I will probably wait until age 67 or 68 to file for Social Security. I understand that I might be able to claim a retroactive benefit. What are your thoughts about this option?
Great question. We touched on this issue several years ago, but the retirement picture is changing. Increasingly, people are waiting until their mid-60s to file for Social Security. As such, they’re discovering that they are eligible, in some cases, to claim a “retroactive benefit,” a big, one-time payout from the government.
But…as tempting as this option might be, I’m not a big fan. And I worry that some retirees are grabbing this without fully understanding the consequences.
Some statistics: A study published last year by the Center for Retirement Research at Boston College found that only about one-quarter of individuals in 2019 who hit age 62 claimed Social Security that year, down from about 45% in 2010. (Sixty-two is the earliest age at which most people can claim benefits.)
What’s more, the study found, “those who forgo early claiming appear to wait to full retirement age to claim their benefits.” Full retirement age is the age when a person can first collect an unreduced benefit. That age, once set at 65, is climbing gradually to 67.
All of which brings us to retroactive benefits.
Here are the rules: If you first claim Social Security after reaching full retirement age, you can backdate your application and receive benefits for the months after reaching your full retirement age, not to exceed six months.
Let’s say your full retirement age is 67 and you’re eligible for a monthly payout of $2,800. If you file for benefits at age 67½, when your payout would be $2,912 a month (remember: the longer you wait to claim benefits, the larger your payout), the Social Security Administration will offer you the option of backdating your application six months. If you accept, you will receive a one-time check for $16,800, or $2,800 times six months. Sweet, right?
Well, not exactly.
If you take this option, your monthly payout going forward—even though you’re claiming benefits at 67½—will be $2,800, the figure you would have received at 67. That amounts to a reduction of almost 4% in your monthly payout—permanently. As in: the rest of your life. And this is where retirees who grab retroactive benefits run into problems.
“All they hear is: ‘I’m getting six months of back pay!’ and they don’t think about what happens after that,” says Jim Blair, a former district manager with the Social Security Administration and a Social Security consultant in Cincinnati.
Social Security representatives, according to the agency, are supposed to explain retroactivity when you file, including what happens to your monthly payout. But Cory White, a senior financial adviser with Modera Wealth Management in Boston, says one of his clients, who recently filed for benefits at 70—and took the retroactive option—was never told that he would end up with a lower monthly payout.
“Once you factor in future cost-of-living adjustments, and compounding, that gap starts to widen over time,” Mr. White says.
Indeed, most experts I spoke with said retroactive benefits, on close inspection, aren’t much help. “It always puzzles me,” says Tom Margenau, a 32-year veteran with the Social Security Administration and author of “Social Security: Simple & Smart.” He adds: “If you want six months’ worth of benefits, why not start them now? Why wait six months and then file retroactively? Why let the government hold your money all that time?”
My advice: If you’re interested in retroactive benefits, you must understand clearly—long before you file—how they work and the consequences. Says Mr. Blair: “This is a lifetime benefit. You need to take some time to make sure you’re doing it right.”
In 2020 and 2021, I converted holdings in a traditional IRA to a Roth IRA. The last transaction occurred in March 2021. I understand that five years must pass to avoid a withdrawal being subject to federal taxes. I am 75 years old. Here are my questions: What if I die? Does the five-year rule still apply to the person who inherits my Roth IRA? If so, when does the five-year clock start?
Actually, we need to focus on the earnings on the funds you converted—not the converted funds themselves.
Let’s start with you. The five-year clock starts on the first day of the year in which you made either a contribution or conversion to any Roth IRA, says Ed Slott, an IRA expert in Rockville Centre, N.Y. If you had no other Roth funds before your conversion, the clock for you began on Jan. 1, 2020. Your five years will be satisfied on Jan. 1, 2025.
If you die before then, your beneficiary must hold the funds until the end of your five-year term to be able to withdraw all of the inherited Roth funds, including the earnings, tax-free, Mr. Slott says. The beneficiary doesn’t have to restart his or her own five years.
(Note: If your beneficiary is your spouse, she/he could roll over your Roth into their Roth. In that case, the spouse could use her/his own five-year period, if that started earlier than yours.)
But again, this five-year rule applies only to withdrawing the earnings tax-free. Under tax rules, earnings are considered to come out last. So, your beneficiary, Mr. Slott explains, could still withdraw part or all of your converted funds tax-free—even before 2025—since they are deemed to come out first. The earnings will be taxable only if taken out before 2025, after all the converted funds have been withdrawn.
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