Questions from InvestmentNews readers tend to run in cycles. This month, the Social Security earnings test seems to be a popular topic with financial advisers and their clients who want to claim benefits early but plan to keep working. That combination can result in some nasty surprises.
Benefits can be temporarily reduced or wiped out if you claim Social Security before full retirement age and continue to work. Full retirement age is 66 for anyone born from 1943 through 1954, and gradually increases to 67 for those born in 1960 or later.
Not only will your benefits be reduced by 25% or more if you file for Social Security at the earliest eligible age of 62, you will temporarily forfeit some or all of your Social Security benefits if you earn too much money.
1. Earned income is defined as wages or net-self-employment income. The earnings test does not apply to other government benefits, investment earnings, interest, pensions, annuities and capital gains. However, employee contributions to a retirement plan do count as earnings if they are included in the employee's gross wage, so you can't avoid the earnings cap by making a large contribution to your 401(k).
2. The earnings test limits depends on your age. If you are under full retirement age for all of 2018, you would forfeit $1 in benefits for every $2 earned over $17,040. For example, if you applied for Social Security at 62 and earned $40,000 this year, you would lose $11,480 in benefits ($40,000 - $17,040 = $22,960/2). Assuming you were eligible for a benefit of $1,500 per month at 62 beginning in January, the Social Security Administration would withhold the first eight months of benefits ($11,480/$1,500 = 7.65) and pay you a monthly benefit starting in September.
In the year you reach full retirement age, a more generous earnings test applies. If you turn 66 in 2018, you can earn up to $45,360 in the months before your birthday without losing any benefits. If you earn more than that, you would lose $1 in benefits for every $3 earned over $45,360.
3. The earnings test disappears at full retirement age, meaning you can earn any amount of money without affecting your Social Security benefits. And any benefits that were forfeited as a result of excess earnings would be restored in the form of higher monthly benefits once you turn 66. For example, if you claimed benefits at 62 and lost 24 months of benefits over the next four years due to the earning test, SSA would adjust your monthly benefit at full retirement age as if you had first claimed at age 64, not 62, resulting in a higher benefit going forward.
4. Earnings test reductions can affect your whole family. If your spouse or children are receiving Social Security benefits on your earnings record, their benefits will also be withheld until the earnings test is satisfied.
5. There's a special rule for the first year you retire. Sometimes people who retire in midyear already have earned more than the annual earnings limit. That's why there is a special rule that applies to earnings for one year, usually the first year of retirement. Under this rule, you can get a full Social Security check for any whole month you're retired, regardless of your yearly earnings.
For example, John Smith retires at age 62 on Oct. 30, 2018. He will earn $45,000 through October. He takes a part-time job beginning in November earning $500 per month. Although his earnings for the year substantially exceed the 2018 annual limit of $17,040, he will receive a Social Security payment for November and December because his earnings in those months are $1,420 or less, which is the monthly limit for people younger than full retirement age (($17,040/12). Beginning in 2019, only the annual limit will apply to him.
6. Earnings test applies to all types of Social Security benefits, whether you claim on your own work record, as a spouse or as a survivor. Your benefit will increase at your full retirement age to account for benefits withheld due to earlier earnings. However, spouses and survivors who receive benefits because they have minor or disabled children in their care don't receive increased benefits at full retirement age if benefits were withheld because of work.
7. Special payments don't count toward the earnings test. Income received after retirement, such as accumulated vacation or sick pay, severance pay and sales commissions, counts as a special payment if the last thing you did to earn the payment was completed before you stopped working.
Special payment rules also apply to insurance salespeople who continue to receive commissions after they retire for policies they sold prior to retirement.