Up to this point in our Social Security blog series, we have covered the core components of Social Security, including eligibility, different benefits that are available, and how benefits are taxed. This post highlights special circumstances when Social Security benefits may be reduced. Our final article will cover the most important question of all – when should I take my retirement benefit?
One of the most significant pitfalls of Social Security applies to those who file early for benefits and continue to work. As previously discussed, retirement benefits may begin as early as age 62 but are permanently reduced. If an early filer remains working after starting their retirement benefit, they may face an additional reduction to their benefits. Social Security applies an earnings limit test to the earned income of early filers. If that income exceeds the limit, your Social Security benefit will be reduced for a period of time. The earnings limit for 2018 is $17,040, which includes wages, self-employment income, bonuses, tips, commissions, and vacation pay.
From the time you file early up to the year you reach your Full Retirement Age (FRA), Social Security will withhold $1 for every $2 of income above the earnings limit. For example, if you earned $10,000 above $17,040 annual limit ($27,040 total), Social Security will withhold $5,000 from your retirement benefit for the year. In the year you reach FRA, the earnings limit is increased to $45,360 (2018). The withholding amount changes to a $1 deduction for every $3 earned above the limit.
Once you reach FRA, the earnings limit test no longer applies. Social Security will recalculate your benefit to give credit for the amount that was withheld. However, this earnings limit can catch recipients off guard if they decide to file early and wish to continue to work, and it can cause considerable cash flow issues if you’re counting on the additional income.
The other reductions that could impact Social Security benefits are the Windfall Elimination Provision (WEP) and the Government Pension Offset (GPO). These apply to individuals who are qualified for Social Security benefits but also worked in a job that paid into a retirement system other than Social Security. The most common scenario we see is public school teachers who paid into the Teacher Retirement System (TRS), not Social Security.
The Windfall Elimination Provision (WEP) impacts individuals who receive a retirement pension from a job where they did not pay into Social Security. If you will receive a “non-covered” pension and are also eligible for Social Security, you may face a reduction for the Social Security benefits you’re eligible to receive. The amount of the WEP reduction is determined by the number of years where you had “substantial earnings” and paid Social Security tax.
If you have less than 20 years of substantial earnings (i.e., you spent most of your career paying into the other retirement system), your Social Security benefit may be reduced up to 40%-50%. The WEP reduction diminishes between 20-30 years of substantial earnings. Above 30 years, there is no WEP reduction. It is important to recognize that the WEP may reduce your Social Security benefit but cannot eliminate it. You will also still receive your full non-covered pension.
The Government Pension Offset (GPO) is also triggered when an individual qualifies for Social Security and has a non-covered government pension. However, the GPO applies only to spousal and survivor benefits, not the individual’s retirement benefit. Unlike the WEP, the GPO may eliminate the benefit a spouse or survivor is eligible to receive entirely.
The GPO reduces spouse and survivor benefits by two-thirds of the amount of the non-covered government pension. For example, if you receive a pension of $600/month, two-thirds of that amount ($400) would offset any spousal and/or survivor Social Security benefits. If your spouse was eligible for a $500/month spousal benefit, they would only receive $100/month from Social Security ($500 – $400 = $100).
If two-thirds of the non-covered government pension is greater than the full spousal or survivor benefit, no Social Security benefit is paid out. If your pension is $3,000/month and your spouse was eligible for the same $500/month spousal benefit in the previous example, the GPO would eliminate that benefit. Two-thirds of the non-covered pension ($2000) is greater than the spousal benefit amount ($500).
These reductions can have a significant impact on your retirement. If you’re considering taking your Social Security benefit early and wish to continue working, it is important to keep your income below the annual earnings test limit. Otherwise, you may be better off waiting until you reach Full Retirement Age and/or until you’re fully retired. If you face the WEP and/or GPO reductions, you may have less control over how your benefits are impacted. Therefore, it’s critical to start focusing on your long-term financial plan long before you retire.
If you have questions regarding your own Social Security benefits, please feel free to contact us today.