The checklist when preparing for retirement is a long one. But you need to be aware of one item in particular if you intended to start taking Social Security before your Full Retirement Age (FRA) and continue working—the Social Security Earnings Test. It can suck Social Security dollars out of the pockets of unsuspecting retirees. To paraphrase a familiar old adage, the government giveth and the government taketh away if you earn too much.
Annual Social Security Earnings Test
Until you reach Full Retirement Age, your Social Security benefit will be reduced if you are working and earn more than a government-set threshold, which generally increases every year. In 2021, that threshold is $18,960. Earn more than that and Social Security takes back $1.00 for every $2.00 you earn above the limit. In the year you reach Full Retirement Age (FRA) the limit is quite a bit higher. If you reach FRA in 2021, the threshold is $50,520. Earn more than that and SSA will take back $1.00 for every $3.00 above the limit.
There is a bright spot concerning the SS Earnings Test. It does eventually go away. Once you reach Full Retirement Age you can earn all you want without the possibility of giving back some of your Social Security payment.
Monthly Social Security Earnings Test
There is also a Monthly Social Security Earnings Test, which can benefit you if you retire mid-year and have already earned more than the annual SSA threshold. If you pass the monthly earnings test you can receive 100% of your Social Security for any whole month the SSA considers you retired no matter how much you’ve earned that year. The monthly test can be used for one year, which is usually the first year you’re retired.
For example, if you’re under Full Retirement Age for all of 2021, SSA considers you retired in any month you earn $1,580 (the annual threshold of $18,960). If you reach FRA in 2021, SSA considers you retired in any month you earn $4,210 (the annual threshold of $50,520) or less.
Let’s say you turn 62 in June and retire at the end of the month. You made $100,000 in the first half of 2021. You want to begin receiving Social Security in July. Based on the Annual Earnings Test you would receive no Social Security Benefit in 2021.
But if you use the Monthly Earnings Test, as long as you don’t earn more than $1,580 (the annual threshold of $18,960) July through December, you would receive your full Social Security benefit. If you earn more than $1,580 in one of those months, SSA uses the $100,000 you earned during the first half of the year and you won’t receive a Social Security check for that month.
If you retire in the year you reach Full Retirement Age (FRA), the earnings test only applies to the months before the month you reach FRA. In 2021, the higher limit of $4,210 would only apply if the Monthly Earnings Test is used.
What Income is Counted for the Test
Not all income is considered for the Social Security Earnings Test, only earned income from a job or self-employment income. Passive income is not included, things like investment income, retirement plan payouts, distributions from IRAs and annuities, and rental income.
Getting Back Forfeited Benefits
You may be asking yourself, “What happens to the money I lost because of the Earnings Test?” The good news is, you will get some of it back as an increase to your monthly benefit beginning in the month you hit Full Retirement Age (FRA).
For this example, let’s say your FRA is 66 but you took early benefits at age 62. That means your Social Security benefit is permanently reduced. When you reach Full Retirement Age (FRA), your monthly Social Security check will increase because some of the forfeited money is added back in, effectively giving you a raise.
Yes, it’s confusing. Just remember that until you reach Full Retirement Age, there are limits on how much you can earn without receiving a Social Security penalty. It may help answer the question, “When is the best time to retire?”