Most Americans rely heavily on Social Security for financial support after they retire. Making a smart decision about claiming your Social Security benefits is therefore vital to guarantee your financial well-being in retirement.

One of the most critical choices you'll make with Social Security is the start date for your monthly payments from the program, with a wide range from age 62 to age 70 available to workers claiming retirement benefits. But what many people don't realize is that there's another choice that some retirees have that can give them retroactive benefits if they want. The big lump-sum payments that retroactive benefits provide can be enticing, but they come with a catch that you need to understand before choosing to take them.

Two Social Security cards over a $100 bill.

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How Social Security generally works

Usually, when you claim your Social Security, you start receiving monthly payments one at a time. The earlier you claim your benefits, the smaller your check will be. Waiting gives you a larger check, but you'll also forego the benefits you could have received during the time that you waited. For instance, if your full retirement age is 66, you can choose to get a full benefit check at 66, a check that's reduced by 25% at age 62, or a check that's 32% bigger at age 70.

Which decision makes sense depends on your individual circumstances and needs. Those who have to have money early in retirement have few good choices and typically take benefits within their first year or two of eligibility. Others who believe that they'll live a long time and want bigger Social Security checks later in life often wait if they can. But whatever choice you make, Social Security makes its payments one month at a time, making it useful to have outside savings to cover unexpected major expenses.

Where retroactive benefits come in

It's the need for a big lump sum of cash that makes Social Security's retroactive benefits provision interesting to some retirees. Under the program, you might be entitled to receive monthly benefits retroactively for a period going back from when you filed your application with the Social Security Administration.

For retirement benefit claims, those who've reached full retirement age have the ability to ask for benefits to be paid for up to six months on a retroactive basis. However, retroactive payments can only be made back to the month in which you reach full retirement age. So for instance, if your full retirement age is 66, then you'd have to be at least 66 1/2 before you could get six full months' worth of retroactive payments.

What you give up to get retroactive benefits

At first, it might seem like asking for retroactive payments would be a no-brainer. However, there's a trade-off in receiving benefits retroactively: The amount you receive is based on what you would have gotten if you'd filed for benefits on the retroactive date six months earlier rather than on your current age.

To see how this works, take an example. Say that a worker is entitled to receive a $1,500 monthly benefit at full retirement age. They decide to wait beyond that age to file, but then six months later, they decide they want to start their benefits.

If the worker takes regular monthly payments, then delayed retirement credits for the six-month waiting period will apply. That works out to a 4% higher payment, so the worker will get $1,560 per month instead of $1,500. That increase will apply for the rest of the worker's life, with future cost-of-living adjustments based on the higher figure.

Alternatively, the worker can take six months of retroactive benefits. However, the retroactive amount will be based on the full retirement benefit of $1,500 without any delayed retirement credits, making the lump sum $9,000. Going forward, the worker will get just $1,500 per month rather than $1,560.

Think through your benefit decision

In some cases, giving up $60 a month for the rest of your life might be worth it to get a $9,000 lump sum. But when you think about it, retroactive benefits rarely make sense. After all, in the example above, the worker could have just filed at full retirement age and gotten those six $1,500 payments on a monthly basis. In effect, the worker gave the government an interest-free loan to hold on to the early payments for several extra months.

That's not to say that retroactive benefits never make sense. However, they're definitely not free money. By understanding what you give up by taking retroactive benefits, you'll be able to make a more fully informed choice that reflects what you really want and need from Social Security.

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