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How to Avoid the Social Security Earnings Limit

Dana Anspach

December 10, 2020

If you claim Social Security before a designated age, which varies based on your date of birth, and if you continue to work and earn in excess of a specified limit, then you will owe some of your Social Security back. This is how the Social Security earnings limit works. Once you reach the designated age, the earnings limit no longer applies, and you can collect Social Security and continue to work and earn any amount without penalty.

Let’s look at the details of how this earnings limit works, and how you can avoid it.

I’d like to introduce you to Peggy. Born in 1958, Peggy attains age 63 in 2021. She worked in retail her whole life, with the past twenty-five years spent in management. Peggy divorced from her husband 14 years ago, is still single, and has no children.

According to the Social Security Administration, Peggy’s Full Retirement Age (FRA) will be age 66 and eight months which is when she will be entitled to full Social Security retirement benefits. FRA is a government set limit that varies based on your year, month, and day of birth. FRA is gradually rising, and for those born on the second day of 1960 or later, FRA is 67.

If you begin benefits before reaching FRA, and continue working, then something called the Social Security earnings limit applies.

Because Peggy is feeling the aches and pains you’d expect after decades in retail, she is exploring the possibility of dialing back her work hours and starting to collect Social Security benefits early at age 63, three and half years before her Full Retirement Age.

How much can Peggy earn from her job before Social Security benefits are reduced?

Thank goodness Peggy is savvy and exploring this now because not knowing the rules could permanently impair her future retirement income. Many folks began Social Security benefits in their early 60’s thinking they can get their full benefit amount and keep working too. A year or so later they receive a notice that they must return some of their Social Security benefits. They happens because of the Social Security earnings limit. If they already spent the money, this can be a big shock and result in a financial hardship.

Here’s how the Social Security earnings limit works. If you begin Social Security benefits before your Full Retirement Age and you continue to earn more money than the “earnings limit,” either as an employee or as a self-employed person, your Social Security benefits will be reduced while your earnings are in excess of the limit.

Once you reach Full Retirement Age (FRA) you can earn an unlimited amount and no reduction will apply. The good news is income from investments, pension benefits, IRA withdrawals, and unemployment benefits do not count as earnings under this rule.

In 2021, the earnings limit is $18,960 (up from $18,240 in 2020) per year or $1,580 per month. That means in 2021 Peggy can earn up to $18,960 for the year and her Social Security benefits will not be reduced.

How does the reduction work?

For the years before reaching Full Retirement Age (FRA), Social Security will take back $1 of Social Security for every $2 that you earn over the earnings limit amount.

Before the year you reach FRA, Social Security looks at income for the entire year, even if you were not entitled to Social Security for the entire year. Except, there is a special rule that allows them to look at it month by month – if you stop working.

For example, assume you turn 62 in June. From January to May of that year you earn $35,000. Then you retire and start collecting benefits. If you don’t work again, you’re fine and you’ll collect your Social Security with no reduction. But what if you pick up part-time work in October and earn $2,000 a month? Starting in October, a reduction in benefits will apply and your income for the entire year will count toward calculating the reduction.

Once you attain FRA, this odd whole-year rule no longer applies. For example, the year Peggy reaches age 66 and eight months, only earnings before the month she reaches FRA count.

Let’s say in the year she turns age 63 Peggy earns $50,000, the earnings limit is $18,960, and she receives $1,200 a month ($14,400 per year) of Social Security. In this example, she earns $31,040 over the earnings limit ($50,000 less the $18,960 limit). Social Security can take back up to $15,520 of benefits – all her benefits for the year ($1 for every $2 over the limit). Yes, that is a lot. This reduction applies to any year before you reach FRA.

The rule above applies until the year you reach FRA. There is a larger earnings limit and a different rule that applies the year of your FRA. In 2021, the limit on earnings for the year you reach FRA is $50,520 (in 2020 it was $48,600.)

There is a different limit for the year you attain full retirement age

If you collect Social Security benefits during the year you reach FRA, Social Security will deduct $1 in benefits for every $3 you earn over the limit.

During the year you reach FRA, Social Security only counts earnings that you receive before the month you reach FRA. So if you are a high-income earner and earned $60,000 in the first half of the year, then reach FRA and begin your Social Security in the fall, the earnings limit will not apply to you.

You may be wondering why the earnings limit goes up the year you reach FRA. The reason the Social Security Administration gives is: “The special rule lets us pay a full Social Security check for any whole month we consider you retired, regardless of your yearly earnings.”  Basically, if you retire before age FRA, that is considered early retirement.  Once you reach FRA, you can be considered “retired”.

The Social Security website provides detailed information on how the deductions work and offers an earnings test calculator, where you plug in your date of birth and expected earnings to see if a reduction will apply to you.

When is the Social Security earnings limit increased?

The earnings limit is adjusted each year depending on the formal measure of inflation, based on the Consumer Price Index. In years where the earnings limit doesn’t change or only changes a little, it means there was low or negative inflation.

What else do I need to know?

If you have a spouse or other family member who receives Social Security benefits based on your Social Security record, and you go back to work and exceed the earnings limit, your earnings in excess of the earnings limit can reduce their benefits too. This can apply in situations where there are spousal benefits or benefits coming in for dependents. See the Social Security publication How Work Affects Your Benefits for additional details.

What should Peggy do?

The safest way for Peggy to avoid the Social Security earnings limit is to wait until she reaches FRA, 66 and eight months, to begin drawing Social Security benefits.

Perhaps she can reconfigure her job situation so it isn’t as onerous so she continues working. Or if that doesn’t work, perhaps she can work part-time and use some of her savings or retirement money to tide her over until she reaches FRA. If Peggy is healthy and has a normal life expectancy these solutions may be a better option for her than starting Social Security early.

However, some people must start benefits because they are laid-off and have no other income or assets. If this happens to you, but your situation changes later, and you go back to work, you can withdraw your application for Social Security within 12 months of starting benefits. However, you have to pay back any benefits received within that 12 month period.

For those who get caught by the earnings limit

If you find yourself in a situation where the earnings limit applies, don’t panic. The amount of benefits withheld is eventually paid back to you. There is a ‘recalculation’ that happens. The result of this recalculation is that once you reach FRA, any withheld amounts are put back in the mix and slowly paid back out to you with each monthly check.

If you find yourself facing an unplanned early retirement, it may be to your benefit to use savings to supplement your income and delay the start of Social Security so that if you find another job, the earnings reduction will not apply.

This introduction to how some of the rules of Social Security work is a lot to take in. If you want to learn more, check out the Control Your Retirement Destiny podcast (particularly Episode 3 on Social Security) on either iTunes or Podbean.