How to trim Social Security reductions for public employees

I’ve noticed an increased interest among financial advisers about Social Security rules that affect their public employee clients. It was a hot topic during my Dec. 9 webcast on Social Security claiming strategies.
It is critical for financial advisers to know that clients who have worked for the 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.
The Windfall Elimination Provision affects individuals who have worked in the private sector at least 10 years — long enough to qualify for Social Security benefits — and who also have worked in the public sector where FICA payroll taxes were not deducted from their earnings. To be subject to WEP rules, clients must have earned a pension from that public sector job.
The WEP rules reduce monthly Social Security benefits by up to 50% of the amount of a 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. But if he receives a $1,000 per month pension from work not covered by Social Security, his Social Security benefit would be reduced by the full $408 per month in 2014, trimming his benefit to $592 per month.
A separate rule, known as the Government Pension Offset provision, affects public sector employees who try to claim Social Security spousal or survivor benefits based on their mate’s private sector earnings.
Janet Critchley, a financial analyst with Brinton Eaton Wealth Advisors, asked me what would happen if a client with a public sector pension continues to work in the private sector. Could he reduce the impact of the WEP reduction on his Social Security benefit?
Yes, he can. But it takes many years of work in the private sector with annual earnings high enough to mitigate the impact of the WEP rules.
“The Windfall Elimination Provision is not a fixed reduction and can be removed,” Social Security spokesperson Nicole Tiggemann confirmed in an email. “Each year, we review the records for all Social Security beneficiaries who work and determine if an increase in benefits is appropriate.”
First, let me outline the basic Social Security retirement benefit formula and explain how the WEP reduction is calculated.
The Social Security Administration calculates a worker’s highest 35 years of earnings, indexed for inflation, and divides that number by 12 to determine the worker’s Average Indexed Monthly Earnings. Then the benefit formula is applied.
In 2014, the benefit formula is 90% of the worker’s first $816 of AIME, plus 32% of AIME over $816 through $4,917, plus 15% of any AIME in excess of $4,917. The dollar amounts increase each year , but the percentages (known as “bend points”) remain the same. So someone who retires in 2014 with $5,000 per month in average indexed monthly earnings would have a retirement benefit of $2,059 per month.
But in the case of public sector workers subject to WEP rules, the first bend point of 90% is replaced with 40%, reducing the amount of the Social Security benefit. Social Security benefits for public sector workers with 20 or fewer years of “substantial earnings” use the 40% bend point in their benefit calculation. Workers with average indexed monthly earnings of $5,000 who are subject to the maximum WEP reduction would receive $1,651 in monthly Social Security benefits — a $408 decrease ($2,059 – $1,651 = $408).
If they work at least 21 years in the private sector, the bend points used in the WEP reduction calculation would gradually rise from 45% in year 21 to 85% in year 29. If they have 30 years or more of substantial earnings, the first bend point returns to 90% and the WEP reduction disappears.
“If it is determined that the beneficiary has an additional year of substantial earnings, the WEP reduction is adjusted as well,” Ms. Tiggemann wrote. “We remove the WEP reduction beginning with the first month of the year following the year the beneficiary earned the 30th year of substantial earnings.”
The definition of “substantial earnings” increases each year. For 2014, it is $21,750 per year. More details about the WEP rules are available online.
(Questions about Social Security? Find the answers in my ebook.)