Ask Bob: How Does Social Security’s Earnings Test Work?

Robert Powell, CFP®

Question

I’m 64 and will turn 65 in November. I am a manager and make more than $150,000 per year.

I had planned to retire in July of this year and set up my Social Security to start in August. My company has now talked me into staying until at least the end of November. Obviously, this year won’t be any problem at all; Social Security will just withhold benefits.

The catch is that if I stay that long, I might want to work until April 1, 2021 to lock in a substantial annual bonus. I understand that Social Security will “withhold” the checks this year. I’m just not clear what it will look like after April 1. With the bonus, I will be over the $48,600 threshold by April. Would that mean I should plan on not seeing any Social Security checks until 2022? Another interesting twist is that my wife is five years older than me. Although she qualifies for benefits, she didn’t work much so it would be better to have her check based on my earnings. We just aren’t clear when she should apply. Luckily, we are in pretty good financial health and Social Security will not be our main income. It is just nice to know what kind of liquid assets will be available.

Answer

There are several issues to cover, says David Cechanowicz, a senior financial planner with REDW.

You filed your claim for Social Security retirement benefits to begin in August, 2020. “As frequently happens, you received an offer that you can’t refuse and now you are planning to continue to work,” says Cechanowicz. “Unfortunately your working will trigger an earnings test because you have applied for benefits prior to your reaching full retirement age. You suggest that the Social Security Administration (SSA) will withhold all of your benefits.”

What is not clear, is why you are sure that Social will just withhold benefits. “Frequently this type of situation causes a lot of grief and future cash flow problems for individuals in similar situations,” he says. “Unless you have notified the SSA that you are going to exceed the earnings test, they generally will not know about your earnings until they are reported in the spring of the following year. By that time, many claimants are surprised when their checks are stopped, which lasts until all of the back payments have been recovered. That’s the cash flow problem that frequently follows that offer to continue working.”

Here’s what Cechanowicz suggests: Consider withdrawing your application for Social Security retirement benefits completely.

This is what the SSA says about withdrawing benefits: “If you change your mind about starting your benefits, you can cancel your application for up to 12 months after you became entitled to retirement benefits. This process is called a withdrawal. You can reapply later.”

Now, you are only allowed one withdrawal per lifetime. And if you cancel your application, you are required to pay back the benefits you received and then you can file at a later date. “The reason for the withdrawal in your case is buried in the details about the earnings test, says Cechanowicz.

The earnings test, he says, is designed to recover Social Security benefits from individuals who claim their benefits prior to reaching their full retirement age and continue to work. “To figure out how much you might have to repay in benefits, you first have to ask whether or not the year in question is the year you reach your full retirement age, or not,” says Cechanowicz. “If it is not the year you reach your full retirement age, you will be subject to the ‘lower threshold.’ If the year in question is the year you reach your full retirement age, then you apply the larger threshold.”

For 2020, the low threshold is $18,240. For each $2 earned above the threshold, $1 of Social Security benefits must be paid back. If 2020 is the year an individual reaches full retirement age, then the threshold adjusts upward to $48,600. Individuals who earn more than the threshold must give back $1 of Social Security benefits for every $3 earned above the threshold.

There are two very important points to note about the earnings test, says Cechanowicz. First, the thresholds are adjusted every year. Secondly, he says, there is a special rule that an individual can use, generally in their first year of retirement. “That rule allows you to start retirement at any point in the year, ignoring all prior earnings, so long as you do not exceed the applicable threshold divided by 12, for a monthly earnings test amount,” says Cechanowicz. “For 2020, the low threshold monthly earnings limit would be $1,520 per month.”

Your 65th birthday is in November of 2020 and that means that you were born in 1955. Therefore your full retirement age is 66 and 2 months. Therefore your “year of reaching full retirement age” will be 2022, says Cechanowicz.

“To keep your claim simple, I would suggest that you withdraw your claim in 2020 and then refile after you have finished working and collecting your bonus in 2021. At that time you could file for the special rule and make yourself subject to the monthly earnings test in 2021 at the time of retirement.

On the second issue of your spouse’s benefits, Cechanowicz says there are several issues that tie into your own date of retirement. “Your wife has her own work record, and you allude to the fact that she is also eligible for a spousal benefit under your work record,” he says. “In cases like this, you need to understand that your wife cannot choose which benefit to receive. She will receive an aggregation of her own work benefit coupled with a spousal benefit.”

Since your wife is five years older than you, she has reached her full retirement age, says Cechanowicz. “She has not yet claimed benefits so she is entitled to a six-month retroactive claim on her work record,” he says.

It turns out, says Cechanowicz, that the best strategy for her would have been for her to claim her own small benefit at age 66, waiting for the balance of the “spousal” benefit to begin once your claim your own retirement benefit.

“If she were to claim now, and ‘become eligible’ for spousal benefit, she would immediately lose her spousal benefit under your claim because of your earnings test,” he says. “What a mess this could make for the SSA. It could take years for them to get the accounting correct.”

Your wife, says Cechanowicz, is ultimately eligible for a spousal benefit on your work record that is equal to 50% of the benefit you would be paid, were you to wait to age 66 to claim. “What actually happens from an accounting point of view is she will get a blended benefit check, partly her benefit, and partly the spousal benefit,” he says.

But to keep this clean and simple, Cechanowicz suggests that you first withdraw your claim as soon as possible. “Then have your wife file for her own benefits as soon as you have notified the SSA that you are withdrawing your claim,” he says. “Her application should state that she is not claiming spousal benefits at the time she files. Your wife should claim her own benefit retroactively for six months. Then, once you have refiled, she will get the spousal benefit that will ‘top up’ her check so that it reaches 50% of the amount you would get at full retirement age.”

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Email Robert.Powell@Maven.io.

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