The Limitations of Social Security
Whether or not these limitations apply to your situation should be discussed
So far in our Social Security series, we’ve covered break-even analysis, portfolio withdrawals and spousal and survivor benefits. Next, let’s talk about the limitations to be aware of. Three primary instances where Social Security may be limited include earnings test, windfall elimination provision and government pension offset.
The earnings test applies before the full retirement age. Once you reach full retirement age, or after, your benefits will not be reduced as a result of earned income. For 2019, Social Security benefits will be reduced by $1 for every $2 over the annual earnings limit of $17,640. A higher limit applies the year in which you reach the full retirement age. For 2019, benefits will be reduced by $1 for every $3 over the annual earnings limit of $46,920.
It is important to note that not all income reduces your Social Security benefit, only earned income. Income from pensions, annuities, IRA distributions, and portfolio income such as interest, dividends and capital gains are not included. Earned income only includes W-2 wages and self-employment income.
When thinking about earned income and how that impacts when you will claim Social Security, it is important to factor how earned income will affect your portfolio withdrawal needs. If earned income is sufficient to cover living expenses, and portfolio withdrawals are not expected, then generally, its beneficial to delay benefits. Since withdrawals from the portfolio are not expected, you are not exacerbating the negative impact of an adverse sequence of returns, and you are benefiting from receiving a larger Social Security benefit by delaying benefits.
Another limitation to consider is the windfall elimination provision. This provision may apply to a person that is eligible for a pension from an employer who doesn’t withhold Social Security taxes from your salary such as a teacher, police officer, firefighter or other government-related jobs. The pension you receive from your other job may reduce the benefit you would otherwise be eligible to receive from Social Security. The windfall elimination provision results in a recalculation of your primary insurance amount (or full retirement benefit). There are several components to the calculation, but the result is typically a reduction of benefits.
Lastly, there is the government pension offset. Similar to the windfall elimination provision, it can reduce Social Security benefits due to receiving a pension from a non-covered (government) employer, but it is different in that it applies only to Social Security benefits as a spouse or survivor. A pension received from a federal, state or local government based on work not subject to Social Security taxes may reduce the spousal or survivor benefits. The amount of the Social Security benefit will be reduced by two-thirds of the government pension.
Whether or not these limitations apply to your situation should be discussed. It is always an unpleasant surprise to find out when you go to file that you will receive a smaller amount than expected, or perhaps none at all.