As a financial adviser, it is critical to know whether your clients who have worked for city, state or federal government — or in some cases, public school systems — may be affected by rules that can reduce or eliminate their Social Security benefits.
That is the case if they worked in jobs where they didn't pay Social Security taxes and earned a pension from such non-covered work. Problems can arise if clients also worked in other private-sector jobs during their career where they accrued enough quarters to be eligible for Social Security benefits, in addition to their public-sector pensions.
Social Security offset rules can also affect public sector workers who attempt to collect spousal or survivor benefits on mates who worked in the private sector.
Unfortunately, your clients may not realize their Social Security benefits will be reduced or, in some cases, completely wiped out because their Social Security estimated benefits statement does not reflect that reduction.
Encourage them to set up a personalized online account at ssa.gov/myaccount. They will be able to download their estimated benefits statement, which includes their earnings history and how much they have paid in FICA taxes over their career. If there are multiple years where their Social Security and Medicare earnings show zeros, that is your first hint that they may be affected by the offset rules.
TWO SETS OF RULES
The Windfall Elimination Provision and the Government Pension Offset rules were enacted in 1983 as part of the sweeping Social Security reform law. Congress approved the provisions to prevent what was perceived as “double dipping.” But many of those people affected by the rules consider them punitive and unfair.
To be affected by the WEP, an individual must have worked in covered employment long enough to qualify for Social Security benefits, as well as in the public sector where FICA payroll taxes were not deducted from their earnings. In addition, they must have earned a pension from that non-covered work.
The WEP rules reduce their monthly Social Security benefits by up to 50% of the amount of their public pension, but not more than $408 per month in 2014. For example, if your client has a government pension of $500 per month, the maximum WEP reduction would be half of that — $250 per month.
The GPO is a related provision that reduces Social Security benefits paid to spouses or survivors when the spouse or survivor earned a pension from a government job that was not covered by Social Security. The GPO reduction is equal to two-thirds, or the amount of the pension payment from non-covered government work.
Unlike the WEP, which can merely reduce a worker's Social Security benefit by up to half of the amount of the government pension, the GPO has no maximum. It can completely wipe out a spousal or survivor benefit.
For example, if a client collects $1,500 per month in a public sector pension, any Social Security spousal benefit she might receive on her husband's earnings record is first reduced by $1,000 per month — two-thirds of her pension. So if she was entitled to a Social Security spousal benefit of $1,000 per month, she would not collect anything in addition to her public pension.
Although most federal workers are covered by Social Security, public-sector employees in 15 states, including public schoolteachers in some of those jurisdictions, are not. Those states including Alaska, California, Colorado, Connecticut, Illinois, Louisiana, Maine, Massachusetts, Missouri, Nevada, Ohio and Texas, plus certain local jurisdictions in Georgia, Kentucky and Rhode Island.
Federal workers hired before 1984 and covered by the Civil Service Retirement System, where they did not contribute to Social Security, are also affected by the WEP rules. However, public service employees who also worked in the private sector and paid Social Security taxes on 30 years or more of “substantial earnings” are not affected by the reductions.
The Social Security Administration estimates the WEP affected about 1.5 million workers in 2012. Another 568,000 beneficiaries had their Social Security spousal benefits reduced by the GPO.
Together, the WEP and GPO affect about 3.5% of U.S. households, according to a recent article in the Social Security Bulletin. And the provisions may have a substantial effect on benefits in those households.
The net present value of lifetime Social Security benefits drops by about 20% for households affected by either the WEP or GPO, according to an analysis published in the Social Security Bulletin. But the reduction is mitigated by their public service pension. As a result, their overall household wealth is reduced by about 5%.
Households affected by both WEP and GPO reductions experience larger benefit reductions of about one-third.
However, because both provisions affect only those households that include a worker who has a pension from non-covered employment, they typically have higher average combined pension and Social Security income and higher total wealth than unaffected households, according to the article.
There is nothing you can do to get around the WEP and GPO reductions. But the sooner you know the real impact of these cuts, the better you will be able to tweak your clients' retirement income plan, even if it means they might have to work a bit longer or trim their spending. Otherwise, you can toss that carefully crafted financial plan onto the trash heap — along with your clients' broken retirement dreams.
(Questions about Social Security? Find the answers in my new e-book.)