When Buying an Immediate Annuity, Give the Government a Shot

If you are in the market for an immediate annuityIt is important to distinguish between this
and are already taking Social Security, anstrategy, which involves paying back your Social
oft-overlooked strategy is to let Uncle Sam giveSecurity benefits instead of, or in addition to, the
you a bid. Often, the government can give you apurchase of an immediate annuity and a different
better return, on a lump sum, than an insurancestrategy, where you purposefully start your
company can. How? Let me give you an example,benefits early, with the intention of paying them
to illustrate.back later.
Imagine you are 70 years old and started yourPerhaps you have heard of this strategy. Some
Social Security benefits at 62. You have $100,000,advisors recommend it. Some even tout it as a
in cash, and you are considering using that cash to"secret" way to "play" the Social Security system.
purchase an immediate annuity.We don't recommend it. We recommend, in
One alternative, that few people know about, isalmost all cases, you wait until age 70 to begin
paying back the Social Security benefits you havetaking Social Security benefits, which is why it is
received. Uncle Sam allows you to do that withoutimportant to distinguish between the two.
penalty and without interest. The Social SecurityThe goal of this second strategy is to start your
Administration calls this a Withdrawal ofbenefits early, repay them later on and pocket
Application. Informally, it is known as a Socialthe interest earned on the benefits in the
Security Reset. The provision was originallymeantime. This strategy is especially appealing to
intended to help claimants who had to go back topeople who worry that, by delaying benefits until
work after beginning Social Security.age 70, they might get nothing if they die before
When you restart your benefits, presumably atstarting benefits. It also appeals to people who
age 70, you are entitled to the full benefitfeel that it is an opportunity, for once, to take
amount, as if you never took benefits to beginfrom the government, rather than the other way
with. This provision has been on the books sincearound.
1964 but has received very little attention untilIn our opinion, the risks of this strategy outweigh
recently.the possible rewards. We think of Social Security
So one possible use for the $300,000, or at leastnot as supplemental retirement income but rather
part of it, is paying back your Social Securityas a cheap source of longevity insurance.
benefits. Using cash to repay Social SecurityWaiting until age 70, to start Social Security
benefits, in exchange for an additional dollarbenefits, matches up the highest benefit scenario
amount, to be paid each month until your death, iswith the highest expense scenario, which is that
effectively the same as buying an immediateyou live too long. When you start benefits early,
annuity.with the intention of repaying them later and
The one major difference is that you can buy anpocketing the interest, you are jeopardizing a
annuity from an insurance company for any value.very important benefit later in life for minimal gain.
You can only buy an annuity from theFor example, many people will not be disciplined
government for the value of the dollars you haveenough to invest the benefits, in CDs or safe
received in benefits.cash equivalents, as they are paid. Some will end
You have to do the math, but often the additionalup spending the benefits. Others may lose it by
benefit, as a percentage of the dollars repaid, willtaking too much risk. Either way, the risk is that
be higher than the interest paid on an immediateyou do not have the money to repay the benefit
annuity from an insurance company. That iswhen the time comes.
because the interest on an insurance annuity isOn the other hand, if you do the prudent thing,
set by market rates. Social Security benefits areand invest the money safely so you are sure to
set by statute.have it when you need to pay it back, the return
As an example, in a recent Journal of Financialyou will receive is minimal. As of this writing, the
Planning article, which described this strategy, thereturn on a 10 year, U.S. Treasury is right at
author, Charles Ryan, CFP®, calculated the2.5%! A return of less than 2%, in exchange for
impact of resetting Social Security for anjeopardizing your longevity insurance policy just
unmarried, 70-year-old female who originally fileddoesn't make sense.
for benefits at age 62. In this particular scenario,So, if for whatever reason, you began taking
her after-tax benefits increase by $8,568 in theSocial Security before the age of 70 and you
first year alone.now find yourself in the market for an immediate
But, this first required her to repay the $110,845annuity, be sure you take a look at the math on
in benefits she had already received. There is arepaying your Social Security benefits for some
tax credit for the taxes she paid through theportion of the income you are seeking.
years on her benefits. The net repayment, afterSometimes, it will be a better deal than an
the tax credit, according to Ryan's calculations, isinsurance annuity.
$87,290.However, it is not to be confused with the
The article then looks at the alternative. In thisstrategy of intentionally starting Social Security
case, using the $87,290 to purchase a Vanguardbenefits early so you can repay them and pocket
immediate annuity. According to Ryan, the annuitythe interest. That, to my way of thinking, is a lot
would generate after-tax income of nearly $5,100of risk for very little reward.
in the first year-well below the amount providedNo statement in this article should be construed
by resetting her Social Security.as a recommendation to buy or sell a security or
Of course, this is only one example and the mathto provide investment advice unless specifically
doesn't always work out this way. So do yourstated as such. All investments involve risk
homework. If you need help, find a retirementincluding possible loss of principal.
planner who can help you evaluate your choices.