A common perception among retirees is that because the retirement earnings test (RET) can reduce or completely eliminate Social Security benefits, income from working should be limited in order to avoid any “lost” benefits. For those folks considering whether to work while collecting Social Security benefits before their Full Retirement Age (FRA), this view can lead to the conclusion of either working less or deciding not to work at all out of fear that they will lose value in their Social Security benefits.
While it is true that the monthly benefit amount can be reduced to zero in years prior to FRA, those reductions are not “lost” but are added back at FRA in the form of a permanent increase to the monthly amount. For those retirees, this means the decision to work in retirement should include many other factors, such as personal preference, the job opportunity itself, income needs, etc., and should not be overly influenced by the effects of the RET.
Deciding to collect Social Security benefits early, or before your FRA, means that you are choosing to collect a smaller benefit payment each month. This reduction is based on the number of months before your FRA that benefits began and is otherwise permanent. Benefits are reduced by 5/9% per month during the 36 months leading up to FRA, and 5/12% per month beyond 36 months. For those born before 1955, age 66 is your FRA with the maximum reduction of 25% at age 62 (the earliest anyone can begin collecting benefits).
If you fall into the group of retirees that decide to collect early and are either planning to work or are considering working, you may be aware of the RET. If you are more than 12 months from your FRA, then benefits are withheld by $1 for every $2 of income from working over $15,720 (2016). During the 12 months leading up to FRA, benefits are withheld by $1 for every $3 of income from working over $41,880 (2016).
This withholding is not the same as collecting early, which imposes an otherwise permanent reduction. When benefits are withheld due to the RET, they are added back at FRA. The monthly benefit amount is re-calculated at that time to permanently increase the amount going forward. The re-calculation will take the months that benefits were withheld and offset months that reduced benefits due to collecting early.
For example, let’s assume a retiree with a FRA of 66 and a monthly benefit of $1,000 at 66 decided to begin collecting benefits at age 63 (3 years or 36 months early), generating a reduction of 20% (5/9% times 36 months) or $800 per month. At age 64, they decide to go back to work for one year and earn $30,120 during the year.
Since $30,120 is over the exempt amount of $15,720, the RET will cause benefits to be withheld for 9 months that year: $30,120 – $15,720 = $14,400, then $1 for every $2 over the exempt amount = $7,200 of benefits withheld, or 9 months of $800 per month. In this example, no benefits would be received for 9 months and then $800 per month.
Assuming they do not continue to earn more than the exempt amount, they would receive $800 per month until age 66 when the benefit amount would be re-calculated and credit given for the 9 months that benefits were withheld. Because 9 of the original 36 months will now be offset, the new monthly benefit amount would be $850, a reduction of only 15% (5/9% times 27 months).
Essentially, the RET provides a similar result to having waited longer before beginning benefits. The question of whether that is a good or bad thing would go back to the original decision to collect early; however, benefits are not truly “lost” by choosing to work while collecting before FRA.
Determining the best strategy for collecting Social Security can include many factors and become very complex. Each strategy should be customized for each person’s circumstances. In order to have confidence you are making the best decision, it is important to work with an adviser who is knowledgeable in Social Security rules to tailor a plan that best fits your situation.