Don’t Get Pinged by the Social Security Earnings Limit

I’d like to introduce you to Peggy. Born in 1957, Peggy reached age 62 in 2019. She has 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 six 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.

The Social Security administration permanently reduces your monthly benefit amount if you begin benefits before reaching FRA. Also, if you are still working prior to FRA 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.

Be savvy like Peggy

Thank goodness Peggy is savvy and exploring this now because not knowing the rules could damage her retirement plans. I’ve received emails from folks in their early 60s who began Social Security benefits early thinking they could get their full benefit amount and keep working too. A year or so later they received a notice that they had to return some of their Social Security benefits. They had to pay back some benefits because of the Social Security earnings limit. They had already spent the money, so this was a big shock and a financial hardship for them.

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.

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

In 2020, the earnings limit is $18,240 per year or $1,520 per month. (In 2019, it was $17,640 per year.)  That means in 2020 Peggy can earn up to $18,240 for the year and her Social Security benefits will not be reduced. For each dollar she earns over the limit, her benefits will be reduced.

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 woud apply and your income for the entire year woud 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 six months, only earnings before the month she reaches FRA count.

Reduced by how much?!?

If you collect Social Security benefits in the years before reaching Full Retirement Age (FRA) while earning more than the annual earnings limit, Social Security will take back $1 of Social Security for every $2 that you earn over the earnings limit amount.

Let’s say in the year she turns age 63 Peggy earns $50,000, the earnings limit is $18,240, and she receives $1,200 a month ($14,400 per year) of Social Security. In this example, she earns $31,760 over the earnings limit ($50,000 less the $18,240 limit). Social Security can take back up to $15,880 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 2020, the limit on earnings for the year you reach FRA is $48,600 (in 2019 it was $46,920.)

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 six 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 off-guard regarding 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.