Social Security and the Earnings Test
No matter how you feel about social security, it is still one of the most important assets a person will have in their lifetime.
According to a study by Allianz, approximately 63% of people fear running out of money in retirement – more than fear death.
Social security is there to help alleviate that fear. It provides a lifetime income source that is impossible to outlive. For some this is their only income source, for others, this is an extra cushion.
Social security has a lot of issues, especially as baby boomers claim more than millennials are contributing.
It may have to cut the benefits to future generations to stay solvent. If people continue to pay into social security, it will remain around to pay out some assets.
It will raise the full retirement age for future generations. Full retirement age started at 65 years old, but people claiming retirement now are at full retirement age when they are 67 years old. For people born in 1955, the full retirement age is 66 years and 2 months. It will gradually rise to 67 years old for people born in 1960 or later. You should expect future generations to wait until 70 years old to reach full retirement age.
Anyone who has attempted to claim social security or inquire about social security already knows, social security is extremely complicated. In this article we want to touch on one aspect of social security, the earnings test. You will get a brief overview of how benefits are calculated, the earnings test thresholds, how to get your money back, and when to tell social security you have an income.
Quick Social Secuirty Benefit Calculator
There are essentially three “levels” a person can claim their own social security at. This ignores claiming disability, ex-spouse, deceased spouse, or spousal benefits.
When you claim your own social security, you can start it at the age of 62. This is claiming your benefits early and will cause you to have a reduction in benefits for the rest of your lifetime. You could have your benefits reduced up to 25% if you claim at age 62 when your full retirement age is 66.
The next level is at your full retirement age. This age depends on when you were born and is now broken down to the year plus a set number of months you must wait.
The third level that you need to be aware of is claiming social security at the age of 70. Waiting this long to start receiving your benefits builds up delayed credits and increases your benefit amount. For every year you wait to claim after your full retirement age will gain you 8% more in lifetime benefits.
These levels are not lines in the sand for receiving benefits. Anytime you claim before your full retirement age, you will have a reduction in benefits. The reduction will be lower the closer you are to your full retirement age.
The full retirement age is the line in the sand. This is not only an exact year but also an exact number of months past your birthday.
The longer you wait past your full retirement age, the bigger the increase in benefits will be. At age 70 you will be required to start receiving benefits.
Claiming Social Secuirty and the Earnings Test
Social security is always trying to find a way to reduce your benefits. They figure if they can harbor more money now, they may not have to pay you as much later.
This becomes apparent if you are currently receiving an income and want to claim your social security benefits early.
In this scenario, social security will subject your benefits to an earnings test. If you make more than $17,640 they will withhold $1 for every $2 you are above that limit. For example, if you made $40,000 then they would withhold $11,180 or $931 a month from your benefits. As you can see, you can quickly earn too much and wipe out all your benefits.
In the year you turn your full retirement age, the income limit increases. If you make more than $46,920 they will withhold $1 for every $3 you are above the limit. Not only did they increase the income limit, but they reduced the benefit reduction. For example, if you make $70,000 in the year of your full retirement age they would withhold $7,693 or $641 a month. That stings a little bit less.
Once you reach full retirement age the earnings test is gone. You can still work and make an income but none of your benefits will be reduced because of it. It doesn’t matter how much you earn or how long you decide to work for.
What counts as income for the earnings test?
According to AARP, “In general, the Social Security Administration defines “earned income” as “income from wage or net earnings from self-employment.” For example, earnings may include bonuses, commissions, and severance pay. Investment income, pensions, capital gains, and inheritances are not considered wages.”
What Happens to Money Withheld in the Earnings Test
Money withheld is not money gone.
No, you will not receive a lump sum payment for all the money that they withheld. What will happen is a recalculation of your benefits. Social security will total all the money they withheld and figure out how many months of benefits it adds up to. Once they have this number they will add it to the date you decided to file to get a new filing date.
For example, you retired at 62 while still earning an income, and they collected 1 years’ worth of benefits from you. Once you hit your full retirement age they would recalculate your benefits as if you retired at the age of 63, not 62. This would allow social security to give you the money they have withheld by increasing your benefits.
Should You Tell Social Security You Have Income
The ultimate question is, should you tell social security you have an income?
Unfortunately, there is no way to hide the fact that you have income from social security. One of the perks of being a government agency is that it allows them to communicate with other government agencies, specifically the IRS.
When you go to claim your social security, it is a good idea to go ahead and tell them you are still going to receive an income. If for some reason you don’t, and they miss it, they will reduce your benefits to make up for it.
They can either reduce your benefits or suspend them completely until they have been paid back the money that they are owed. There is nothing worse to count on the extra money from social security only to have them suspended completely. Social security doesn’t make mistakes often with their calculations, but it can be a headache when they must reduce benefits and recalculate. You want to avoid all this headache and make sure they get it right the first time be informing them of your intentions.
Special Rule That Allows You to Work Part of a Year
What happens if your full retirement age doesn’t happen until August, but you retire in March after you’ve already made an income of $50,000. Normally, social security would reduce your benefits $1 for every $3 that you were over the limit. It doesn’t matter than you have no current income because you retired. The fact that you made money during the year still counts as being over the income limit.
What you can do in this situation is tell social security that you want them to calculate your benefits monthly instead of annually. They will ignore the money you made before you retire and start claiming and start counting your monthly income going forward. The downside of this is that they will turn the annual limit to a monthly limit.
Let’s say you had the $50,000 in income through March, you retire but your full retirement age isn’t until August. In May, you work a part time job and make $5,000 for the month. This amount would be over the monthly limit of $3,910, so your benefits will be reduced.
With social security, it can be difficult to see the forest through the trees. There is a lot of inner-workings happening that can make it confusing when you try to claim your own benefits.
Once you understand the earnings test you will have a good idea on how your benefits will be affected if you claim early while earning income.
There are certain income limits that if you are above, your benefits will be reduced. These income limits are low which make them easy to cross. Once you are in the year of your full retirement age the income limits and reduction become much more lenient. As soon as you hit your full retirement age, the earnings test goes away completely.