For most Americans Social Security plays an important role in maintaining retirement security. The benefit payments represent an income stream that is free of the risks of default, investment, inflation and longevity (outliving your money).
In other words, regardless of economic and market conditions, Social Security pays an annuity that will increase with inflation and continue for as long as you or your spouse live.
It is well known that workers and spouses who qualify for Social Security can elect to receive them at any age between 62 and 70. Benefits received prior to an individual reaching full retirement age are subject to an actuarial reduction for early retirement. Conversely delaying benefits until age 70 would result in an increase in the benefit amount.
Less well known is the impact that continuing to work has on an individual who is already collecting Social Security. A person’s decision when to collect benefits is independent of when they decide to leave the workforce. There is nothing to prevent someone who is otherwise eligible to receive benefits from doing so while remaining on the job. However, for those who claim benefits prior to full retirement age and continue to work and exceed certain income thresholds, Social Security imposes an “offset” that reduces, sometimes substantially, the full monthly benefit that would otherwise be paid. This offset is known as the Retirement Earnings Test (RET) and it applies to employment income only, not earnings from investments, pensions, etc.
Under this test, a worker who will be younger than full retirement age during the entire calendar year will be subject to a $1 reduction in benefits for every $2 they earn above $15,120 (2013). During the calendar year in which the person reaches full retirement age, a less onerous earnings test is imposed. Social Security will reduce benefits by $1 for each $3 of earnings above $40,080 (2013). Once a person attains full retirement age, there is no reduction of benefits regardless of income.
The conventional wisdom among seniors is that the Retirement Earning Test represents a harsh penalty that when added to payroll and income taxes removes any financial incentive to continue working. At a time therefore when most seniors would greatly improve their financial security by continuing to work, they instead choose to reduce their earnings below the test’s thresholds to avoid triggering the reduction or worse, leave the workforce entirely. This perception is based on an incomplete and incorrect interpretation of the test. This misunderstanding exists in large part because the Social Security Administration, financial services industry and financial press have done a poor job of explaining how the test works. As a result many older Americans, who are otherwise able and willing to continue working, make uninformed decisions that negatively affect their retirement security.
Here are the facts. It is true that the Retirement Earnings Test reduces the benefit for Social Security recipients under full retirement age who continue to work and earn above the legal thresholds. However once the recipient reaches full retirement age, Social Security increases the monthly benefit amount for the remainder of the person’s life. Assuming the individual lives to average life expectancy, they would recoup any benefits lost due to the Retirement Earnings Test in earlier years. Simply stated, rather than a permanent penalty on seniors discouraging them from continuing to work, the Retirement Earnings Test actually represents a re-timing of benefit payments from the pre-full retirement age to the post-full retirement years when seniors could benefit most from the higher income.
John Spoto is the founder of Sentry Financial Planning in Andover and Danvers. For more information, call 978-475-2533 or visit www.sentryfinancialplanning.com. This article is for general information purposes only and is not intended to provide specific advice on individual financial, tax, or legal matters. Please consult the appropriate professional concerning your specific situation before making any decisions.