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Explaining the Social Security Earnings Test

Social Security is an excellent source of retirement income for individuals and is generally incorporated when creating a retirement plan.  However, it comes with a number of limitations.  One of the larger limitations is an earnings cap, which places a maximum amount on the gross earned wages that you bring home in any one year while still collecting your Social Security benefit.  For 2016, that limit is $15,720 or $1,310 per month.  After that threshold, for every $2 of earned wages you forfeit $1 of Social Security benefit.

With this rule in place, a common question we see from retirees is what happens if I retire in the middle of the year?  For instance, an individual making $100,000 per year ($8,333 per month) who wanted to retire in March would surpass the Social Security earnings limit in their first two months of work.

Stipulations to Rules

Luckily, there are two caveats to the Social Security Earnings Test rule.  First, if you have reached full retirement age you are able to collect Social Security and earn as much income as you can with no limitations. What Social Security defines as “Full Retirement Age” is dependent on your birth year.

Birth Year 1943-1954 1955 1956 1957 1958 1959

1960 & Later

Full Retirement Age

66 66 + 2 Months 66 + 4 Months 66 + 6 Months 66 + 8 Months 66+ 10 Months

67

For those that do not wait until Full Retirement Age, you do not have to wait until the year after you retire to collect Social Security. In the year of your retirement, Social Security only applies the earnings test in months after your retire.  For Social Security purposes, you are considered retired if you earn less than $1,310 in any month.

Let’s say the individual we discussed above wanted to retire at the end of March.  The individual’s year-to-date earnings at the end of March would have been approximately $25,000. That individual would apply for Social Security to begin in the first month of retirement, April.  From April through that individual’s Full Retirement Age they would be able to collect their Social Security benefit without penalty provided their income did not exceed $1,310 per month.  Any month’s in which their income exceeded $1,310 would be penalized.

The penalty occurs by Social Security withholding payments until the penalty is fulfilled.  For instance, if you were $5,000 over the earnings limit for the year, Social Security would withhold $2,500 from future payments to satisfy the penalty.  The earnings limit and resulting penalty is another reason why in most cases it makes more sense for individuals to wait until Full Retirement Age, if not age 70, to take Social Security.  In addition, to the earnings limitations, taking Social Security before your Full Retirement Age can result in a 6.7% deduction of benefits each year, while waiting past Full Retirement Age can increase your benefits by 8% each year until age 70.

 

Important Disclosure Information

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This information is based upon RegentAtlantic’s current understanding of Social Security legislation.  This legislation can change at any time.

Please remember that RegentAtlantic does not give tax advice.  Please consult with a tax professional of your choosing prior to implementing any tax strategy including any strategy mentioned in this article.