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October 27, 2013

Understanding the retirement earnings test

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.

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