If a person is under Full Retirement Age (FRA) and works while also receiving Social Security, their Social Security benefit will be subject to the earnings test: $1 in benefits will be withheld for every $2 earned over the annual threshold (earnings test link shows that threshold amount for the present year).
An example for earnings test application:
To quickly calculate how much will be withheld for a particular person, take the person’s annual earnings, subtract the threshold amount, and divide by 2. For example, say a person applied for Social Security at the end of 2020. SSA would ask them if they planned to work in 2021 and how much they expected to earn. Let’s say it’s $50,000. SSA would subtract $18,960 (to get $31,040) and divide by 2 (to get $15,520) [2021 thresholds at the time this post was drafted]. Then they would divide this amount by their monthly benefit amount to determine how many checks should be withheld. If the person is receiving $2,100 per month in benefits, $15,520 divided by $2,100 is a little over 7, which means 8 whole checks will be withheld. From January through August the person would receive no Social Security checks. The $2,100 benefit would start up again in September. When the person’s actual earnings are reported to Social Security Administration by the IRS in January of 2022, any necessary adjustment would be made (such as the overage from that eighth check). Meanwhile, withholding for 2022 would have already begun based on the person’s new estimate and the earnings test threshold for 2022.
As you can see, the earnings test is a hassle simply because earnings start and stop which is hard on most people’s budgets. If a person is under FRA and work, please consider NOT applying for Social Security. This goes for retirement benefits, survivor benefits, spousal benefits, even dependent benefits. If the recipient of the benefit is under FRA and works, the earnings test will apply. If the person on whose record the benefit is being paid (in the case of spousal and dependent benefits) is under FRA and works, the earnings test will apply.
Moral of the story: Wait to claim benefits as late as possible, up until age 70 (when delay adds no further benefit dollars anymore).
What happens at FRA if you applied for benefits and worked while younger than FRA:
If a person applied for benefits and are/were under FRA and work, they need to understand what will happen when they turn FRA. Some people have heard that they will “get it all back” at FRA. Other people think that those withheld benefits are permanently lost (“so unfair”). Still others think that even a few checks a year are better than nothing, so they should apply for benefits even if they are under FRA and work.
So let’s look at what happens when a person is subject to the earnings test and then turns FRA. SSA will count the number of checks that have been withheld. Then the early-claiming reduction for each of those checks will be removed. This is only fair because the person did not receive those checks. It’s as if the they are applying at FRA with respect to those checks. Then the original reduced amount (for the checks they did receive) and the full PIA amount (for the checks they didn’t receive) will be combined to create a new permanent benefit amount.
Let’s say Bob has a PIA of $3,000 and his FRA is 67. If he files for Social Security at 62, his benefit will be 70% of $3,000, or $2,100. This will be his permanent benefit except for COLAs. Now let’s say that between age 62 and 67 he has seven checks a year withheld for the earnings test. Of the 60 checks that would have been issued over the five-year period from age 62 to 67, he would have received only 25 of them (five a year). Thirty-five of those checks (seven a year) would have been held back. (SSA’s rationale in imposing the earnings test is that if you’re working you’re not really retired and therefore do not need “retirement income.” This is why someone still working in their main, full-time job would likely have all of their benefits withheld under the earnings test. But SSA also understands that if you’re working part-time at a lower salary, you might need some retirement income and that’s why they set some basic amount, the $18,960 in 2021, as the amount you can earn before any benefits will be withheld.)
When Bob turns FRA, his benefit will be recomputed to remove the early-claiming reduction with respect to those 35 checks he did not receive. His new benefit will be a combination of the reduced amount (the $2,100) and the full amount (the $3,000) in proportion to the number of checks received or not received out of the total of 60 checks. The proportion of received checks (25/60) makes up .4167 of the total benefit. The proportion of withheld checks (35/60) makes up .5833 of the total benefit. To combine them, multiply the fully reduced amount by the ratio: $2,100 x .4167=$875. Then multiply the unreduced amount by the ratio: $3,000 x .5833=$1,750. Then add them together. The new benefit will be $875 + $1,750=$2,625. (SSA’s actual computation may be slightly different, but this is the basic idea. It is done automatically and people are notified by letter of their new benefit amount when they turn FRA.)
As you can see, this is not an easy explanation. That’s why people try to simplify it, and this leads to misleading ideas about “getting it back” or “losing it altogether” or whatever.
To simplify the explanation: “The amount being withheld is not really lost, it’s just delayed. It will come back to you over time. Think of it as if you had applied at FRA with respect to that portion of your benefit that you didn’t receive.” The main point to get across is that people are not penalized for working. They ARE penalized for applying early. It can be easy for people to get the idea that they’ll come out ahead if they apply at 62 and either not work at all or keep their earnings under the threshold. Not true. This would just guarantee them a lower lifetime benefit and deprive them of additional earnings.
Because the earnings test takes the form of withholding, not confiscation, it actually serves to increase their benefit when the actuarial reduction is removed at FRA. When referring to the earnings test, always say benefits are “withheld” (not “taken away”) so people get the idea that they’ll be released later—and in a higher amount once the early-claiming reduction is removed.
Maximization strategies
Let’s say you know a person who lost their job and applied for Social Security at 62 in order to make ends meet. A year later they find another job. They wonder if they can suspend their Social Security now that they no longer need the income. The answer is no. It is not possible to voluntarily suspend Social Security if you are under FRA. But the earnings test serves the same purpose. If the person earns enough to have all benefits withheld, it’s the same as suspending because the benefit will be recomputed at FRA to remove the reduction with respect to those withheld benefits. Then, once they are over FRA, they can voluntarily suspend his benefit to build delayed credits to age 70. (Note: remember that a person can always withdraw their application within 12 months of applying, even if they are under FRA.)
What if the person will be switching benefits?
There are a few instances where the general advice to not apply for Social Security if you’re under FRA and working does not apply. This is when the person will not be receiving the recomputed benefit long enough to recoup the withheld amount. An example might be a widow who will be applying for her own maximum benefit at age 70. She can start her survivor benefit as early as age 60. If she works, the benefit will be subject to the same earnings test as any other benefit received before FRA. And it will be recomputed at FRA as described above. But because she won’t be receiving that survivor benefit very long before switching to her own benefit, she may not get the full amount back. So I would say that unless a widow earns enough to have all of her survivor benefits withheld, it probably makes sense for her to apply before FRA [to receive that extra income]. But please make sure her own benefit at 70 will indeed exceed the survivor benefit. If there is any doubt, she should plan to claim the survivor benefit at FRA in order to get the full amount. She can always switch to her own benefit at 70 if it turns out to be higher.
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.
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