Working May Decrease Your Social Security Benefits

Many taxpayers currently underemployed due to recent economic conditions may consider applying for social security retirement benefits earlier than they previously planned to supplement their income. But, continuing to work while receiving those benefits may cause their benefits to be reduced below the anticipated amount. If you are a social security beneficiary under the full retirement age (currently age 66), an earnings test determines whether your social security retirement benefits will be reduced because you earned more from a job or business than an annual exempt amount (discussed below). A different earnings test applies to individuals entitled to disability benefits.

As a general rule, the earnings test is based on income earned during the year as a whole, without regard to the amount you earned each month. However, in the first year you receive benefits, they are not reduced for any month in which you earn less than one-twelfth of the annual exempt amount.

One of the provisions of the Senior Citizens’ Freedom to Work Act is that the social security retirement earnings test is eliminated in the calendar year in which you reach your full benefit retirement age for the month of, and months after, such attainment. In other words, once you reach your full benefit retirement age, there is no longer an earnings test to reduce your social security retirement benefits. However, the earnings test still applies for the years and months before the month you reach your full benefit retirement age.

Social security beneficiaries under the full benefit retirement age who have earnings in excess of the annual exempt amount are subject to a $1 reduction in benefits for each $2 earned over the exempt amount (currently $14,160) for each year before the year during which they reach the full benefit retirement age (see the example). However, in the year beneficiaries reach their full benefit retirement age, earnings above a different annual exempt amount ($37,680 in 2010) are subject to a $1 reduction in benefits for each $3 earned over the exempt amount. Social security benefits are not affected by earned income beginning with the month the beneficiary reaches full benefit retirement age.

You use the first exempt amount (currently $14,160) from the year you reach age 62 through the year before the year you reach your full benefit retirement age. The second exempt amount (currently $37,680) is used in the year you reach your full benefit retirement age. (However, social security benefits are not affected by earned income beginning with the month you reach your full benefit retirement age.)

Example:  Applying the annual earnings test.

Charles, age 62 and a commissioned salesperson, currently averages $2,000 per month in commissions. He has recently experienced a decrease in his income due to lower sales and is considering applying for social security benefits to supplement his reduced income. Charles’s social security retirement benefits will be $1,200 per month, so he expects to receive benefits totaling $14,400 per year. However, since he will earn $9,840 over the $14,160 first exempt amount ($24,000 – $14,160), his benefits will initially be reduced by half that amount, or $4,920. Therefore, he will receive only $9,480 in social security benefits ($14,400 – $4,920). The results would be the same if Charles was self-employed, rather than an employee.

As you plan your retirement, be mindful that, as the example shows, working during retirement may reduce your social security benefits. This, in turn, could have a negative impact on your financial plans.