Last week we discussed basic strategy in deciding when to begin receiving Social Security benefits. A quick recap might be in order. Later is usually better. You do not have to take the benefits the moment you stop working. Your personal Social Security decision will last a lifetime. So be careful.
Today’s topic expands on your benefit decision by considering what happens when you keep working while receiving Social Security benefits. We explore potential taxes on the benefits. We briefly explain family benefits. Finally, we give a short answer about workers who earn money not covered by Social Security.
WORKING WHILE RECEIVING BENEFITS
The Social Security Administration might defer a portion of your benefits if you keep working after triggering your benefit checks. The first key thought for those who are not ready to hang it up as far as gainful employment after they have become Social Security eligible is that the result is a deferment, not a reduction. When the Social Security Administration reduces your paid benefit amount based on other work, it increases the amount you will receive later. If you live long enough, it will be close to a wash.
The Social Security Administration only defers benefits if you have not reached “full retirement age.” If you have not retired yet, that age falls somewhere between birthdays 66 and 67. Meaning that if you follow the general advice to delay receiving your Social Security benefits as long as possible, you will not have to worry about benefit deferment.
Those starting benefits early and continuing to work should understand amount of the deferment. The answer results from a formula that takes into account whether you are single or married, the amount you earn outside of Social Security and how close you are to full retirement benefits. Lower levels of extra earnings may result in zero deferment of benefits. Once you fall into the “deferment zone,” for every $2.00 of income you earn, you will see $1.00 of benefits deferred. That ratio improves to 3-1 in the year before your full retirement age. You can see the full explanation here.
Why is all this so important? The worst Social Security benefit mistake you could make is to start your benefits early, continue working and make enough money to defer your entire benefit check. The result reduces your lifetime benefits without the advantage of receiving the earlier payments. No one would consciously make that mistake. Still, you could get trapped by the lure of “early retirement,” later running into circumstances that compel a return to work. Or maybe a new opportunity that is “too good to refuse. I cannot say it enough, so I will say it again. Be careful about taking Social Security benefits early!
TAXES: UNCLE SAM GETS HIS
Ben Franklin was right when he said: “…in this world, nothing can be certain except death and taxes.” For a long time, Social Security benefits escaped the rule. In 1984, we started taxing some of those benefits. Later we bumped up the amount of benefits subject to taxation. Take note that these tax decisions were bipartisan and part of a plan to help the system remain solvent.
The tax rules are not as draconian as some believe. To make the accountants happy, we have tables and formulas. But the basics are as follows. Start with how much you “earn” (or if married, how much you and your spouse earn). For this calculation, your Adjusted Gross Income plus any non-taxable interest gets added to your Social Security benefits for a “combined income” figure. If your combined income falls under $25,000.00 for an individual or $32,000.00 for a married couple, you will not see your benefits taxed. If the combined income exceeds the first threshold, but stays under $34,000.00 for an individual or $44,000.00 for a couple, only 50% of your benefits will be taxed. Anything more and 85% of your benefits will be taxed.
One big takeaway here applies to Empty Nesters who own businesses. Make sure your tax adviser knows about your plans for Social Security benefits. That information generates good compensation and tax deferral strategies. For instance, there is no age limit for IRA contributions. During a younger working life, the big benefit to making I.R.A. contributions is tax deferral. That benefit compounds when you defer taxes on the income you earn and reduce taxes on your Social Security benefits, so an I.R.A contribution, even later in life, can make sense.
SPECIAL FAMILY SITUATIONS
Social Security provides part of the “safety net” in America. When you have a family, your income impacts their standard of living. As a result, there are situations in which a spouse, a child or an ex-spouse qualifies for benefits based on your earning record. The number one thing to remember here is that payments to others do not reduce the payments to you.
For a current spouse to receive benefits, generally the spouse must be at least age 62. In addition, you need to be taking your benefits, not just be eligible for them. If your spouse qualifies for benefits based on his or her own record, that amount gets paid first. If the spouse is eligible for a higher amount of benefits based on your record, the Social Security Administration increases the spouse’s check to the larger amount. The spousal benefit paid cannot be more than 50% of your full retirement amount.
Spouses born before 1954 have the option of taking just the spousal benefit to preserve a higher personal benefit later. Younger spouses do not get that option. Starting early with the spousal benefit will reduce their personal benefit forever. The earnings deferment test we discussed earlier applies to the spousal benefit as well.
Children may be eligible for a benefit based on your record if they are young or disabled. To receive a benefit based on age, the child must be single, under 18 or under 19 and still in high school. To receive a benefit from your record based on disability, the child’s disability must have started before age 22. A child’s work earnings will reduce or eliminate the benefit. If your spouse cares for a disabled child, the age minimum for the spousal benefit goes away.
The most surprising potentially eligible family member is the ex-spouse. It bears repeating that payments to the ex-spouse will not reduce your benefits. For an ex-spouse to take benefits, he or she must meet the same criteria as a current spouse. In addition, however, you and the ex-spouse must have been married at least 10 years.
EARNINGS NOT COVERED BY SOCIAL SECURITY
Many Americans work in a job sometime during their lives that does not contribute to Social Security. Instead these workers pay into pension systems from which they draw their retirement benefits. Two issues arise out of these situations. First, how do Social Security benefits and pension payments mesh? Second, how does an exempt pension impact spousal benefits?
In both scenarios, you will receive less from Social Security than you would in the absence of the pension. That reduction comes from Social Security law, not the terms of the pension. If you feel like the reduction is unfair, write your congressperson or senator. Your local or state government cannot change the formulas.
The “Windfall Elimination Provision” or “WEP” operates to reduce Social Security benefits for those who receive pensions based on non-Social Security earnings. For every year a person works in a job that Social Security covers, the earnings get credited to a record. When it comes time for the Social Security Administration to compute a benefit, it applies a percentage figure to each of those earnings years. The WEP tells the administration to reduce that percentage based on the amount of your non-social security pension. If you spend a long-time in an exempt pension job (think Texas teachers) and a short time in a job Social Security covers, the WEP will come close to eliminating your Social Security benefits.
The Government Pension Offset or “GPO” works on spousal benefits. The formula is simple. Your spousal benefit is reduced by an amount equal to 2/3 of your pension. If you are otherwise entitled to a $600.00 spousal benefit, but receive a $1,000.00 monthly pension generated by earnings outside of Social Security, the GPO wipes out the spousal benefit. Sad, but true.
All the numbers can make your head spin, but here are the key points to think about when considering how much you can count on from Social Security:
- Social Security is not going bankrupt
- The later you start taking benefits, the bigger your benefit will be
- Working while taking early Social Security benefits will probably defer some your benefits
- Some portion of your benefits will likely be taxed
- Benefits may be available for your family as well as you
- Pensions from earnings not covered by Social Security can greatly reduce or eliminate benefits
- The decision to start benefits is irrevocable and has major long-term consequences.
Based on all that, work with a financial adviser knowledgeable about your benefits so you can make it part of a well-thought out plan for the best Empty Nest retirement.