Working and Social Security Benefits
Most people are not aware of the Social Security earnings test, or income limits, if they claim benefits while still working prior to reaching their Full Retirement Age (FRA) [FRA is THE MONTH & YEAR you are eligible for 100% benefits. Before FRA, benefits are reduced. After FRA, benefits increase by 8% simple each year]. This is dismaying because it means people are not only not waiting until age 70 to claim their maximum benefit, but they are also locking in a permanent reduction by claiming before full retirement age.
Of course, if they have to claim benefits because of not working, that’s different and the earnings test is a moot point. The following assumes they don’t have to claim benefits, but choose to do so, even while still working.
Claiming benefits subject to the earnings test, or income limits, while still working while also under their FRA, are signing up for several years of administrative hassles with SSA, obligating themselves to report their expected earnings, having their benefits adjusted and re-adjusted after actual earnings are reported, and having their benefit recalculated at full retirement age to account for the withheld benefits. Why would anyone put up with all this if they could be paid to wait [i.e., receive higher benefits later]?
Dealing with a government agency as big as Social Security is no fun. SSA’s automated systems are excellent, but once you step outside the bounds of automation and have to interact with human beings—which the earnings test forces you to do—you’re in for long wait times on hold and a high potential for errors.
First note that any and all benefits received before FRA are subject to the earnings test [see Who’s Benefits Will Be Withheld section later]. This goes for survivor benefits, spousal benefits, dependent benefits, and child-in-care benefits. Widows can claim their survivor benefit as early as age 60, but if they work, the benefit will be subject to withholding under the earnings test.
Also note that if a person is under FRA and works, all benefits paid off that person’s record will be withheld, even if the recipient, such as a dependent, doesn’t work. [See examples at the end of this article: Who’s Benefits Will Be Withheld section later].
And further note that earnings prior to application don’t count. This is a common question. “I’ve already earned $100,000 this year and plan to apply for Social Security next month. Will the $100,000 be counted for the earnings test?” The answer is no. Earnings prior to application don’t count.
Conversely, earnings after FRA don’t count. “I’m still working but plan to apply for Social Security next month when I turn FRA. Will I be subject to the earnings test?” The answer is no. Earnings after FRA—starting on the first of the month in which the client turns FRA—do not count for the earnings test.
How the earnings test works
Here’s how the earnings test works. Everyone who applies for Social Security does so somewhere in mid-year. So during that first year, if they are under FRA they will be under the monthly earnings test. Starting with the month of application, if they earn more than the monthly threshold, which is $1,580 in 2021 ($18,960/12) [for current year thresholds after 2021], $1 in benefits will be withheld for every $2 they earn over the threshold.
Earnings prior to application will not be considered, but earnings after benefits start will be. If a person fully retires and starts Social Security mid-year, there will be no withholding regardless of how much they earned prior to application. But if they plan to work part-time after starting benefits, the monthly earnings test will apply: $1 will be withheld for every $2 earned over $1,580.
Near the end of the year SSA will ask how much they plan to earn in the coming year. Now in their second year, the annual earnings test kicks in. One dollar in benefits will be withheld for every two dollars earned over the annual threshold. The threshold in 2021 is $18,960. Let’s say a person is expected to earn $40,000 this year. SSA will subtract $18,960 from $40,000 and divide by 2 to get $10,520. This is the amount that would be withheld. If the benefit is $2,000, this means 6 checks would be withheld ($10,520 ÷ $2,000=5.26). SSA withholds whole checks and makes up the difference after earnings are reported after the first of the year. This is also the time adjustments are made if actual earnings turn out to be different from the estimate.
In the year a person turns FRA, in the months leading up to their FRA month, the annual FRA-year earnings test applies. A client who was receiving Social Security last year (i.e., is now under the annual, not the monthly, earnings test) and who turns FRA of 66 and 2 months this year will have $1 in benefits withheld for every $3 earned over the FRA-year threshold of $50,520 [for current year thresholds after 2021], Once the person turns FRA there will be no earnings test at all. A person’s birth month matters here.
A person who turns FRA early in the year could escape withholding if they keep earnings under the $50,520 in the months prior to turning FRA. Being born later in the year is a disadvantage due to the greater likelihood of exceeding the threshold before turning FRA. Also note that FRA rises to 66 and 2 months for those born in 1955.. So if a person is born in 1955 and has his 66th birthday in November or December, they would turn FRA of 66 and 2 months in 2022. They would be under the pre-FRA year threshold all of this year even though they turn 66 before the year is over. [The same holds true for those born in 1956 through 1959, where FRA actually occurs in the following year depending on the birth month and number of months needed to reach their FRA].
If a person starts benefits in his FRA year, the FRA-year monthly earnings test applies. In the months leading up to the month he turns FRA, $1 in benefits will be withheld for every $3 earned over the 2021 monthly threshold of $4,210 [$50,520/12 in 2021; changes each year after]. Starting in the month they turn FRA, they can earn any amount with no withholding.
[Note the link to the Earnings Test Calculator on Social Security’s website below].
[Note: SSA considers GROSS earnings, prior to deductions such as contributions to a 401k; SSA does not use NET earnings for purposes of the earnings test.]
SSA likes to withhold the benefits as the salary is being earned. This makes sense from a cash-flow standpoint, but it does create those administrative problems: client estimates earnings for year 1; SSA withholds benefits based on that estimate; in year 2 employer reports actual earnings for year 1; SSA adjusts benefit for year 1 based on reported earnings while withholding benefits for year 2 based on client’s projected earnings, and so on.
It is possible to deal with these hassles by simply not giving SSA an estimate of projected earnings—in other words, ignoring their request for estimated earnings and letting SSA deal with it after earnings are reported by the employer. This is not exactly kosher, but it is not illegal. It means SSA will charge them with an overpayment so they’d better have the funds that should have been withheld available to repay SSA when the overpayment notice arrives.
Business owners and self-employed individuals must meet a different standard. SSA knows that it is possible for people to set a salary just under the earnings test threshold in order to avoid withholding. So for these people they look at the amount of time the client spends working in the business. If it’s more than 45 hours a month (about 10 hours a week), the client is considered “not retired” and all benefits will be withheld. The client may have to produce financial records, depending on how far SSA wants to take it. This is why we recommend that business owners and self-employed individuals wait until FRA or later to claim benefits. For them, the earnings test is a much bigger hassle.
Whose benefits will be withheld?
It often comes to a surprise to people that if they are under FRA and work, both their own benefit and any auxiliary benefits paid off their record, including spousal and dependent benefits, will also be withheld. Or, if the worker is over FRA but the auxiliary recipient is under FRA and works, there will be withholding based on the recipient’s earnings. Here are some ways this could play out.
- Jim is over FRA and works. Judy is under FRA and doesn’t work. Jim applies for his retirement benefit and Judy applies for her spousal benefit. Will there be any withholding? No. Because Jim is over FRA the earnings test does not apply. Because Judy doesn’t work, her spousal benefit will not be subject to the earnings test.
- Dave is over FRA and doesn’t work. Dina is under FRA and works. Dave (born before 1954) wants to file a restricted application for his spousal benefit based on Dina’s record. Dina applies for her own retirement benefit so Dave can start his spousal benefit. Will there be any withholding? Yes. Dina’s retirement benefit will be subject to the earnings test. Dave’s spousal benefit will also be subject to withholding.
- Mike is under FRA and works. Mary is under FRA and doesn’t work. Can Mary apply for her benefit without triggering the earnings test? Yes. Because Mary doesn’t work, and because she is applying for her retirement benefit (i.e., not a spousal benefit), there will be no earnings test. If Mary’s PIA is less than half of Mike’s PIA, she may add on her spousal excess (the difference between her PIA and one-half of Mike’s PIA) after Mike files for his benefit. If Mike is still under FRA and working when he files, both his own retirement benefit and Mary’s spousal benefit will be subject to the earnings test. If Mike is over FRA when he files, and if Mary is still not working (or she is over FRA), there will be no earnings test.
- Steve is under FRA and works. Sarah is over FRA and works. Steve and Sarah each file for their own retirement benefit. Will there be any withholding? Yes. Because Steve is under FRA, his benefit will be subject to the earnings test. Because Sarah is over FRA, none of her benefits will be withheld for the earnings test.
- Bob is under FRA and works. Betty is over FRA and doesn’t work. Betty applies for her own retirement benefit. Bob plans to delay his benefit to age 70. Will there be any withholding? No. Bob’s earnings will not affect Betty’s retirement benefit. If Bob were to file for his benefit and Betty were to take a spousal benefit (i.e., her PIA is less than half of his), her spousal benefit would be subject to the earnings test because the person on whose record the spousal benefit is being paid (i.e., Bob) is under FRA and works.
- Jim is under FRA, works, and has two minor children. Jim applies for his benefit so his kids can get dependent benefits. Will there be any withholding? Yes. As long as Jim is under FRA and works, his benefit and the children’s dependent benefits will be subject to withholding for the earnings test.
What constitutes earnings?
The definition of earnings for the earnings test is pretty narrow. It is pretax income received in exchange for labor—that is, salary or wages. It is not investment income or pension income or insurance proceeds or any other type of income that is not strictly earned income.
For self-employed individuals it is net Schedule C income (but see previous note about additional scrutiny). Income received “on account of retirement,” such as severance pay, is not supposed to be counted, but I’ve seen SSA try to come after people for withholding after the severance pay is reported.
If retiring, and they insist upon applying for benefits before FRA, make sure they’ve received all of their pay before applying for benefits. For types of income that you’re not sure about, see this Summary of How Types of Remuneration Are Treated.
The earnings test does not look at joint income. It considers the earned income of the individual Social Security recipient only. If Bob works and Betty doesn’t, and if Betty applies for her Social Security benefit, Bob’s income—that is, the income reported on their joint tax return—will not be considered.
But speaking of joint income, it does factor into the taxation of benefits. Please understand that the earnings test is very different from taxation of benefits. The earnings test looks at the individual earnings of the worker as reported on their W-2 or Schedule C, and only while they are under full retirement age. Taxation of benefits is based on adjusted gross income (i.e., all the different types of taxable income that make up AGI) as reported on the single or joint tax return and can happen at any age. So while Bob’s income will not subject Betty’s benefit to the earnings test, it may—and probably will—cause up to 85% of her benefits to be subject to federal income taxes.
And while we’re on the subject, Medicare Part B premiums are charged to the individual person on Medicare, but the Income Related Monthly Adjustment Amount (IRMAA) is based on joint income. So even though Betty doesn’t work, if Bob earns enough to throw them into one of the IRMAA tiers, she will pay the IRMAA [and Bob will too if he too has Medicare Part B]. [More on IRMAA “extra charges added to your premium” on Medicare’s costs webpage].
Original article for an adviser newsletter by Elaine Floyd, CFP®, Director, Retirement and Life Planning, Horsesmouth, LLC, within which I’ve made edits for the broader public.