Social Security “Free Loan” Loophole Redux

Researchers over at Boston College’s Center for Retirement Research have analyzed the “interest-free loan” opportunity presented by the loophole in Social Security that I’ve discussed before. Once their findings reach Congress, I’m betting this loophole gets closed.

Alicia Munnell and her colleagues at the Center recently published a short note in which they examine the potential impact of the loophole.  The idea is this: normally, once you retire, your Social Security retirement benefit level is locked in – other than adjustments for inflation, it can’t go higher.  The older you are when you start taking Social Security, the bigger your monthly check.  But the system is designed to be actuarially fair: the amount that you receive is based on the assumption that you will live a normal life expectancy.  An “actuarially average” person who starts taking checks at 62 would get the same lifetime benefit as one who starts taking them at 70.  However, there is a quirk in the law that allows some retirees to get more than their actuarially fair share.

As I noted in a previous post, journalist Scott Burns and Boston University professor Larry Kotlikoff have drawn attention to the fact that current rules permit a person who started taking Social Security at 62 to pay back the amount received (without interest) and re-start his or her benefit at a new, higher age.  A 70-year-old who started taking benefits 8 years ago, if he can pay back the benefits, can start again and get a much higher check.  He can keep any money earned on the benefits and if he lives long enough he’ll actually end up with extra money.

Of course, if the retiree gets extra money, it has to come from somewhere.  The question asked by the group at the Center for Retirement Research was, how much extra would the Social Security system have to pay out if every retiree aged 70 in 2006 took advantage of this loophole?  Using data from the University of Michigan and the Bureau of Labor Statistics, they concluded that an extra $10 billion would have been paid out.

They went further, noting that most retirees don’t have enough assets to actually use this strategy – you can only do it if you have enough assets to pay back the benefits previously received.  Many retirees actually need to spend their Social Security benefits to pay for basic needs.  Recalculating to determine the cost if only those with sufficient assets carried off the scheme, the amount dropped to $5.5 billion.  They noted, as I’ve pointed out before, that this benefit would accrue to retirees who are least in need of the money – the wealthiest 40%.  They also point out that the growing cohort of retiring boomers will make this loophole more costly in the future.  They also speculate that some lender might start offering loans to retirees who don’t have the cash but want to pull this scheme off anyway.

As this idea attracts more and more attention, expect Congress to pounce on it.  If you’ve already taken benefits for a few years and are in a position to use this strategy, you’d best do it now.  If you’re 62 now and were thinking you’d plan to take benefits now, earn interest on them, and re-apply when you’re 70, be warned: the chances of this loophole lasting that long are slim to none.

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Thomas Fisher, CFP®

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