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Social Security Closes Free Loan Loophole

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Social Security CardBefore the Social Security Administration published new guidance to change it, you could effectively take an interest free loan against your Social Security benefit if you were eligible to receive benefits. Once you were eligible to receive benefits, you could start taking your benefits early (and thus a reduced benefit) and then withdraw your benefit application once you hit full retirement (and thus maximum SSA benefits). Once you withdrew your application, you’d have to pay back the benefits you received. Once you did that, you were all square with the SSA and you could continue to wait until full retirement age, when you’d receive the maximum benefit. The end result was an interest free loan.

You can start taking Social Security benefits at age 62 but it’s reduced compared to what you’d at 66, which is full retirement age. You would start claiming the benefits at 62, put them in an interest bearing account, and then withdraw your application when you turned 66. At that point, you’d pay back whatever benefits you received and keep the interest. Then immediately apply again and get full benefits.

The door has pretty much been closed on the free loan loophole (OK, technically it’s been shut to a sliver) when the SSA created a 12-month deadline to withdraw your application. In other words, you can get a loan but it’s only for a year. A percent or two in interest each year for four years might be worth the paperwork but it’s not really worth it for just 12 months.

Hat tip to the fine folks at the NY Times Bucks blog, where I first read about this change.

(Photo: thehi)

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15 Responses to “Social Security Closes Free Loan Loophole”

  1. zapeta says:

    I’m surprised that loophole existed in the first place. Given current interest rates it definitely doesn’t make sense to do this kind of loan now.

  2. jsbrendog says:

    it’s crazy how many backdoor boogaloos are built into our government systems….especially the ones very few people know about. and of course, they make them hard to understand so less people will take advantage of them. le sigh

  3. freeby50 says:

    SS statement says: “The agency is changing its withdrawal policy because recent media articles have promoted the use of the current policy as a means for retired beneficiaries to acquire an “interest-free loan.””

    I remember a lot of people talking about this. I guess the agency noticed as well.

  4. I hadn’t heard about this, but it doesn’t really surprise me all that much. Whenever a system exists with rules, there will always be people looking to find some tiny little “loophole” to exploit. At least they caught it.

  5. DIY Investor says:

    There is a huge difference between taking social security early and waiting until you must take it. The government apparently felt it protected them from recipients who showed up when they were 70 and said they didn’t know – sort of like today’s recharacterizing opportunity with Roth conversions.
    IMHO the government needs to stop treating people like little children. If you can’t read well enough to understand that by waiting you can double your soc. sec. payment then too bad. Closing this loophole is an excellent idea. They should even close the 12 month window IMO.

    • tbork84 says:

      I definitely agree that there are far too many rules in place that end up treating citizens like children who need to be told what to do. It would be much more productive if the government spent its time creating programs that would actually educate citizens as to what they should do and what risks, dangers and rewards exist for different decisions.

    • cubiclegeoff says:

      I could see a benefit of allowing a 12 month window. If someone loses their job and runs out of benefits and needs to take SS to survive at 62, but 6 months later find a job and go off SS, then I think they could pay back that amount and it would be reasonable.

      • Scott says:

        So it’s a kind of welfare for those who do not plan for a rainy day at age 61.5?

        Besides that, they would not benefit in your scenario. You can stop taking benefits at 62 and pick back up at a higher rate at 67, 69, etc. based on adding back in your newfound wages.

  6. Scott says:

    I’ve been hearing about this for the past year. Probably used by a small # of people and now the masses know. They’re probably doing this now so they are not flooded with the lay persons doing it.

    I wish there was a program to educate seniors, maybe a public program to bring them up to speed on the services (financial & public) they could use or not based on them knowing. It’s not like they have a job to go to…unless they didn’t plan. Maybe offer it at Walmart…they’d probably pay for it if they thought they’d make money from them shopping.

    I agree with doing away with the program, just for the record. Just a loophole for those who can afford to pay it back after years of using it.

  7. Tummy says:

    You are completely missing the point of this and the great benefit of the loophole. By returning the money and reapplying at the full rate, you would be locking in the increased benefit for the rest of your life as well as off your surviving spouse.

    Also in the year you return the money, it is deducted from your income so you will have a negative income for that year. If you have money in a regular Ira, you are then able to do a roth conversion and not have to pay any income taxes on that amount.

    In 2007 about 500 people took advantage of the loophole, but that increased as it became more widely known to about 1,000 people in 2009.

    The benefit was way more than a free loan.

  8. Scott says:

    I would have done it just to hedge my life expectancy. Most of my family don’t live past 70, so if I’m still living healthy, I re-pay at age 69 and up my monthly income.

    In the meantime, I’d invest and get 4-5% on their money.

    No doubt this was made for a much larger reason, just wish we were told the truth as to why.

  9. Terry says:

    Most people know they would get a larger monthly benefit by waiting…the issue is that the individual must make a calculation based on their subjective life expectancy.

    Since you lose ALL benefits and collect nothing – thank you for playing! – if you die between 62 and your full retirement age, it should not be a surprise that so many opt for the early benefits.

  10. Mike says:

    I knew of and thought about using the loophole until I began wondering whether I would be able to recoup the income taxes paid for all the years I collected early payments. Maybe I could recoup 3 years worth but not all the years. If I am correct (and I am not saying I am!), maybe the “government” would be better off financially to leave the loophole in. Of course the SSA would not be better off because the unrecouped taxes would have been paid to the IRS and not returned to the SSA account. I agree with jsbrendog, too many loopholes which benefit a small group of people. I am for a simple system that everyone pays a percentage of ALL their income (Why is there a cap? – another great topic!)

  11. govenar says:

    Why don’t they just make people repay the interest too?

  12. Mark says:

    The benefit was way more than a free loan.<==

    Not to mention if you die between age 62 and age 66 your heirs will keep all benefits paid. If you are waiting for age 66 to apply for social security and you die at age 65 your heirs are SOL.


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