Monday, February 27, 2006

Social Security: Early retirement and the Annual Earnings Test

Social Security law allows retirees to start collecting benefits for the first full month after the 62nd birthday. The actual payment is not actually made until the month following that, so effectively social security is available at age 62 plus two months. The benefit is less by an actuarially determined amount based on life expectancy. The reduced benefit continues after reaching full retirement age because of the actuarial calculations. Retirees without pensions or whose pensions are reduced by a social security offset (below) may feel financially pressured to start Social Security benefits early; corporate retirement policies often seem to be predicated on the assumption that they will.

Between age 62 and full retirement age, which keeps creeping up according to birth year (it is 66 for me), Social Security applies an Annual Earnings Test, which reduces benefits once wages from continuing to work go over a certain amount, by one dollar for every two dollars of overage until benefits go to zero. If a person gets a good job and stops benefits, the benefits will be mathematically more than they would have been once the person reaches full retirement age. Because a good job would probably improve the earnings and FICA contributions record (the best 35 years), the benefit after full retirement will usually improve further.

Great complexity goes into administering the Annual Earnings Test. One area is the grace year, which most often (not always) is the first year of benefits when the Earnings Test is applied over a partial year. In general, the earnings test is broken down per month and benefits are paid for each “non service” month during the grace year, where a non-service month is defined as a month in which earnings are less than a montly maximum and time spent in self-employment is less than a certain number of hours, based on previous occupation. Only wages (or bona fide self-employment earnings) count toward the Earnings Test, not pensions or investment income or most rental income (except when it is closely associated with an occupation).

Social security goes to some length to make sure that someone before full retirement age is fully “retired” and, if he or she had received substantial income from self-employment, is not hiding income from self-employment with other compensation, especially to other family members. This gets to be an arcane subject. Here is the major descriptive SSA reference.

The good question is, why does Social Security go to such excruciating pains to enforce earnings limits before full retirement? If the retiree paid his FICA taxes and is willing to take out less by starting earlier, why is that not his or her own decision? Good question. The reason seems to be ideological. Social Security was started during the New Deal and is conceived of as a welfare program even if funded by separate payroll taxes. During the years from 62 to full retirement, it is viewed more as a kind of unemployment insurance. President Bush's plans for social security would suggest the president's own philosophical disagreement with this more socialistic view of Social Security retirement "insurance"; he wants the retiree to have complete control of his own well being.

The most important link giving SSA’s own account of the rules in consumer language is at this link.
The chart giving the specific monthly and annual maximums by year is at this link.

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