One of the biggest decisions that you'll make as you approach retirement is when to start receiving monthly payments from Social Security. The choice you make has implications for you and your family that will affect your finances for the rest of your lives.
Until recently, that decision was a lot easier, because you could actually change your mind about when to start taking Social Security if your initial choice turned out to be not as good as you'd hoped. A recent rule change by the Social Security Administration, however, is putting the kibosh on that flexibility, and it has a lot of seniors up in arms.
Understanding Social Security
Throughout their careers, most workers pay into Social Security through automatic reductions in their paychecks. Yet at the other end of their working life, figuring out how much you're entitled to receive is anything but automatic.
Under current law, you're entitled to start taking Social Security as early as age 62. But the earlier you start taking payments, the smaller those payments are. For instance, if you were born between 1943 and 1954, your normal retirement age is 66. If you take payments four years early, your check will be 25% smaller than it would be if you waited. In addition, the benefits your spouse is entitled to receive will get an even bigger haircut of 30%.
In contrast, you can defer taking Social Security as late as age 70. If you do so, you'll get higher monthly payments when you do start receiving them -- for those born in 1943 or later, an 8% bump per year that you wait.
Changing your mind
With those monthly payments locked in for life, it's hard to know what the right choice is. In many ways, it's a gamble on your life expectancy; starting early gives you as much as eight years of extra payments, but if you live long enough, the higher payments you get by waiting may be enough to let you catch up.
That's why a once-little-known provision was so useful. If you took early benefits but later wanted to increase your payments, you could withdraw your initial application for Social Security, pay back all the money you'd received, and then basically start the clock over. Your benefits would be calculated based on your age at the later date. You wouldn't even have to pay interest on the money when you paid it back.
As I noted in this column three years ago, that deal was extremely beneficial for Social Security recipients. That's probably why the Social Security Administration has established a new rule that greatly limits its use. The SSA blamed a recent upsurge in media reports touting the "free loan" as forcing it to take action. An uproar among those planning to use the strategy has raised the possibility that the rule may be changed, but for now, the provision is dead.
Do it yourself
Even if you can't change your mind with the SSA, you can get a similar effect with a strategy using dividend stocks. Say you retired at 62 and start getting $750 per month, reflecting a 25% reduction for early benefits. Four years later at age 66, you'd like to change your mind and start taking your full retirement benefit of $1,000. Under the old rule, you could pay $36,000 back to the SSA and reapply for full benefits.
Now, you can't do that. But you could take the $36,000 and invest it in dividend stocks. It would be hard to generate the $3,000 you'd need every year to restore your monthly payment to its full value -- even top-yielding S&P 500 stocks Frontier Communications
But a well-diversified set of high-yielding stocks could get you most of the way there. For instance, continuing to focus on the 20 top-yielding stocks in the S&P, if you created a portfolio that included tobacco giant Altria
Of course, you'd be subject to the risk of the stock market, rather than enjoying the sure thing that Social Security provides. But that could work both ways -- faster dividend increases or strong capital appreciation could leave you better off.
The removal of the change-your-mind rule for Social Security takes one planning option off the table. But it doesn't mean you won't be able to retire successfully. With some forethought, you can structure your options in a way that will work no matter what happens.
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Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.