Higher earnings limit applies at 66

My recent column on how the Social Security earnings cap is applied during the first year of retirement…

My recent column on how the Social Security earnings cap is applied during the first year of retirement triggered several more questions.

Normally, people who collect Social Security benefits before the full retirement age of 66 must forfeit $1 in benefits for every $2 earned over a prescribed limit. For this year, the earnings cap is $15,120.

It is important to note that these benefit reductions aren’t truly lost but merely deferred. Benefits will be increased at full retirement age to account for benefits that were withheld due to earnings.

So, say an individual collected benefits at 62 and ultimately forfeited 12 months’ worth of benefits over the next four years. Once that person reached full retirement age, Social Security would recalculate the benefits as if their collection began at 63, instead of 62, resulting in a higher amount going forward.

ONE-YEAR RULE

As I noted in my recent column, there is a special one-year rule that applies to earnings during the first year of retirement. Under this rule, an individual can get a full Social Security check for any whole month a person is retired, regardless of the yearly earnings prior to claiming benefits.

For 2013, a person who is younger than full retirement age for the entire year is considered retired if his or her monthly earnings are $1,260 or less. The monthly limit is 1/12th of the 2013 annual earnings limit of $15,120.

For example, John Smith retires at 62 on Oct. 30, 2013, after he earned $45,000 through October. Beginning in November, he takes a part-time job earning $500 per month.

Although Mr. Smith’s earnings for the year substantially exceeded the 2013 annual limit of $15,120, he will receive a Social Security payment for November and December because his earnings in those months are less than $1,260, the monthly limit for people younger than full retirement age.

Beginning in 2014, only the yearly limit would apply to him.

If an individual reaches full retirement age during 2013, Social Security applies a more generous earnings test. It deducts $1 in benefits for every $3 earned above a higher limit — $40,080 — until the month full retirement age is reached.

That prompted Larry Hilkemann, an accountant from Norfolk, Neb., to ask me in an e-mail, “Does that first-year rule also apply to the year you qualify for full benefits at age 66? Therefore, can you earn up to $3,340 per month after you start taking benefits in the year you turn 66?”

That amount is 1/12th of the higher annual earnings cap of $40,080 that applies to workers who turn 66 this year.

Yes, in the first year of retirement, Social Security will compute an individual’s payments using both the annual and monthly limits. The individual will be paid using whichever method is best for him or her.

Once that individual reaches full retirement age, the earnings restrictions disappear completely.

Here is an example of how the earnings test applies to someone who turns 66 this year. I have taken it directly from the Social Security publication “How Work Affects Your Benefits.”

Let’s say an individual will turn 66 in November. That person will have filed for Social Security in January 2013 — 10 months before his or her 66th birthday — and is entitled to benefits of $600 per month.

WITHHOLDING PAYMENTS

The individual expects to earn $41,580 from January through October. That is $1,500 above the annual earnings limit of $40,080 for people who turn 66 this year.

During that period, Social Security would withhold $500 in benefits — $1 for every $3 earned over the limit ($1,500/3 = $500) — in the months leading up to the 66th birthday.

To do this, Social Security would withhold all the payments until the full earnings cap reduction is satisfied.

In the above example, that means that the person’s first $600 benefit check of the year would be withheld to satisfy the entire earnings test reduction.

Then, beginning in February 2013, the person would have received his or her normal $600 benefit, and would be paid that amount each month for the remainder of the year. The individual would receive the remaining $100 (the excess amount withheld from the first check, $600-$500 = $100) in January 2014.