By Heather Schreiber, RICP®
One of the many ripple effects of COVID-19 has been a surge in lost jobs. The U.S. unemployment rate peaked in April 2020 to 14.8%, the highest number since the Great Depression of the 1930s. Since then, unemployment has slowly declined to 6.2%, as of February 2021, according to the Bureau of Labor Statistics. That’s progress, but joblessness was still nearly double the 3.5% rate of February 2020!
If you are one of the millions of workers out of work, navigating an unexpected exit from the workforce might cause you to reevaluate your financial plans. Collecting unemployment benefits may be possible. And, if you are 62 or older, you may consider filing for Social Security benefits. Can this potential parlay solve your cash flow crunch? Perhaps, as you’ll see from this response to a question I received from James:
My wife Ann and I, now both 64, had planned to retire and file for Social Security when we reached our full retirement age of 66 and 6 months. However, Ann lost her job, making it harder for us to make ends meet. Ann has been collecting unemployment but that alone is not enough for us to bridge the income gap. I’ve heard that filing before full retirement age while working can affect Social Security benefits. Is Ann’s unemployment compensation considered earned income in this calculation?
Working in Retirement
James’ question refers to the annual earnings test, which applies only to early filers – those who claim Social Security retirement benefits before their full retirement age (FRA) – and who continue to work. Earned income above a certain threshold, $18,960 in 2021 for someone under FRA during the entire year, causes 50% of the wages over the earnings limit to be withheld before the monthly Social Security benefit can commence. Earnings of a spouse are not considered when applying the earnings limit for the early filer; other sources of income such as dividends, IRA distributions, or pension payments are also exempt.
A more generous annual earnings limit ($50,520 in 2021) applies in the year you reach your FRA: only $1 for every $3 of earnings over the limit will be withheld from Social Security benefits. Once you reach your FRA, the annual earnings test no longer applies.
The earnings limit can be an unwelcome surprise to someone who doesn’t fully understand how excess earnings will affect benefits. Suppose you earn $10,000 over the earnings limit, causing $5,000 to be withheld from your Social Security. If you otherwise would collect $1,000 per month, the first 5 months of Social Security benefits would be withheld before Social Security would begin to pay your full monthly benefit in month 6.
Good news I: Suppose Ann already exceeded the $18,960 in earnings prior to losing her job. A special rule, generally during the first year of retirement, allows Ann to disregard earnings prior to her claim provided she earns no more than the monthly equivalent of the annual limit ($1,580) for the rest of the year. The following year and any subsequent year, the effect of continued work will be applied only using the annual earnings test. This special rule permits someone who retires, or loses his or her job, mid-year to avoid having to wait until the following year to file for benefits.
Good news II: Such withheld benefits are not truly lost. They will be restored eventually in the form of a higher monthly benefit to account for the number of months previously withheld. The increased payout will appear once the claimant reaches FRA. Still, excess earnings before FRA can delay the onset of needed cash flow from Social Security.
For more information on the earnings limit visit https://www.ssa.gov/pubs/EN-05-10069.pdf.
Good news III: Unemployment compensation is not considered earnings under the annual earnings test. Therefore, Ann’s collecting unemployment won’t decrease her Social Security benefits, beyond the normal reduction for claiming before FRA.
(Currently, Minnesota is the only state that may reduce unemployment compensation, depending upon when Social Security benefits began. Refer to https://www.uimn.org/applicants/affectsbenefits/other-income/index.jsp for more information.)
On the negative side, unemployment compensation is subject to federal income taxes. Consequently, those payments could cause a portion of Ann’s Social Security benefits to be taxable, even more likely when added to James’ earnings. Taxation of Social Security benefits is based upon adjusted gross income (AGI), among other variables, so the potential for taxes to erode a portion of the benefit is the gift that can keep on giving. This couple should make sure to take taxes into account when deciding whether Ann should claim Social Security now.
In this computation, James and Ann should realize that the recently-passed American Rescue Plan Act waives federal income taxes on the first $10,200 of unemployment insurance benefits for individuals with modified AGI of less than $150,000. This waiver, which applies to 2020 tax returns, can be a welcome reprieve on the tax front. Not all states conform to the federal waiver, so check your state’s treatment of unemployment compensation. However, the entire amount of unemployment compensation, including the first $10,200 for all recipients, must be included for purposes of determining whether any part of Social Security benefits is federally taxable.
Bottom line: It pays to work with a trusted tax or financial professional to make sure you are adequately prepared before making a Social Security claiming decision.
About the author: Heather Schreiber, RICP®
Heather Schreiber, RICP®, president of HLS Retirement Consulting, is a nationally recognized keynote speaker and consultant on retirement-related topics including Social Security as an integral component in developing a holistic retirement income strategy. Heather is the author of Social Security Advisor, a monthly newsletter designed to educate the public on this critical income source, and has been quoted in Forbes, USA Today, and ThinkAdvisor.