Understanding the Social Security Earnings Test
One of the most common questions I am asked by folks approaching retirement and even already in retirement is how continuing to work and earn money while drawing social security will affect their benefits. The rules can be confusing, even for seasoned financial advisors, and how it affects any particular person versus another can often be quite different depending on specific circumstances.
Recent surveys conducted by multiple organizations show that over 50% of us over the age of 55 intend to keep working to some degree in retirement. Because of the prevalence of this, a primer on the social security earnings test (we'll call it SET for short) is useful information, so that is my subject today. Here are some important facts you need to know if this applies to your situation:
First of all, just know that once you reach full retirement age (which differs based on the year you were born; you can find a table at ssa.gov/benefits/retirement/planner/agereduction), there is no SET anymore. You can work and earn all you want, and it will NOT affect any retirement benefits to which you are entitled and claim.
However, as you may know, you can begin as early as age 62 to claim social security benefits, albeit at a reduced amount. Whether that is a wise thing to do or not I have written about extensively in the past and, of course, is a decision to be made based on many factors. But, if you do begin to claim benefits before full retirement age and continue to work, the SET can affect the amount of benefits actually received.
Under what is known as the annual earnings test, for every $2 in gross wages or net self-employment income earned above the annual exempt amount, the Social Security Administration (or SSA) will reduce your benefit by $1. For the year 2022, the annual exempt amount is $19,560. Earnings from investments or retirement funds do not affect this test.
A monthly earnings test also exists that can sometimes be help someone avoid a reduction in benefits even in a year that they exceed the annual amount. Under the monthly test, a recipient can receive the full benefits they would otherwise be entitled to for any month their work income is less than 1/12 the annual amount, which for 2022 is $1,630 per month, even if for the entire year they exceed the annual amount.
This can be especially helpful in the year retirement occurs or there is a significant work-related change since annual income in such a year may be too high under the annual test. It is important to note that the monthly test can only be used in one year.
Now, in the year you finally reach you full retirement age, another limiting rule applies. In that year, the benefit reduction is $1 for every $3 earned above a higher annual exempt amount, which for 2022 is $51,960 (or $4,330 per month if using the monthly earnings test). Then, starting in the month of full retirement age, there is no longer a limit on earnings (hooray!).
While this reduction in benefits may seem onerous, it's not all bad news because the benefits not paid to you are not altogether lost. This is because once you reach full retirement age, the SSA recalculates your full retirement age benefit. What this means is your benefits will be increased to account for the number of months that you did not receive a benefit.
For example, if your benefit was reduced the equivalent of say, 12 months' worth of benefits from age 62 to full retirement age, your benefit will be recalculated as if you started claiming social security benefits at age 63 instead of age 62. This results in a higher monthly full benefit amount that, since paid the rest of your life, could result in more money being received over time than what was withheld in the early years.
Because the SET and related benefit reductions can significantly impact your early retirement budget considerations, it's critical to understand the earnings test and weigh all of your possible options when making your Social Security filing decision. Hopefully this information helps you make the choice that is right for you.
