Planning for retirement got more challenging recently, thanks to the Social Security Administration's (SSA) announcement in December 2010 of new rules surrounding so-called interest-free loans. Many clients who planned to take advantage of this strategy will no longer be able to do so, which could have a big impact on retirement cash flow planning and perhaps even their retirement start date.

First, let's review how these interest-free loans worked. As most financial advisors will attest, determining when to claim Social Security benefits is perhaps one of the most important decisions a retiree can make. The SSA permits retirees to apply for reduced benefits as early as age 62-or to delay receipt of benefits to full retirement age or age 70, when the monthly benefit, which includes delayed retirement credits, is much higher.

Before Dec. 8, 2010, there was a little-known provision that allowed retirees who accepted early benefits at age 62 to pay back all benefits received once they reached full retirement age and then to reapply to receive higher benefits, subject to the SSA's approval. Retirees could do so without paying any interest, or any gains earned, on the benefits they received during this period.

Granted, the interest-free loan rule was likely established for retirees who decided to go back into the workforce shortly after they began receiving benefits. It wasn't intended as a way to receive a free loan from the government, until other more substantial assets became available. Nevertheless, many astute financial planners who were knowledgeable about this feature were able to help clients maximize their choices in terms of their retirement start dates, cash flow and even the ability to take part-time employment.

LOSS OF FLEXIBILITY

With the new rules, which took effect immediately, this flexibility no longer exists. For example:

* The time period retirees have to voluntarily withdraw an application for retirement benefits is now limited to within 12 months of entitlement, and retirees can withdraw only one application per lifetime.

* Benefits can be suspended retroactively only for the past months in which no benefits were entitled or received. (This change is in direct response to the planning strategy discussed here-where retirees applied for early retirement benefits with the intention of later withdrawing the application, repaying the benefits and reapplying for higher benefits.)

* Retirees can no longer repay benefits and ask the SSA to recalculate their benefits based on their current age.

* Retirees can still suspend their benefits and restart them at a later date, but without the dramatic adjustment the interest-free loan strategy previously promised.

There are likely several factors behind the SSA's decision to remove the interest-free loan feature. The Center for Retirement Research estimates that those taking advantage of the interest-free loan strategy could cost the system as much as $11 billion. And if you consider that delayed claiming would increase the survivor benefit to couples, the amount could be even higher.

One can also assume that the recent reduction in Social Security payroll tax-from 6.2% to 4.2% for the 2011 tax year-will result in less revenue, so removing the loan feature would lessen the financial impact of the tax reduction on the Social Security trust funds. And when you consider that more individuals are amassing wealth through 401(k) plans-therefore giving themselves a dependable retirement income stream-an increasingly large percentage of retirees could potentially try to take advantage of the interest-free loan strategy. So it makes financial sense-given concerns over the solvency of the Social Security trust funds-for the SSA to eliminate the possibility.

FUTURE IMPLICATIONS

In theory, the interest-free loan strategy created many inequities between those who could afford their retirement and those who were not financially prepared to retire. Realistically, we can assume that anyone who can afford the payback option has sufficient income to support their lifestyle in retirement.

This is interesting, as it begs some additional questions. For example, if one of the main reasons for the rule change is the perceived misuse of the interest-free loan, might the SSA use this as a reason to make future changes to the system? What other features that benefit financially savvy investors might be removed? How will such changes impact retirement income plans crafted just a few years ago?

Matthew Somberg of Levine, Gottfried & Somberg in Glastonbury, Conn., says the new rules may certainly change some of the recommendations he makes going forward. "It confirms for me that Social Security benefits can and will change; as a result, we need to update our retirement income planning consistently for our clients."