Q: In a recent column, you said that someone’s Social Security check might go down if they are still working while getting Social Security checks. You must be talking about taxes, because my husband is 69 and still working, and he gets an increase every year in his benefits. So, can you please clarify things for us?
A: You’ve probably heard the phrase, “You are mixing an apple with an orange.” Well, in your case, you are mixing an apple and an orange and a kumquat!
In this situation, the kumquat is the taxation of Social Security benefits. And in the prior column you mentioned, I was not discussing that issue. In fact, I rarely get into the topic of the taxes you pay on your Social Security benefits. Why? Because, frankly, I don’t feel comfortable discussing it. As a retired Social Security guy, I know all about the payment of Social Security benefits, and that is what I write about. But the taxation of those benefits is handled by the Internal Revenue Service, not the Social Security Administration. So, when people need to know about the taxes they might pay on their Social Security benefits, I send them to the IRS or to a good local tax advisor.
Let’s get back to that apple and orange. The apple is the penalty that applies to Social Security beneficiaries under full retirement age if they are working and earning over a prescribed limit. The orange is the increase in benefits that might occur for people (usually folks over their full retirement age) who continue to work after they start getting Social Security.
OK, let’s peel that earnings penalty apple first. Once you are over your full retirement age, you can make as much money as you want and still get all of your Social Security benefits. But if you are under full retirement age, you lose $1 in benefits for each $2 you make over an earnings threshold that goes up slightly every year. Currently, that threshold is $18,240.
Here is a quick example: Fred is 63 and getting Social Security. He takes a part-time job that will pay him $25,000 in 2020. That is $6,760 over the $18,240 earnings penalty limit. Half of that, or $3,380, must be withheld from his 2020 Social Security checks. Let’s say his normal monthly benefit is $2,000 per month. The Social Security Administration will hold back one of his checks and $1,380 from another check in order to recover the $3,380 that he is not due.
That’s a very simple explanation of the earnings penalty process. As I explained in a recent column, this provision of the law is usually a mess to administer because people rarely know exactly how much money they are going to make. So, the SSA starts withholding benefits based on whatever estimates you initially provide. But as your income changes and the estimated yearly income changes, the withholding amounts change, and you either get overpaid or underpaid. So, this “apple” of a law usually ends up being all mushy — maybe more like applesauce!
And now let’s get to the orange. You said your husband is 69, still working and gets an increase every year in his benefits. That’s quite a sweet orange, isn’t it? Here is what makes it sweet.
Your husband’s initial Social Security retirement benefit calculation was figured on his average monthly wage using his highest 35 years of inflation-indexed earnings as a base. If he works after he starts getting Social Security, those earnings he has and the taxes he pays will bump up his monthly benefit if the extra earnings increase his overall average monthly wage. In other words, they will add in his new year of earnings, drop out the lowest of the 35 years used in his original computation, and refigure his benefit.
There are a couple of very important points I need to make about this process. First, it is automatic. You don’t have to apply for it. The SSA has a computer program that annually refigures benefits for all working Social Security beneficiaries. Those who are due increases usually get them by the middle of the following year. In other words, if you are a Social Security beneficiary who worked in 2020 and who made enough to raise your average monthly wage, you will see your benefits go up around June of 2021 (with the increase paid retroactively to January 2021).
But the other important point I need to make about this process is that not everyone gets an increase. In fact, I’d guess most working beneficiaries don’t. Remember, I said that you only get an increase in benefits if the extra earnings you have increase the average monthly wage upon which your Social Security benefit is based. Or, to put that another way, you get an increase in benefits if the earnings you have now are higher than the lowest year of inflation-adjusted earnings used in your original benefit formula.
Here is an example: Let’s say 67-year-old Hank made $20,000 in 2019. He thinks he should get an increase in his benefits because he was making only about $10,000 per year in 1984, which he figures must be the lowest of the 35-year base of earnings used in his original Social Security computation. But Hank needs to remember that those past earnings were indexed for inflation. In other words, when the SSA figured his original benefit, they didn’t use the $10,000 he actually made. They multiplied that by an indexing factor of probably around 4. That means they used $40,000 instead of $10,000 as his 1984 wages. So, $40,000 (not $10,000) is his lowest year of earnings. The $20,000 that Hank made in 2019 is way less than that. So those new earnings he had will not increase his overall average monthly wage and thus will not increase his monthly Social Security check.
On the other hand, if Hank had made $50,000 in 2019, that would have been higher than the lowest year in his original benefit formula, and it would have resulted in a small increase in his monthly Social Security check.
“Small increase” is a key phrase here. Although the amount of the increase depends entirely on your current earnings and your past earnings history, usually a year of good earnings might bump up your monthly Social Security check by $10 or $20.
If you have a Social Security question, Tom Margenau has the answer. Contact him at email@example.com.