cons of taking a large Social Security payout.

If you wait until after your full retirement age to claim your Social Security retirement benefits, there is a little-known rule that could entitle you to a large chunk of cash all at once. This provision enables retirees who meet this requirement to receive up to six months of retroactive benefits in one lump sum.

Sound appealing? While this option may be a great choice for some, there are several things to consider before you go for it -- namely its impact on your future benefits.

The rule is a bit complicated, but Kia Anderson, a spokesperson for Social Security Administration, illustrates a possible scenario: Say a retiree reached full retirement age in November 2012, but then waited to file an application for Social Security benefits until November 2013. In this example, the retiree might be entitled to retroactive benefits -- paid in a lump sum -- beginning from May 2013, or six months before he or she finally filed for benefits.

Because of the six-month limitation on this rule, the first six months of benefits would effectively be gone for a retiree in this situation. But for those who need a large chunk of cash for an emergency or for those who are in bad health and don't expect to live long, the six months of benefits that are still available may be much appreciated.

Still, there is a major drawback to claiming retroactive benefits in a lump sum: It will reduce your ongoing monthly Social Security benefits for the rest of your life. That means that retirees should examine their circumstances before choosing this option, says Anderson.

"It depends on a person's individual situation as to whether they would like to file for retroactive retirement benefits," she says.

Russ Settle, founding partner with Social Security Choices in Elkton, Md., says that it makes sense to claim the retroactive payment if you've received bad news about your health or if you face a financial crisis that requires an immediate infusion of cash. But in most other situations, it's a bad move because claiming the retroactive benefits locks you into an earlier "official" retirement date, even if you waited until after your full retirement age to claim your benefits.

In other words, if you take six months of retroactive benefits in a lump sum payment at age 67 when your full retirement age is 66, your monthly Social Security payments going forward will be calculated as if you started taking payments at age 66 and a half.

"There are many situations where taking the benefits in a lump sum would not be advisable because you are lowering your monthly benefits for the rest of your life," Settle says. "But if you expect a relatively short life expectancy, it makes sense. Giving up the money now and gaining it later assumes that you'll be around later to get it, which might not be the case if you don't expect to live long."

You might think that you'll be able to invest the six months of retroactive benefits wisely, and that this makes taking the lump sum payment a sound financial move, even if you don't face a financial emergency or serious health problem.

But Robin Brewton, vice president of client services with Overland Park, Kan.-based Social Security Solutions, said that clients all too often spend the money they plan to invest. She's seen it with clients who take their Social Security benefits before they reach full retirement age and doubts that those who take the lump sum payment are any more likely to invest their sudden bundle of cash.

There are tax implications to consider too. As much as 50 percent of your Social Security benefits are taxable if your total annual provisional income -- which includes your adjusted gross income, tax-exempt interest and one-half of your Social Security benefits -- comes to $25,000 or more if you are single or $32,000 or more if you are married and filing jointly.

Up to 85 percent of your Social Security benefits are taxable if your total provisional income is higher than $34,000 if you're single or $44,000 if you're married and filing jointly.

Taking the lump-sum payment, then, might boost your provisional income enough to cost you at tax time.

Settle says that for most retirees, taking the lump sum payment instead of the higher monthly payments for life simply doesn't make sense.

"In this low-interest-rate environment, getting any rate of return that would be close to the rate of return that delaying Social Security benefits would offer you is really impossible," he says. "That assumes, of course, that you expect to live long enough to take advantage of those higher monthly benefits."

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Be gone, social security when you retire?

1:00 PM retire, security, Social No Comments

| By Leslie Kramer, LearnVest

Most people agree that the Social Security program needs to be adjusted. But not everyone agrees on the next steps.

Social Security benefits used to be something all tax-paying workers could count on. A portion of your pay would be deducted automatically from your paycheck, through the payroll tax, and in return, you would reap the benefits of the program when it came time for you to retire.

For many decades, the program worked well. “Today’s employees would raise the revenue to pay current retirees, and were assured that when their time to retire came, the current employees of the day would pay into the system to finance their retirement,” explained Olivia S. Mitchell, the director of the Pension Research Council at the Wharton School of the University of Pennsylvania.

But due to the recent financial crisis and recession, as well as the current high unemployment rate and the size of the aging baby boomer population, many of whom are expected to live far past age 65, there may eventually be insufficient money coming in from payroll tax revenue to pay out full Social Security benefits. This has many people worried about the overall future of the system and whether Social Security will be there for them when it’s their turn to retire.

For Social Security to continue to exist as it does today, Congress must figure out a way to shore up the expected deficit in the program. Otherwise, it will have to resort to paying out reduced benefits.

Instead of relying on Social Security as a way to support their retirement, people may have to depend on their own savings and investments, says Ellen Derrick, a certified financial planner for LearnVest Planning Services. “People need to ask themselves: ‘What can I do now to make sure I am protecting myself for the future, a future that may not include Social Security?’” she says.

According to forecasts made by the Social Security Board of Trustees, there should be enough money coming into the program to pay out only about three-quarters of total expected benefits starting in the year 2032. “So if you were to receive $1,000 a month, it is projected that you would only receive $750 a month instead,” says Derrick. “Those benefits should be intact through the year 2086,” she notes.

Part of the reason this may occur: “The law says that the Social Security administration can only pay benefits up to the amount of revenue that it has, so if it’s insufficient, the government will have to figure out new solutions if it does not want to cut payments,” explains Mitchell. And that will take policy changes.

So what can you do now to prepare yourself for the possibility that the full amount of Social Security benefits won’t be there when it’s your time to retire?

The simplest answer is to keep working. If you're already retired or close to retiring, you don’t need to worry; your benefits are secured. “But if you’re 10 years away from retirement, it’s time to buckle down,” says Derrick. She tells her clients who are age 55 and younger that they should not even include Social Security in their retirement planning calculations. “If you do get it, it will most likely be a smaller amount than what you are currently being promised,” she says.

Many financial planners are advising people to keep working and retire later than they may have originally planned. “It’s helpful to delay retirement until as late as possible,” says Mitchell. In fact, there are already added benefits built into the Social Security system if you defer claiming benefits until age 70 instead of taking them at 62, the earliest available age. “Your monthly benefit could go up by as much as 76%,” she says. It is important to realize that the age you take your Social Security benefit can vary from person to person. This is a topic you should discuss with your financial professional to figure out what time is right for you.

Mitchell also recommends that people start saving more while they are still working, and that they spend less. The recommended percentage of one’s paycheck that people should invest in a retirement fund varies greatly according to age and circumstances, but many financial planners advocate putting away from 10% to 20%. The more you can save, the better, Mitchell advises. Another factor is that many people are living a lot longer than they used to. “Longevity is increasing, and it is expected that people may soon start living to over 100,” she notes. That means many more years of savings will be needed.

Another tip: Everyone who is offered a 401k retirement plan from his or her employer with a contribution-matching program should take it. The match is free money! If you’re self-employed, setting up a traditional individual retirement account, Roth IRA or individual 401k account is key. If possible, you should contribute the maximum amount those plans allow each year. “Even if you are a stay-at-home mom, you can set up an IRA in your name and deposit income coming in from your spouse,” Derrick advises.

Staying healthy is another way to protect yourself now for later on in life. “You should be investing in your mental and physical health, because that is your capital,” Mitchell says. Good health will help allow you to work longer and hopefully reduce medical expenses when you are in your retirement years.

She also suggests that people start to think about their social capital, which includes friends, neighbors, community and family. “In the old days, when parents would grow old, they would move in with their kids, but that has changed,” Mitchell says. Today, if you have friends and family who can help you, it may allow you to remain out of a nursing home and in your own home longer, which will be less expensive later in life, she explains.

Continuing to work part time, even in retirement, is another good idea. “People who work part time remain mentally alert and connected to friends. It is another aspect of successful aging,” she says.

Derrick also recommends that workers check their retirement plan at least once a year to see if it remains on track. “If it’s not, you should adjust your contributions, especially if you get a raise or a new job that could make a significant difference in your salary,” she says. At times, you may find that you have to rearrange your savings rate to take care of a child’s needs or to set up a college fund. “But at the same time, you don’t want to sacrifice your own retirement; you want to weigh those priorities,” says Derrick.

The earlier you start saving for your retirement, the better, even if it’s a just small amount at first. “People come up with all sorts of reasons to put off saving for their retirement, but retirement is the one thing you can make the biggest difference with if you start saving early on,” Derrick notes. That’s because the earlier you start, the more time you have to let your money grow.

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Social Security traps to avoid

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If you're looking forward to turning age 62 so you can begin collecting Social Security benefits and live on easy street, you might get caught off guard. Some of the Social Security rules can be frighteningly complex.

Because it will likely represent a large portion of your retirement income, it's important to understand how the government program works.

For instance, there are limits on how much you can earn while collecting benefits, and if you exceed those limits, your Social Security benefits will get cut substantially. That's just one of the snares that could trip you up.

Make sure you plan appropriately to avoid these six Social Security traps.

If your earnings exceed a certain level, up to 85 percent of Social Security benefits may be taxable. Even income sources that are normally tax-exempt, such as income from municipal bonds, must be factored into the total income equation for the purpose of computing tax on Social Security benefits.

Eric Levenhagen, CPA and Certified Tax Coach with ProWise Tax & Accounting, says to find out whether any of your Social Security benefits are taxable, "Look at your total taxable income plus half of your Social Security benefit. Make sure you add back any tax-exempt interest income."

When your taxable income, tax-free income and half of your Social Security benefit exceed $25,000 ($32,000 for married couples filing jointly), that's when you're in the zone to pay taxes on Social Security income.

Another unexpected income source that could impact taxes on Social Security: proceeds from a Roth conversion.

If you're thinking about doing a Roth conversion, do so before receiving Social Security benefits, says Steve Weisman, an attorney and college professor at Bentley University. "A lot of people considering converting a traditional (individual retirement account) into a Roth IRA should be aware that if they do that, they will end up paying income tax on the conversion, which will also be included for determining whether Social Security benefits are taxable," he says.

Required minimum distributions, or RMDs, must generally be made from tax-deferred retirement accounts, including traditional IRAs, after a person reaches age 70 ?. The distributions are treated as ordinary income and may push a taxpayer above the threshold where Social Security benefits become taxable.

"This is a double-edged sword," says Weisman. "If you are over 70 ? , you are required to begin taking distributions from IRAs (except Roth IRAs) and other retirement accounts."

"Here again, you take half of the Social Security benefits plus all other income to determine whether Social Security benefits are taxable. RMDs will be included and drive that up," says Levenhagen.

You can't avoid required minimum distributions, but you can avoid being surprised at tax time.

Most people assume Social Security is available to seniors throughout the U.S., but not every type of work will count toward earning Social Security benefits. Many federal employees, certain railroad workers, and employees of some state and local governments are not covered by Social Security.

"Some of my clients have participated in retirement programs offered by employers that don't pay into Social Security," says Charles Millington, president at Millington Financial Advisors LLC in Naperville, Ill. "If your employer does not participate in Social Security, then you should be covered under the retirement program offered by your employer."

However, certain positions within a state government may be covered by Social Security.

Find out whether your employer participates in Social Security or not and if not, whether your position may be covered by Social Security. Make sure you understand where your retirement benefits will be coming from.

If you opt to take Social Security as soon as you are eligible, you may be doing yourself an injustice.

"If you delay taking benefits until age 70, you will see as much as an 8 percent increase in benefits for each year you delay," says Steve Gaito, Certified Financial Planner professional and director of My Retirement Education Center. "In addition to receiving a higher benefit, the annual cost-of-living adjustment will be based on the higher number."

"It's hard to find that kind of rate of return on regular investments, so it's good to delay if you can," says Weisman.

Of course, life expectancy plays a part in the decision of when to begin drawing benefits. "You generally know how healthy you are and what your family medical history is," says Ryan Leib, vice president of Keystone Wealth Management. "We advise clients to determine whether they think they will live longer than age 77. If so, delaying until age 70 will net you more in benefits than opting to start collecting benefits early."

If you're able to live off other funds and delay taking Social Security, you should seriously consider doing so. "Delaying taking Social Security until age 70 could mean the difference between cat food and caviar in retirement," says Leib.

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