How Does the Earnings Test Apply to Social Security Benefits?
Choosing when to take your Social Security benefits — whether that moment is before, at, or beyond your Full Retirement Age (or Normal Retirement Age) — could be one of the most important decisions you will make for your retirement income plan.
Why is knowing your Full Retirement Age (FRA) so critical? Claiming your Social Security benefits prior to reaching your FRA results in a reduction of your benefit, a reduction that lasts for your entire life. Since Social Security is likely to be the largest “income asset” for many people, understanding what could reduce that payout, and potentially how to avoid that reduction, is paramount.
It’s not just that. If you are working and take Social Security benefits before attaining your Full Retirement Age, the Social Security Administration will also reduce your benefits payments should your earnings exceed certain limits. This is called the “Earnings Test” by the SSA and financial professionals. According to Transamerica Center for Retirement Studies, 53% of workers plan to work past 65, and 56% plan to work after they retire.
Given that lots of Americans have working plans for their retirement future, how could the Earnings Test affect their benefits payments? For one, it isn’t clear to many people exactly what earnings apply toward the Earnings Test — and therefore what could affect their benefits payouts.
Full Retirement Age — a Lynchpin in the Earnings Test
Remember how your Full Retirement Age can affect your Social Security checks? Well, here is a quick rundown of what it entails really fast.
As a reminder, the Social Security Administration determines your FRA based on the year in which you were born. If you were born after 1943, your FRA is somewhere between your 66th and 67th birthday. This chart can help you pinpoint when your Full Retirement Age applies.
Let’s say you were born after 1961, giving you a FRA of 67. If you start your retirement benefits at age 62, your monthly benefit amount is reduced by about 30 percent…forever. This data from the Social Security Administration shows how your benefits will be reduced when you start taking them at other pre-FRA ages:
- 63 is about 25 percent
- 64 is about 20 percent
- 65 is about 13.3 percent
- 66 is about 6.7 percent
If you are thinking of claiming early and then potentially working to earn extra income to compensate for the loss, the Social Security Administration has something to say about that, too.
Putting Your Earnings to the Test
If you are below your Full Retirement Age and take Social Security benefits while still working, Social Security withholds benefits if your earnings exceed a certain level, called a retirement earnings test exempt amount. There are actually two earnings thresholds to be concerned about: one that applies during the years before you attain your FRA and one that applies the year you attain it.
For example, the Annual Retirement Earnings Test Exempt Amounts for 2018 are $17,040 if you have not reached your FRA and $45,360 in the year you attain that status.
These exempt amounts generally increase annually with increases in the national average wage index. According to the Social Security Administration, this higher exempt amount applies only to earnings made in months prior to the month of attaining FRA (Thanks for keeping it simple, SSA!).
What happens when you earn more than these earnings test amounts? The government starts taking scissors to your monthly benefit.
For every $2 you earn above the lower exempt amount ($17,040), your Social Security benefit is reduced by $1. If the higher amount ($45,360) applies to you, for every $3 you earn above that, your benefit is reduced by $1. Earnings in or after the month you reach FRA do not count toward the retirement test.
How Do I Calculate My Earnings?
You calculate your earnings the same way the government calculates your annual earnings: any combination of gross wages from an employer and net earnings from self-employment. These are reported to the Internal Revenue Service, which then shares this data with the Social Security Administration.
And what types of income don’t count? The SSA writes that it doesn’t consider the income such as the following for the earnings limits:
- Other government benefits
- Investment earnings
- Interest
- Pensions
- Annuities
- Capital gains
That being said, employee contributions toward a pension or retirement plan do apply in the earnings limits, though, if the contribution amount is part of the employee’s gross wages.
Laurence Kotlikoff, author of Forbes.com’s popular “Ask Larry” column and a professor of economics at Boston University, explains that since those IRS reports are received after the year in which the income was earned, they are only used for enforcement purposes.
“Social Security initially relies on what a beneficiary reports as their expected earnings when determining whether or not to withhold benefits for earnings test reasons,” he writes.
“$17,040 is the calendar year limit, but there is an alternate monthly retirement test that can be used in the first year of a person’s entitlement to Social Security benefits, and if the monthly test is more advantageous,” he states.
Are Those Withheld Benefit Amounts Gone Forever?
Good news: Unlike the penalty for taking your Social Security before FRA, which reduces your benefit payout forever, any benefit amounts withheld due to exceeding the earnings test while you were working are not permanently “lost.” According to the Social Security Administration, once you reach FRA, your monthly benefit will be increased permanently to account for the months in which benefits were withheld.
In retirement your goal is to maximize income so that you can live comfortably and without financial stress. With Social Security benefits being such an important income source for so many of us, knowing when to elect to take your benefits—as well as the impact of working while taking those benefits—needs to be part of any retirement planning conversation.
As a starting point, it’s helpful to know the Break-Even Ages for Social Security. If you have a partner, consider how long both of you might live, each other’s individual earnings record (whose is larger), what your future working plans will be, and personal expectations for taking your benefits.
You may want to work with a financial professional to coordinate your “benefit taking” choices with the rest of your retirement and income planning efforts. That way you can enjoy the most comfortable, income-rich retirement possible.
Need Help Planning for an Income-Rich Retirement?
If you could use the guidance of a financial professional in coordinating your Social Security benefits with other income-paying strategies, SafeMoney can help you. Financial professionals stand ready to assist you starting with a no-obligation conversation about your goals and situation.
You can connect with someone directly by using our “Find a Financial Professional” section. Should you need a personal referral, call us at 877.476.9723.
