Investment losses and rising costs are driving many Social Security recipients back to the work place. A question to consider is how earning income affects Social Security benefits.
One of the original goals of Social Security was to remove people from the work force. Unemployment was high. Social Security would gradually induce older workers to leave their jobs and allow others to take the positions.
Social Security induces people to leave the work force through the earned income penalty, which reduces retirement benefits when income exceeds certain levels. In 1997 the earned income penalty was scaled back significantly and eliminated after Full Retirement Age (FRA), but those planning to receive benefits before FRA still are at risk of losing benefits to the penalty.
There never was an earned income limit for those aged 70 and over. As of 2002, there is no earned income limit on those who are FRA or older. FRA depends on your year of birth, and is 66 for those born from 1943-1954. There is an earned income limit for those who receive Social Security retirement benefits from age 62 up to their FRA. The limit and the amount of the penalty depend on the beneficiary’s age. The current limits are readily accessible on the Social Security web site at www.socialsecurity.gov. The limit is applied monthly and applies each month until the FRA is reached.
In the year full retirement age is reached, benefits are reduced $1 for every $3 earned over a dollar limit. The limit is $37,680 in 2009 and is indexed for inflation. The limit applies on a monthly basis until the month you reach FRA. Beginning with that month, there is no earnings limit.
Example. Max Profits will reach FRA in November 2009. He is receiving retirement benefits of $600 per month or $7,200 for the year. Max earned $39,000 in the 10 months from January through October 2009. Social Security would withhold $440 ($1 for every $3 earned above the $37,680 limit). To implement the limit, Social Security would withhold the January check of $600. Beginning in February 2009, Max would receive the $600 benefit monthly, and this amount would be paid each month for the remainder of the year. Social Security would pay the remaining $160 from the January 2009 check in January 2010.
Between age 62 and the year FRA will be reached, benefits are reduced $1 for every $2 earned over the limit. The limit is $14,160 for 2009 and is indexed for inflation each year.
Example. Max Profits is a 62-year-old earning $30,000 in 2009 and due $7,200 in benefits. He will lose all Social Security benefits for the year. If Max earned only $20,000, $2,920 of benefits would be withheld. The income of $20,000 minus the limit of $14,160 shows an excess income of $5,840. Divide the excess by two, and he loses $2,920 of benefits. Social Security would withhold the January through June benefits. The $600 monthly benefits would be paid July through December. In January 2010 Max would be paid the $440 extra that was withheld in June 2009.
Before the start of each year, you tell the Social Security Administration how much income you expect to earn the coming year. The SSA then computes the penalty and withholds the appropriate amount of benefits. If your earned income changes, in either direction, you are to notify the SSA so it can adjust the withholding.
When someone begins Social Security benefits during a calendar year, earned income before the benefit beginning date does not count in applying the penalty. Instead, the annual earnings limit is computed on a monthly basis, and only the monthly earnings after the date retirement benefits begin count toward the penalty. For example, in 2009 the monthly earnings limit for someone younger than the FRA is $1,180 ($14,160 divided by 12).
The loss of benefits from the earned income limit might not be permanent. Once FRA is reached, benefits will be recomputed to give you credit for the lost benefits. But credit is allowed only for months when the entire benefit was lost.
Also, continuing to work could increase your benefits after FRA. Your highest earning 35 years will be used to determine the benefits. Each year Social Security reviews the records of beneficiaries who earned income. If the latest year is one of the top 35 earnings years, the benefits are automatically recalculated. The higher benefit should be paid in December of the year after the year of the new earnings. For example, suppose your 2008 earnings would result in a recalculation of benefits for 2009. The additional benefits, retroactive to January 2009, would be calculated during 2009 and paid in a lump sum in December 2009.
Earned income is income from a job or self-employment. It includes most income from providing personal services or selling goods or services. Earned income does not include investment income and passive income such as interest, dividends, capital gains, pensions and IRA distributions. Self-employment income is net self-employment income, not gross income.
You might be able to plan and manage income to avoid losing Social Security retirement benefits before reaching FRA. But you also need to be wary of any strategies that are suggested to you. Bogus strategies constantly are being promoted. If a strategy is recommended to you, check it out either with a knowledgeable, objective advisor or by contacting Social Security.
One way to avoid a reduction in benefits might be to defer income. Income is applied against the limit in the year it is earned, not in the year it is paid, in most cases. So you cannot avoid the earnings limit simply by agreeing to have your employer pay it in a future year. If you have the legal right to receive the income, it must be included in your earned income for Social Security purposes in the year you earned it. But if the right to receive the income is not vested and might be forfeited, it is not earned yet.
Self-employed people often are advised to use corporations to avoid Social Security taxes on salary as well as to avoid the earned income limit on retirement benefits. The strategy is to set a low salary for the owner-employee that stays under the earned income limit. When cash is needed, the owner takes dividends or distributions other than salary and bonus.
Both the IRS and the Social Security Administration state a salary must be reasonable in light of the work done and the qualifications of the employee. If it is set at an artificially low level, the SSA considers it fraud. You have to establish the salary as reasonable for the work done and your level of expertise. If your salary declines sharply the year benefits begin, your hours worked also should change. Some advisors believe you also should transfer voting control of the corporation or set up an independent board or committee that sets the salary.
Not all income counts towards the earnings limit. Generally, compensation that is tax-free also is not counted as earned income for purposes of the Social Security earnings limit. For example, you might be able to work with your employer to maximize health insurance and other tax-free benefits and minimize cash compensation. You should check with SSA to verify a form of compensation does not count towards the earnings limit.
There are several types of income that Social Security does not consider earned income. These include rental income, pension and IRA distributions, jury duty pay, worker’s compensation, unemployment compensation, lottery and prize winnings, and employer reimbursements for travel or moving expenses.
More details about how different payments are classified are available in the Social Security Handbook (free from local Social Security offices), the Social Security web site, and the Social Security telephone assistance at 800-772-1213.
RW August 2009.