Social Security Earnings Penalty?

A good deal of misinformation is published about a so-called Social Security earnings penalty. Many are led to believe that if they earn money while collecting Social Security, they'll lose some of this benefit forever. Retirees should ignore all talk about a “penalty,” which only discourages prudent cost-benefit analysis.

The Social Security retirement earnings test affects those who earn income while claiming Social Security benefits before age 66, which is full retirement age (FRA) for those born before 1955. It impacts equally those who are claiming personal retirement benefits, spousal benefits and survivor benefits. Those who delay claiming their benefit until FRA or later will not be impacted. For example, after age 66, you can earn $1 million (or more) a year without cutting into your Social Security checks.

Even if you are under age 66, going back to work has a double benefit. For starters, this additional income can raise your 35-year income average, which is the basis of your Social Security benefit. Second, going back to work is treated as if you had delayed taking your retirement benefit to an older age and you begin receiving this higher benefit at FRA.

Here’s how the earnings limit works: Only wages count towards this earnings test, not your investment earnings or pension payments. For 2013, the general limit is $15,120. For every $2 over this limit, you will see your Social Security benefit reduced by $1. For example, if you are 63 and your wages are expected to be $24,000, this puts you $8,880 over the earnings limit and will reduce your benefit by $4,440.

If your Social Security benefit happens to be $2,220 per month, Social Security will withhold payments for the first two months to cover the $4,440 excess amount and then resume your normal payment in the third month. At FRA, your benefit is increased to account for the two-month delay. This means that you will be repaid the benefits that you deferred with interest over your lifetime. Those who die prematurely may receive a negative return on this deferral but those who live to life expectancy or beyond will receive a healthy inflation-adjusted payback.

If you reach full FRA during 2013, you will only have $1 withheld for every $3 earned over $40,080. However, these rules don’t affect you in the year you retire that protects you from both earnings limits. You can earn an unlimited amount for the first part of the year, retire, and immediately begin receiving your full benefits.

The earnings test in not a penalty but rather a deferral of retirement benefits. In fact, some retirees who now understand that claiming early Social Security benefits was a poor decision could go back to work and have the earnings test give them a do-over.

Because the earnings test is not a penalty, retirees should not hesitate to go back to work. In fact, since so many are confused by this topic, we should wonder why the test exists at all. In fact, the Social Security Earnings Test Repeal Act of 2013 aims to strike this option from the records. The problem with repealing this law is that too many people already claim benefits at age 62. Removing the illusion of a penalty might incentivize more people to claim early. And delaying your Social Security benefit is almost always the correct answer.

About the author

Matthew J. Illian, CFP®, AIF®
Matthew J. Illian, CFP®, AIF®

Matthew Illian is part of the Investment Committee at Marotta Wealth Management, Inc. and specializes in small businesses consulting and retirement planning. He is devoted to his lovely wife and three rambunctious boys all under the age of six. Favorite mountain biking trails: Forest Hill Park

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