Many taxpayers are applying for social security retirement benefits earlier than they previously planned to supplement their income. But, continuing to work while receiving social security benefits may cause the benefit to be reduced below the anticipated amount. If you are a social security beneficiary under the full retirement age (currently 66), an earnings test determines whether your social security retirement benefits will be reduced because you earned more from a job or business than an annual exempt amount (discussed below). A different earnings test applies for individuals entitled to disability benefits.
As a general rule, the earnings test is based on income earned during the year as a whole, without regard to the amount you earned each month. However, in the first year, benefits you receive are not reduced for any month in which you earn less than one-twelfth of the annual exempt amount.
The social security retirement earnings test is eliminated after you reach your full benefit retirement age for the month of, and months after, such attainment. In other words, once you reach your full benefit retirement age, there is no longer an earnings test to reduce your social security retirement benefits. However, the earnings test still applies for the years and months before the month you reach the full benefit retirement age.
Social security beneficiaries under the full benefit retirement age who have earnings in excess of the annual exempt amount are subject to a $1 reduction in benefits for each $2 earned over the exempt amount (currently $14,640) for each year before the year during which they reach the full benefit retirement age (see the example). However, in the year beneficiaries reach their full benefit retirement age, earnings above a different annual exempt amount ($38,880 in 2012) are subject to a $1 reduction in benefits for each $3 earned over the exempt amount. Social security benefits are not affected by earned income beginning with the month the beneficiary reaches full benefit retirement age.
Example: Applying the annual earnings test.
Edward, age 62, currently averages $2,000 per month in commissions ($24,000 per year). He has recently experienced a decrease in his income due to lower sales and is considering applying for social security benefits to supplement his reduced income. Edward’s social security retirement benefit will be $1,400 per month, so he expects to receive benefits totaling $16,800 per year. However, since he will earn $9,360 over the $14,640 exempt amount ($24,000 – $14,640), his benefits will initially be reduced by half that amount, or $4,680. Therefore, he will receive only $12,120 in social security benefits ($16,800 – $4,680). The results would be the same if Edward was self-employed, rather than an employee.
As you plan your retirement, be mindful that, as the previous example indicates, working during retirement and prior to your full retirement age may reduce your anticipated social security benefits. This, in turn, could have a negative impact on your overall financial plans.