Edward A. Zurndorfer, Certified Financial Planner

A previous My Federal Retirement column entitled  "FERS Annuity Supplement: Understanding the Earnings Test"  discussed the "earnings test" as it applies to the FERS retirement annuity supplement.

This column discusses the same "earnings test" as it applies to Social Security retirement benefits. Since many federal employees are expected to retire over the next few years and will also be eligible for Social Security retirement benefits, this column will be especially useful to these federal employees as well as to those employees who will be retiring in the future.

In general, an "earnings test" is applied for individuals collecting Social Security benefits prior to their full retirement age (FRA). FRA is determined by an individual's year of birth, as presented in the following table.

The earnings test is based on an individual's "earned" income. "Earned" income includes salary/wages and net income/profit from self employment that is subject to the self-employment (SE) tax. The SE tax includes both the employee and employer portion of the Social Security (FICA) and the Medicare Part A (hospital insurance) payroll taxes.

The earnings test does not affect Social Security benefits beginning in the month a Social Security recipient reaches FRA. As will be shown below, this means that once a recipient reaches the month of his or her FRA, he or she can have as much as "earned" income without losing any Social Security retirement benefits.

The "Earnings Test" During 2012

Those Social Security retirement benefit recipients who are younger than FRA during 2012 -- in particular, those recipients between the ages of 62 and 65 who were born between 1947 and 1950 -- can earn up to $14,640 without losing Social Security retirement benefits. If one's earnings exceed $14,640, then $1 of benefits is withheld for every $2 earned above $14,640. Note that this test applies to Social Security retirement benefits; a different "earnings" test applies to Social Security disability benefits.

A separate "earnings test" applies to a Social Security retirement benefit recipient in the year he or she reaches FRA. In particular, during 2012 "earned" income in excess of $38,880 prior to the month a recipient reaches FRA is subject to a $1 reduction for every $3 earned in excess of $38,880. Note that individuals born sometime during 1946 will reach their FRA (age 66) during 2012.

Two examples illustrating the "earnings test" for recipients younger than their FRA throughout 2012:

Example 1. Doris became age 63 during 2012. She retired from federal service in 2011 and receives $1,000 of Social Security retirement benefits per month. During 2012, Doris works part-time and earns $16,000. Her Social Security benefits will be reduced by $1 for every $2 of earnings over the exempt amount -namely, $14,640. ($16,000 less $14,640)/2 or $1,360/2 equals $680, meaning that Doris will lose $680 of her Social Security retirement benefit. Since 2012 is not the first year Doris received Social Security benefits (2011 was), the result is the same regardless of whether the income is earned in one month or equally throughout the year (see below).

Example 2. Peter applies for Social Security retirement benefits in January 2012. March 2012 is the first full month that he is age 62. Peter works throughout 2012 and earns $24,000. His monthly Social Security benefit is $800. ($24,000 less $14,640)/2 = $4,680. In this example, $4,680 of benefits are withheld for the five months of March through July ($800 x 5 = $4,000) and a partial benefit of $120 ($800 less ($4,680 less $4,000)) is payable for August 2012. His full monthly benefit of $800 is payable for September through December 2012.

Monthly Earnings Test Applies in the First Year Benefits are Received

In the individual's first year in which benefits are received, earned income is measured on both an annual and a monthly basis. Full benefits will be paid for any month the individual earns no more than one-twelfth of the annual exempt amount. A different test applies if the individual is self-employed. Consider the following example:

Cliff retired June 30, 2011 at age 64 and receives Social Security benefits of $900 per month. From January through June he earned $10,600. He earned $1,100 per month for the rest of the year (July though December) bringing his total wages for 2011 to $17,200. If an annual earnings test were applied, Cliff would have lost $17,200 less $14,160 (the exempt amount during 2011)/2, $3,040/2, or $1,520 of benefits. However, since 2011 is Cliff's first year of receiving benefits, he will not lose benefits for any month( subsequent to his starting to receive Social Security retirement benefits) in which he earns no more than $1,180 ($14,160/12) or is not substantially self-employed. Therefore, because Cliff earned $1,100 per month starting July 1, 2011, he has no reduction in Social Security benefits.

Two examples -- individual attaining FRA (66) during 2012

Example 1. Jill applied for Social Security retirement benefits in January 2012 and reaches FRA in July 2012. She is working throughout 2012, earning $82,260. Her earnings in the period January through June 2012 are $41,130. Her monthly Social Security retirement benefit is $2,360.

Jill's earnings test for 2012:
($41,130 less $38,880/3 = $750

In this example, $750 of benefits are withheld for the period January through June. Because her monthly benefit is over $750, a partial benefit equal to $2,360 less $750 or $1,610 is payable for January 2012, and the full monthly benefit of $2,360 will begin with February 2012.

Example 2.  In example 1, Jill's earnings during 2012 are $150,000. She earned $100,000 during the period January through June 2012. As in Example 1, she applied for benefits starting in January 2012 when she reaches her FRA and monthly benefit is $2,360.

Jill's earnings test applicable for 2012:
($100,000 less $38,880)/3 = $20,373

In this example, the $20,373 exceeds the $13,800 of total benefits received for the period January through June 2012 and Jill will forfeit her $13,800 of Social Security retirement benefits. Her monthly Social Security benefit will therefore begin in July 2012 because in July 2012- Jill's FRA - the earnings test no longer applies.

Special Payments after Retirement

After an employee retires, the retired employee may receive payments for work the retired employee performed before starting to receive Social Security benefits. Usually, those payments -- called "special payments" -- will not affect one's Social Security benefits. The following discussion focuses on some of the most common types of special payments, helps a retired employee decide if he or she received a special payment, and what needs to be done in the event a retired employee receives a special payment.

Special payments to employees include bonuses, accumulated vacation (for federal employees - annual leave), severance pay, back pay, standby pay, or deferred compensation reported on a W-2 form for one year but earned in a previous year. These amounts may be shown on a W-2 in the box labeled "nonqualified plan". Special payments are not counted towards the Social Security earnings limit.

The following example illustrates how a special payment is treated under the Social Security earnings test rules:

Cathy retired from federal service at age 62 in December 2011 and began to receive Social Security benefits in January 2012. Cathy received in early January 2012 a check for $12,500 for her unused annual leave at the time of her retirement. Because Cathy's annual leave was earned before she retired, the Social Security Administration will consider it as a special payment and not include the unused annual leave lump sum payment towards the earnings limit for 2012.

Federal employees who are between age 62 and FRA who intend to retire during 2012 and who also intend to start receiving their Social Security retirement benefits during 2012 or early 2013 should be aware of the 'special payment" rules. If these employees want to be assured that their lump sum payment for unused annual leave is not included as part of the "earnings test" for 2012 or 2013, they should download from the Social Security Administration website (http://www.socialsecurity.gov) form SSA-131 (Employer Report of Special Wage Payments) and give the form to the Personnel Office of the agency they retired from. The Personnel Office will then submit the completed form SSA-131 to the Social Security Administration on behalf on the retired employee. The annual leave lump sum payment paid during 2012 or early 2013 will then not be counted as earnings used in the 2012 or 2013 earnings test.

Posted 01/17/2012

About the Author

Edward A. Zurndorfer is a Certified Financial Planner, Registered Health Underwriter, Registered Employee Benefits Consultant and Enrolled Agent in Silver Spring, MD and the owner of EZ Accounting and Financial Services, an accounting, tax preparation and financial planning firm also located in Silver Spring, MD.  He is an instructor at federal employee retirement seminars throughout the country and writes numerous columns and books on federal employee benefits.

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