Social Security While Working: The Earnings Test

If your retirement plan includes a stage of semi-retirement, you’ll want to take the Social Security earnings test into consideration when making your plans.

In brief, the earnings test says that, for years before full retirement age during which you work while claiming Social Security benefits, for every $2 by which your annual earnings exceed a certain amount ($14,160 in 2011), your annual Social Security benefit will be reduced by $1.

Example: Neal is two years away from full retirement age and is already claiming Social Security benefits. He worked this year and earned $25,000 (or $10,840 in excess of $14,160). As a result of the earnings test, his annual benefit will be reduced by $5,420 (half of the $10,840 excess).

There are three additional points worth noting here.

First, after reaching full retirement age, the earnings test doesn’t apply. You can earn as much as you want without a reduction in your benefits.

Second, for earnings test purposes, only wages, earnings from self-employment, and a few less-common types of income are considered. (For example, IRA distributions, interest income, and capital gains do not count.)

Third, the calculation is different for the year in which you reach full retirement age. In that year:

• The exempt amount is higher ($37,680 for someone reaching FRA in 2011),
• $1 of benefits is withheld for every $3 of earnings in excess of the exempt amount rather than $1 being withheld for every $2 of excess earnings, and
• Earnings for months of the year after you reach FRA are not taken into consideration.

How the Reduction is Applied

Contrary to what you might expect, if your benefits are reduced as a result of the earnings test, they will not be reduced on a pro-rata basis throughout the year. Rather, your benefits will be withheld completely until the withholding requirement for the year has been satisfied.

Example: Aside from the earnings test, Laurie’s Social Security benefit would be $18,000 per year ($1,500 per month). However, because of the test, her benefit will be reduced by $4,500 this year. As a result, Laurie will receive no benefits in January, February, or March. Then she will receive full benefits for the remaining nine months of the year.

When Laurie reaches full retirement age, her benefits will be recalculated to adjust for the months that she didn’t actually receive full benefits. That is, if she had claimed benefits 48 months before FRA, but the earnings test eliminated her benefits for 12 of those 48 months, her benefit will be recalculated as if she had only claimed 36 months early rather than 48.