Hey guys, Mike Frontera here back with another Retirement Theory video!
OK, this is the last of three videos talking about some lesser understood Social Security benefits. I get a ton of questions on this topic, and it causes a tremendous amount of confusion, so I’m excited to set the record straight and provide much needed clarity about…..the earnings test!
Over the next few minutes, I’ll explain what the earnings test is, when it applies, and whether you would be affected, and exactly how it impacts your Social Security benefits. There are a bunch of rules involved, and it may seem complicated, but we’ll make it as simple as possible.
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Alright, let’s get right to it!
First, what is the Earnings Test? The earnings test limits how much you can earn through working, while still receiving your full Social Security benefits. Keep in mind, this test only applies to those who are younger than Full Retirement Age, which as you remember we will refer to as “FRA.” And if you need it, here’s a quick refresher on those FRA ages (show year born and corresponding FRA).
OK – now, for 2022, the earnings limit for those who won’t reach FRA by the end of the year is $19,5601. This limit is substantially higher for those who haven’t quite reached FRA, but will do so in that current year. In that case, the earnings limit is $51,960 in 2022. These limits bump up each year for inflation.
So, what is considered earnings? It’s basically, any income that you as the Social Security beneficiary make through employment. This is an area where I typically see some confusion. IRA withdrawals, pensions, dividends and interest…none of that income counts toward those limits. We’re strictly talking about employment income. A couple other points here….first, you cannot reduce your earnings for purposes of this earnings test by making a contribution to your company’s 401(k) plan. They’re looking at top line gross wages. Second, there is an exception for what are called “Special Payments”, which includes lump sum vacation or sick pay, severance pay, which all don’t count toward the earnings test, assuming the work for which those payments are based occurred before your Social Security claim. There is another exception, this time for self-employed or contract freelance workers based on the amount of time devoted to their business. And that is, if you work less than 15 hours in a month, you are not considered to have performed substantial services and thus are not typically subject to an earnings test for that month.
OK, we now know what the earnings test is. Let’s talk about when and how it applies. Assuming you’re younger than FRA, the earnings test starts as soon as you apply for Social Security benefits. By the way, earnings test affects more than just retirement benefits. If you’re eligible for spousal benefits or survivor benefits, those too could be subject to the earnings test. In fact, if your family receives benefits on your work record, their benefits could be impacted by you working, even if they themselves are older than FRA. The only exception here is if you’re receiving benefits based on your EX-spouse’s work record and they are younger than FRA. Even if they far exceed the earnings test, the benefits you receive off of your ex spouse’s record would not be impacted. You cannot be denied benefits off their record even if they’re working full-time, even if it’s purely out of spite.
OK, so how do we calculate the earnings test? We have our earnings limit of $19,560. For every $2 that you are over that limit, $1 in benefits will be withheld. So how does that happen? And more importantly, are those withheld benefits lost forever?
Let’s turn to our old pal Jerry as he applies for retirement benefits and find out.
So, Jerry retires in August 2022 at the age of 62 and applies for his monthly benefit of $1000. When Jerry applies, and each subsequent year until FRA, Jerry provides an estimate of his earnings for the following year to the SSA. It’s important to point out that in this very first year that Jerry receives benefits, he can elect to have the earnings test applied on a monthly basis, rather than annually. This allows Jerry’s earnings prior to his Social Security claim to not count against him.
Alright, let’s assume for 2023 that Jerry estimates his earnings to be $30,560 and, again, the earnings limit is still $19,560. That would put Jerry $11,000 over the earnings limit and so $5500, or half, of his excess will be withheld from his benefits. Assuming Jerry’s benefit is still $1000 per month, SSA would then withhold the first six $1,000 monthly payments 2023. That covers his $5,500 and actually exceeds it by $500.
The following year, once SSA compares Jerry’s actual earnings to what he estimated, they will correct any withheld full or partial payments. So, assuming Jerry did actually earn $30,560 in 2023, he would receive a refund for the extra $500 that was withheld in 2023.
For that portion of the year that Jerry is not yet FRA, but will become so in the same year, remember the rules are slightly different. For that part of the year, his earnings limit is much higher, $51,960 rather than $19,560 for that year. So his threshold is higher and now, $1 of benefits is withheld for every $3 that Jerry exceeds that limit.
Fast forward to when Jerry finally reaches FRA! So…did he lose all those benefits from working too much? Not really. The SSA will add up all of the months that had previously been withheld and recalculate Jerry’s benefit as if those withheld months were never claimed. In other words, if Jerry claimed benefits at 62 but had 6 total payments withheld before reaching FRA, at FRA his benefit would be recalculated as if he had originally claimed benefits at 62 years and 6 months. So while Jerry won’t recoup those withheld benefits in a lump sum, they are designed to be actuarially equivalent over the rest of his life expectancy. Oh… let’s not forget Jerry’s ace in the hole! SSA calculates your benefit based on your average of your top 35 years of earnings. If one of Jerry’s recent earnings years is one of his 35 highest, his future benefits will be recalculated using those higher figures. That’s true even after Jerry has started receiving Social Security benefits.
So, do you have questions for me? Come visit me at www.retirementtheory.com or send me an email at email@example.com. Did you click subscribe on this video or follow me on Facebook? I think that you should. You’ll continue to see videos like these on everything retirement planning. Once again, thank you for joining me, we’ll see you next time.