Personal Finance: Working While Receiving Early Social Security Benefits

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Wednesday, November 26, 2014

Joe Alfonso, GoLocalPDX Contributor

Deciding when to begin taking your Social Security retirement benefit is a very important decision for several reasons.  When you start your benefit affects how much you receive insofar as there is a reduction for starting benefits before your full retirement age (FRA).  Conversely, there is an 8% credit for each year you delay beginning your benefit after FRA (up to age 70).  The difference is significant and is compounded over time given that Social Security benefits are adjusted for inflation.  For someone whose FRA is 66, the difference between the age 62 early benefit and the age 70 delayed benefit is 76%.  Clearly, timing is critical in deciding when to start taking your Social Security benefit.

In spite of the reduction for early claiming, some beneficiaries still decide to take an early benefit for a variety of reasons.  These can range from the valid, such as a shorter expected life expectancy or a lack of other income sources to fund a delay in claiming, to the less valid, such as a fear that the Social Security system is in danger of becoming insolvent.  

Regardless of the reason, it is important to realize that taking Social Security benefits before your FRA subjects you to another benefit limitation known as the annual Earnings Test.  The Earnings Test impacts early beneficiaries who work while receiving benefits and needs to be considered before deciding to move forward with an early claiming plan.  This test is often misunderstood.  The following is an overview of how it works.

Who Is Affected?

Anyone receiving Social Security benefits who has not yet reached FRA and earns wages for work performed or who has net self-employment income is subject to the Earnings Test.  

Who Is Not Affected?

Early Social Security beneficiaries whose only other sources of income are IRA distributions, pensions, unemployment benefits, or investment income are not subject to the Earnings Test as these are not considered wages.   Beneficiaries who have reached FRA are fully exempt from the Earnings Test regardless of how much they earn.

How Does the Test Work?

Beneficiaries younger than FRA will have $1 of benefits withheld for every $2 dollars of income earned over an annual maximum amount.  In 2014, the annual maximum amount is $15,480.  In the year that a working beneficiary reaches FRA, and up until the month of attaining FRA, the annual earnings limit increases and only $1 for every $3 earned in excess of this limit is withheld.  In 2014, the FRA year earnings limit is $41,400.

Let’s look at some examples to illustrate the test in action.

• Earnings Test in Pre-FRA Years:

Jim files for benefits in January 2014 at age 62.  His reduced benefit is $600/month or $7,200/year.  During 2014 he earns $20,800 ($5,320 above the 2014 $15,480 earnings limit).  Jim will have $2,660 of his 2014 benefits withheld under the earrings test ($20,800 - $15,480 = $5,320/2 = $2,660). Social Security will withhold all of Jim’s benefits through May 2014, totaling $3,000, and restart these in June.  In January 2015 Jim will receive a refund of $340 for the additional amount withheld in May 2014.  

• Earnings Test in FRA Year

Let’s assume that Jim reached FRA in November of 2014.  From January through October, Jim earned $42,900, $1,500 in excess of the 2014 Earnings Test limit in the FRA year.  This would result in a $500 withholding of benefits ($42,900 – $41,400 = $1,500/3 = $500).  Social Security will withhold the January 2014 $600 benefit check in its entirety and begin normal benefit payments in February.  In January of 2015, Social Security will refund the excess $100 withheld in January 2014.

• Special Rule in The First Retirement Year

A special rule applies to beneficiaries who first begin receiving benefits in mid-year having earned more than the annual earnings limit.  In this case, the beneficiary’s earnings before starting benefits are not counted.  For the months after starting benefits, the pre-FRA age annual wage limit will be pro-rated to $1,290/month and only wages earned in excess of this amount will be subject to withholding.  

Let’s assume that Jim earned a total of $45,000 through October 2014.  In November Jim turns age 62 and begins receiving Social Security.  At that time he takes a part-time job earning $500/month.  Even though his total annual earnings in 2014 will be well in excess of the $15,480 annual pre-FRA earnings limit, Social Security will pay Jim his entire monthly benefit in November and December because his earnings in each of these months are less than $1,290.  Beginning in 2015, Jim will be subject to the annual earnings limitation for the entire year.

What Happens to Withheld Benefits?

It is important to note that benefits withheld due to the Earnings Test are not permanently lost.  They will be paid back to you starting at FRA in the form of an actuarially increased monthly benefit.  

Let’s use Jim again as an example.  Assume Jim’s FRA benefit was $1,000/month and he decided to take an early benefit at age 62.  This would result in a 25% benefit reduction yielding a monthly benefit of $750. Let’s further assume Jim returns to work and between age 62 and his FRA has a total of 12 months of benefits withheld due to the Earnings Test.  Upon reaching FRA, Social Security will credit these 12 months to Jim by adjusting his effective initial claiming age to age 63.  At Jim’s FRA, this results in an increased monthly benefit of $800, in today’s dollars, reflecting the adjusted claiming age and a lower commensurate benefit reduction of 20%.  

One last thing to note is that benefits paid to spouses or children based on your retirement benefit will also be reduced if your retirement benefit is impacted by the Earnings Test.  Any earnings these family members have of their own will not affect your retirement benefit but may impact any benefits they receive.

It is important to be aware of the Earning Test if you are thinking of working while receiving early Social Security benefits.  It probably does not make much sense to file for early benefits if you know most or all of these will be withheld due to the test.  If circumstances, however, require that you still need to work by all means do so since any benefits lost will be eventually refunded beginning at your FRA.

Readers with questions on personal finance and Social Security can email Joe Alfonso at [email protected].

Joe Alfonso, CFP®, ChFC, EA regularly writes on financial topics and is an expert on Social Security planning. He is founder of the Fee-Only financial planning firm Aegis Financial Advisory in Lake Oswego, Ore., and is the principal advisor for the firm. Joe is a CERTIFIED FINANCIAL PLANNER™ professional and an Enrolled Agent, admitted to practice before the IRS to represent taxpayers at all administrative levels for audits, collections, and appeals. He is a member of The National Association of Personal Financial Advisors (NAPFA).

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