A Change To The Social Security “Free Loan” Loophole

Last March, I predicted that Congress would close the door on the Social Security “interest-free loan” loophole strategy that has been discussed in various publications over the last couple of years. I was almost right: the Social Security Administration (SSA) itself has taken the initiative to clamp down on this practice by severely restricting the circumstances under which it can be done.

The idea was that people who have filed for retirement benefits at a relatively early age (say, 62) had the option later of paying back previous benefits received (without interest) and then reapplying for benefits calculated on the basis of their current age.  Since benefits are higher the older you are (up to age 70), a person taking this strategy could get a much higher monthly check, as would their spouse if the spouse were entitled to death benefits.  It was really like buying a government-backed annuity.

As expected, when this strategy started to get a lot of public attention, including an analysis done by the Boston College’s Center for Retirement Research, the SSA observed an increase in the number of people taking advantage of the loophole.  In addition to the media attention, this idea has been an active topic of discussion among financial planners for the past few years, so I’m not surprised by the surge in people doing it.

Effective December 8th of last year, the Social Security Administration issued a final rule that limits ability of a retiree to use this technique.  The rule, RIN 0960-AH07, docket no. SSA 2009-0073, provides that those who receive retirement benefits can only cancel them once within their lifetimes and it must be done within the first year of receiving benefits.

The rule notes that the SSA is “under a clear congressional mandate to protect the Trust Funds. It is crucial that we change our current policies that have the effect of allowing beneficiaries to withdraw applications or suspend benefits and use benefits from the Trust Funds as something akin to an interest-free loan….Applications for old-age benefits are most prone to manipulation for personal financial gain by our current policies. For these reasons, these changes will be limited solely to applications for old-age benefits.”

The rule still provides some flexibility; for example, a person who retires and then decides to work within a year of stopping has the option of pushing benefits out into the future,

Personally, I’m relieved by this change.  I was never comfortable with this strategy because it tended to benefit those who needed it least:  it was accessible only to retirees with excess cash, while the poorest retirees couldn’t make use of it because they can’t afford to pay back prior benefits.

About the author

Thomas Fisher, CFP®

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