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Social Security as Investment Account?

Sunday while I was wrestling with the indexing project,PBS mumbled away, background noise that I wasn’t listening to. My attention was snared, though, by a personal finance program identifying itself with Kiplinger’s, whose guests were going on about ways to finance one’s retirement. In the course of conversation, they reminded me of something I’d heard before: if you start taking Social Security early, there’s a way to engineer your way into the higher payment bracket you’d have qualified for if you’d delayed collecting Social Security payments. You can repay the entire amount the government has doled out through Social Security, and that will allow you to start over.

This provision in the Social Security code allows a person who retires early, changes her mind, and goes back work to stop collecting Social Security, remit the funds she collected, and then later restart payments at the amount she would have had if she had not tried to take early retirement.

One of Social Security’s several catches is that if you retire before the so-called “full retirement age,” the government giveth and government taketh away. For every buck you earn above a certain very low threshold, they take back 50 cents, meaning that if you dare to earn a living wage, you get $0.00 from your “entitlement.” This policy ends when you reach “full retirement age” — for me, that’s age 66 1/2 — and after that you get to keep your Social Security, though you have to pay income tax on it. So, if you quit your job and start collecting Social Security at age 62, then go back to work at age 64, your payments are “disappeared” as long as you’re earning more than about $14,000 a year.

Second catch is that the amount of your Social Security payments depends on the age when you start collecting: the younger you are, the less you get. If I had retired at the age of 62, for example, my payments would have been $857 a month. According to the latest statement, retiring right now would give me an income of $1,019. If I wait three and a half years before collect, my monthly Social Security income would be $1,394. But if I can hold off retiring until I’m 70, my payments will be $2,094. These figures are based on actuarial statistics that estimate how long Americans in a given age range will live. The government plans to pay out a specific amount to each participant; assuming you live out your full life expectancy, you would get about the same total distribution no matter when you started collecting.

You can recover from the error of continuing to work after early retirement by canceling the SS payments and returning the money you were already paid. Then when you reach the next age plateau (or when you decide to quit working in earnest), you start collecting at a higher rate.

The speakers on the PBS program pointed out that because only earned income counts against the amount you’re allowed to keep when you start collecting early, if you have enough to live on from dividend income, pensions, and annuities, taking Social Security at the earliest possible moment can be made to amount to an interest-free loan from the government, one that you can use to generate extra income. Here’s the strategy:

  1. Retire from your job and start taking your Social Security payments.
  2. Pay the required income taxes on the Social Security gross.
  3. Immediately place the net Social Security in a fairly low-risk interest-bearing instrument.
  4. Collect until you reach the next highest age plateau.
  5. Repay the government the amount it has doled out to you. Note that no interest is charged on this amount!
  6. Collect the tax refund that the government will now return to you. When you repay Social Security funds to the government, the taxes you paid on them are refunded!
  7. Reapply for Social Security and collect a significantly larger monthly payment.

Effectively what you’re doing is funding an investment with an interest-free loan from the government. If for some reason you decide not to go through with the plan, you still end up with a nice kitty in the bank.

Now, that’s all very well and good if you have plenty of money: enough invested to put you past the crossover point (where passive income = amount needed to live on) without benefit of Social Security. I don’t, of course. So far do I not that my present plan is to continue working until I’m 70 or until the Great Desert University cans me, whichever comes first.

Let’s suppose I actually do manage to cling to my job for another seven years. That would allow me to collect “full retirement age” Social Security for 3 1/2 years. By the time I turn 70, I will have collected $1,394 x 12 x 3.5 = $58,548. The tax rules for Social Security income are, like all tax rules, stupefyingly complex, but from what I can tell they do not amount to the rate for ordinary income because some part of the Social Security income may be exempted. Presumably, then, I would pay something less than 28%. Let’s say it’s around 20%: $58,548 – 20% = $46,838 net income over three and one-half years. At a 6% return, interest income on that would be roughly $2,810 of free money.

When I reach 70, I return the Social Security lucre to the government. The Treasury Department refunds $11,710 to me, leaving me with a total of $14,520 to go back into my retirement savings (at 4%, that yields a munificent $580 a year, just slightly better than a hit on the head). But now I collect $2,094 a month: $700 a month more than I was paid when payments were based on my starting age of 66 1/2.

Seven hundred bucks a month is worth the effort. If I haven’t already done so, I quit my job now. My earned income drops significantly, and so taxes on the Social Security drop commensurately. I end up with a Social Security drawdown that makes a real contribution to my living expenses, something $857 would not do and $1,019 would barely do.

So, here’s the Poor Woman’s Answer to the Fat Cat’s Social Security Investment Strategy:

  1. Hang on to my job for all I’m worth.
  2. Start collecting Social Security at age 66 1/2, but do not quit working then.
  3. Bank every after-tax penny of Social Security income in an instrument that returns at least some interest income.
  4. At age 70, quit my job and repay the government the amount of Social Security paid to me.
  5. Reapply for Social Security, giving myself a $700 a month raise plus a “bonus” of 3.5 years’ worth of tax refunds.

What if I don’t make it to age 70? What if I throw over the traces before then, or if the university lets me go?

In that case, because I’ve banked every net penny of the $1,394 the government started paying me at age 66 1/2, my retirement savings have grown considerably. If nothing else, I’ve accrued a nice emergency fund, or at least enough to kick off retirement with a vacation in the south of France.

If I die before the age of 70, I’ve contrived to recover a certain amount of my contributions to the Social Security fund, which I can pass down to my heir — something I could not have done had I tried to delay collecting until I quit my job.

So, is this worth the trouble? Only if you live into your mid-80s. If I die in my 70s, then I’ve stayed in the salt mine altogether too long and missed out on a real retirement period. That certainly is a possibility.

However, if I dodge the family disease (and chances are I’d have it by now if I were going to get it), then I may be carrying the “good” genes. My father lived to the age of 84 after a lifetime of heavy smoking and unadulterated scorn for the concept of teetotaling. I don’t smoke and never have. The two women that I most take after lived into their mid-90s…and they were Christian Scientists. With decent medical care, I could live at least to age 95 and possibly to 100. Since that kind of longevity poses the risk that I could outlive my savings, yes. Yes, it is worth the trouble. An extra $700 a month could mean the difference between cat food and canned salmon.

Assuming any salmon are still swimming in the ocean by the time I reach that age.

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