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Social Security: pay it forward

SAN FRANCISCO — Many people start their Social Security benefits early — at age 62 — because they embrace the adage that a bird in the hand is worth two in the bush. It turns out that sometimes you can have all three birds.

You may think that once you start Social Security benefits, you can't go back and change your mind, but a little-known rule allows you to cancel your decision and start over.

The catch? You must have the assets available to pay back all the benefits you received. There's no interest or penalty tacked on.

After paying back those benefits, you can re-apply for benefits at a higher monthly amount, thanks to the fact that you're older.

Consider high-wage earners who are now 63 years old. If they started benefits at age 62, the payout would total just $18,794 per year.

By waiting until full retirement age of 66 to start benefits, the annual take goes to $25,732. At 70, the benefits jump to $35,250, almost double the dollars earned when tapping the system at the earliest age. (In general, your benefit increases by 8 percent per year until age 70, after which it does not increase).

Paying back your benefits and then restarting at a later age can mean a "potentially huge increase in your living standard," said Laurence Kotlikoff, an economist at Boston University.

Still, the window during which this strategy makes sense is somewhat narrow. Someone who is already, say, 78 years old likely shouldn't do it "because they don't have that many years over which to recover" the lump-sum repayment, Kotlikoff said.

"It's sensitive to your particular circumstances. If you're 68, 69, 70 and you took your benefits around 62 and you have less than $500,000 in assets, then you're talking about anywhere from a 5 percent to 30 percent living-standard hike," said Kotlikoff, based on his plugging sample scenarios into a financial tool he developed. That tool, available for a fee at ESPlanner.com, is based on the theory that individuals are best served by smoothing their living standard over time, thus avoiding major financial spikes and declines.

The payback-and-restart strategy won't provide the same living-standard increase to retirees with higher net worth, as Social Security benefits comprise a smaller percentage of income.

Meanwhile, people with health concerns who don't expect to live an average life span, or those who expect to need that lump sum for, say, nursing-home costs should probably avoid this pay-back strategy.

Don't forget the opportunity cost, said Christine Fahlund, senior financial planner with T. Rowe Price in Baltimore. If you pay back the money and delay benefits for a few years, you're delaying money you could otherwise invest or spend. If you die sooner than you expect, you may not recoup the lump-sum you paid back (though your widow and minor children are eligible for survivor benefits).

Still, she said, while investing Social Security benefits can result in a nice nest egg down the road, choosing to delay receiving benefits is often the more lucrative option, and that means paying back and restarting may make sense.

Social Security beneficiaries "should definitely look into it because the increases you get by delaying are so substantial and they are guaranteed," Fahlund said. Plus, she said, Social Security's annual cost-of-living adjustment works in your favor at a higher monthly benefit.

Social Security "takes your initial (benefit amount) and compounds that number over the years for inflation. Compounding a bigger number gives you more money," Fahlund said.

Living longer

Often, people don't like the idea of delaying money into the future — they want the bird in hand — but given longer life expectancies many planners are trying to convince people to change those views.

"People don't necessarily get where the risk is here," Kotlikoff said. "When you're dead, you're not going to feel bad because you left money on the table. It's only when you're alive that you've got to care about it." Running out of money before you die is the biggest risk, he said.

The decision to delay benefits "comes down to your life expectancy," said Brian Berberet, a chartered financial analyst at Carrick Bend Advisors, in San Mateo, Calif.