Whether to Work While Collecting Social Security
Earned Income Can Reduce Early Retirement Benefits
By Thomas M Dalton and Diane D. Pattison
JULY 2008 -
Two retirement trends are converging that will soon create a dilemma
for many of the 78 million baby boomers approaching retirement.
First, the Social Security Administration reports that approximately
73% of retired worker beneficiaries elect to begin collecting Social
Security benefits before their full retirement age (OASI Monthly
Statistics, June 2007, Table 3). Second, vast numbers of baby boomers
are financially unprepared for retirement (according to regularly
published news reports) and will need to continue working even while
collecting Social Security benefits. Therein lies the dilemma. People
collecting Social Security benefits before full retirement age—and
who also are earning wages or self-employment income in excess of
allowed amounts—will lose all or a portion of their monthly
Social Security benefits. For these people, does the loss of Social
Security benefits outweigh the economic gain from earning a few
extra dollars in retirement?
individuals look to their CPAs for guidance on this question.
Although the answer may at first appear to be obvious—as
much as $1 of Social Security benefits will be lost for every
$2 earned over the allowable threshold—a closer examination
reveals that the answer depends on a beneficiary’s personal
situation. A CPA must understand how the Social Security Administration
generally calculates benefits when a retiree continues working.
A CPA must also be able to make a judgment call as to whether
this calculation will have a material effect on an individual’s
financial situation, and, if so, whether the overall effect will
be beneficial or detrimental.
must make two primary decisions about receiving Social Security
benefits. First, should one start receiving benefits before reaching
the full retirement age? Second, if benefits are started early,
should one continue working? This article examines the factors
that need to be weighed in making the second decision.
Age at Retirement Affects Benefits
benefits are reduced when a person begins collecting benefits
before full retirement age, whether working or not. Full retirement
age depends on when a person was born. Exhibit
1 presents full retirement ages based on the year of birth.
For example, a person born on March 2, 1943, has reached full
retirement age when he or she has reached the age of 66 years
and zero months.
When a person
elects to collect Social Security benefits before full retirement
age, the person’s normal retirement benefits (also called
the Primary Insurance Amount, or PIA) are reduced. The reduction
is equal to 5/9 of one percent, multiplied by the first 36 months
before full retirement age and by 5/12 of one percent for each
additional month before full retirement age. For example, if Joe,
born March 2, 1953 (full retirement age 66 and zero months), elects
to begin receiving benefits at age 62 (48 months before full retirement
age), then Joe’s retirement benefits will be reduced by
25% [5/9 of 1% for 36 months, plus 5/12 of 1% for 12 months].
When a person elects to receive early benefits, the benefits continue
at the lower amount, even after the beneficiary reaches full retirement
note that, under Social Security rules, a person can begin collecting
Social Security early in the first month that she is 62 for the
entire month. Also note that a person is considered to turn 62
on the day before her birthday. Therefore, people whose 62nd birthday
falls on the first or second day of the month can begin collecting
Social Security in the month they turn 62. All other persons can
begin collecting Social Security when they turn 62 years and one
month. This means that some people can collect early benefits
up to 48 months before full retirement age, and others only up
to 47 months. Furthermore, people born on January 1 are considered
to have been born in the prior year.
Earned Income in Early Retirement Affects Benefits
benefits are further reduced when a person younger than full retirement
age earns more than a minimal (or exempt) amount of income. Social
Security benefits are intended to partially replace earnings in
“retirement.” Under this logic, retirees collecting
Social Security benefits historically have forfeited all or part
of their benefits during years in which they are not fully retired.
“Not fully retired” is currently defined within the
context of Social Security as when a person has—
- not reached
full Social Security retirement age, and
more than the exempt amount of income.
of exempt income that can be earned annually before triggering
this second reduction in benefits is determined by two factors:
the year the earnings occurred, and the age of the beneficiary.
exempt amount of income varies each year according to increases
in the national earnings level. Exhibit
2 shows the annual exempt amount of income for 2000 through
2008. The beneficiary’s age determines what column in Exhibit
2 is relevant. Beneficiaries reaching full retirement age during
the calendar year have a higher threshold than beneficiaries who
have not reached full retirement age during the calendar year.
For example, a person born March 2, 1943, will reach full retirement
age in March 2009 (66 years, 0 months). If this person is collecting
early Social Security benefits in 2008, he or she can earn up
to $13,560 before his or her Social Security benefits are reduced.
A person born September 2, 1942, will reach full retirement age
in July 2008 (65 years, 10 months). If collecting early Social
Security benefits in 2008, this person may earn up to $36,120
during January through June, before Social Security benefits are
reduced. All amounts earned after June 2008 would be exempt.
earnings reduction is $1 of Social Security benefits for every
$2 of earnings over the lower threshold for people who are not
yet in the year they reach full retirement age. In the year a
person reaches full retirement age, the excess earnings reduction
is $1 of Social Security benefits for every $3 of earnings over
the higher threshold. During the month of reaching full retirement
age and thereafter, beneficiaries can earn an unlimited amount
without a reduction in their Social Security benefits.
assume that Jerry, born March 2, 1943, is collecting early Social
Security benefits in 2008. He will not reach full retirement age
until March 2009. Jerry earns $14,600 in 2008. The Social Security
Administration will reduce Jerry’s annual Social Security
benefits by $520 [($14,600 -- $13,560) ÷ 2]. It appears
that Jerry pays a 50% excess earnings “tax” (i.e.,
a two-for-one reduction) on his wages in excess of $13,560—in
addition to federal, state, and employment taxes (assuming his
Social Security benefits are nontaxable, so there is no tax benefit
when this income is reduced). This represents $43.33 in lost benefits
Joan, born September 2, 1942, is also collecting early Social
Security benefits in 2008. Further assume that Joan earns $41,520
in 2008 in the months before she attains full retirement age in
July. Because Joan reaches full retirement in 2008, the Social
Security Administration will reduce Joan’s annual Social
Security benefits by $1,800 [($41,520 -- $36,120) ÷ 3].
It appears that Joan pays a 33% excess earnings “tax”
(a three-for-one reduction) on her wages that are in excess of
$36,120—in addition to federal, state, and employment taxes.
This represents $150 in lost benefits each month. After June 2008,
Joan can earn an unlimited amount of income without a reduction
high effective tax rate on earnings in excess of the 2008 threshold
amounts, Jerry and Joan might choose to spend 2008 playing golf
rather than earning wages. An additional disincentive for exceeding
the earnings threshold amounts is the uncertainty that is always
present when dealing with a governmental agency as large as the
Social Security Administration. Seniors are generally fearful
that any event changing their current Social Security benefits
might trigger errors that will take months to correct. Retired
people on a fixed income usually cannot afford these errors and
will avoid actions that might cause them (such as exceeding the
excess earnings threshold).
is not without a sense of fair play. Seniors who lose Social Security
benefits because they exceed the excess earnings thresholds are
at least partially compensated when they reach full retirement
age. The Social Security Administration recomputes the recipient’s
monthly benefit, taking into consideration the months the recipient
lost benefits because of excess earned income. In effect, the
recomputation pretends that the recipient did not elect early
retirement during the months when Social Security benefits were
reduced or eliminated. The early retirement reduction of 5/9 (or
5/12) of 1% is removed for each of those months. The recomputed
benefit becomes the recipient’s new monthly benefit, beginning
at full retirement age.
assume that Jenny (full retirement 66 years, 0 months) elected
to begin receiving Social Security benefits at age 62 years, 0
months. If Jenny’s normal monthly benefit (PIA) at age 66
is $2,267, Jenny will receive only $1,700 per month at age 62
(75% of $2,267). This first reduction is because she began receiving
benefits 48 months before her full retirement age. However, if
Jenny continues working for 12 months after she begins receiving
Social Security benefits—and if she earns enough during
this time to reduce or eliminate 12 months of benefits—her
monthly benefit amount will be recalculated when she reaches full
retirement age at 66 and will equal approximately $1,814. Instead
of a reduction in normal benefits of 25% [5/9 of 1% for 36 months,
plus 5/12 of 1% for 12 months], the reduction should only be 20%
[5/9 of 1% for 36 months].
But has this
recalculation fully compensated Jenny for her previous loss of
Social Security benefits? Section 724 of the Online Social
Security Handbook at the Social Security website (www.ssa.gov)
describes the calculation of reduced benefits while working. The
recomputation of benefits at full retirement age is described
in section 728. The website also provides examples of benefits
reductions and recomputations under Retirement Planner
of whether a person is undercompensated or overcompensated by
the Social Security recalculation at full retirement age (because
excess earnings previously led to benefit losses) requires consideration
of the following:
- The person’s
benefits, due to early retirement;
Social Security benefit increases, due to inflation; and
- An assumption
about the time value of money.
is useful in calculating the present value of losses and subsequent
gains that result from a decision to work while collecting Social
Security benefits. The calculation should be tailored to each
beneficiary’s situation, but some generalizations can be
made by running a few simulations. Exhibit
3 graphs the present value of cumulative lifetime Social Security
benefits versus the recipient’s age at death under two scenarios.
In the first scenario, reduced benefits are collected beginning
at age 62, and there are no further benefit reductions because
of excess earned income. In the second scenario, reduced benefits
are collected beginning at age 62, and the recipient loses annual
benefits at ages 64 and 65 because of excess earned income. The
projection also assumes that the normal monthly benefit at full
retirement age is $2,267, that Social Security benefits increase
annually at 2.5%, that the recipient’s normal retirement
age is 66, and that the present-value discount rate is 7%.
indicates that a breakeven point between alternatives occurs when
the recipient is approximately 87 years old. In other words, under
these assumptions, both alternatives provide the same approximate
present value of Social Security benefits if the recipient dies
If this recipient
dies before reaching 87, the recipient is not adequately compensated
(on a present-value basis) for benefits lost due to excess earnings.
Not enough time has elapsed for the recalculated, increased Social
Security benefits to pay back the recipient for the benefits previously
lost due to the income earned in excess of the maximum threshold
before age 66.
If the recipient
dies after 87, the situation reverses. A recipient is overcompensated
(on a present-value basis) by the recalculation at full retirement
age and the resulting upward adjustment to Social Security benefits.
of these assumptions can be tested by running additional scenarios.
For example, when the present-value discount rate is lowered to
5%, the breakeven age of death is approximately 82 years. When
the present-value discount rate is raised to 9%, the breakeven
age of death is over 100 years. If present value is disregarded
altogether, the breakeven age of death is about 76 years. In any
case, however, the difference in lifetime benefits between alternatives
appears to be no more than around $10,000.
Is the Decision Relevant?
is relevant only when an individual has already begun receiving
Social Security benefits early. In other words, the retiree is
younger than his or her normal retirement age, has already registered
with the Social Security Administration, is already collecting
benefits, and is presently considering whether it is worthwhile
to go back to work and earn more than the maximum allowable income.
make no sense for a person to elect early Social Security benefits
knowing in advance that he or she will lose those benefits by
working. For example, Jane, age 62, is considering either: 1)
registering for Social Security benefits at age 62, but earning
enough during age 62 to eliminate Social Security benefits for
the entire first year; or 2) simply delaying Social Security registration
and benefits until age 63.
Jane’s full retirement age benefit is $2,267 per month and
the age 62 benefit is $1,700 month (75% of $2,267). If Jane registers
for Social Security benefits at age 62, but loses those benefits
the first year because of working, she will collect $1,700 during
ages 63 through 65, and then approximately $1,814 per month for
all remaining years (ignoring inflation adjustments).
On the other
hand, if Jane simply waits until age 63 to register with Social
Security and begin receiving benefits, those benefits will be
$1,814 per month beginning at age 63 and all remaining years (again,
ignoring inflation adjustments.) The second strategy gains Jane
an additional $114 per month for ages 63 through 65.
All the Factors
above is generally needed once a person has already made the decision
to collect Social Security benefits early. Typically, either personal
financial constraints will require the beneficiary to collect
early benefits, or the beneficiary will make the decision based
upon his or her personal life expectancy (for more discussion,
see “Retirement at 62: Is Receiving Social Security Early
Worth It?” The CPA Journal, June 2006). Assuming
that a person elects to collect early Social Security benefits,
the secondary decision of whether to work before reaching full
retirement age may come into play.
life expectancy and estimate of the present-value discount rate
are relevant to the decision to work. The Centers for Disease
Control and Prevention (CDC) estimates that the average 62-year-old
person in the United States will live an additional 21 years (National
Vital Statistics Reports, Vol. 54, No. 14, April 19, 2006). Simulations
indicate that the present-value discount rate must be about 5%
or less for the breakeven age of death to be 83 or younger. Therefore,
the average 62-year-old person should not expect to be fully compensated
by the excess earnings recomputation of Social Security benefits
unless either: 1) he believes the present-value discount rate
is less than about 5%, or 2) he believes he will live longer than
the average age of 83.
life expectancy varies considerably, depending on factors such
as lifestyle, sex, race, and location. In addition, the importance
and estimate of the time value of money (the discount rate) varies
widely from person to person. People with expectations of living
far beyond the normal retirement age should expect to recoup lost
Social Security benefits in the long run. People with low expectations
for longevity likely will not. People who expect a lower discount
rate to apply to their financial situation will tend to favor
the decision to work, while those who expect a higher discount
rate will not.
person’s benefits are taxed also affects the decision. The
simulation above assumes that the benefits are not taxed. If the
benefits are taxed (or become taxed because of the additional
income received from working) then it becomes less advantageous
for the retiree to work while collecting early Social Security
benefits. It is difficult to generalize, however. This simulation
also assumes that if a retiree works, all Social Security benefits
will be eliminated. If there is only a partial elimination of
benefits, the estimate will be much more complicated (and maybe
not worth the effort).
A few general
conclusions can be made (as stated above) about the decision to
work or not work when collecting early Social Security benefits.
In general, though, it is probably true that the decision to work
or not work while collecting early Social Security benefits should
be based on more proximate factors than whether the initial loss
in benefits will be fully compensated in later years. Factors
such as the need for additional income and the need to participate
in useful activities may be much more relevant to a senior than
the ultimate present value of lifetime Social Security benefits.
Furthermore, income level and activity level in early retirement
can affect both the quality and length of a senior’s life,
so as to render spreadsheet assumptions unreliable. At the very
least, these projections indicate that the cost-benefit differential
is not so great that a senior should worry excessively over the
decision to work when collecting Social Security benefits.
M Dalton, PhD, CPA, is a professor of accountancy and taxation,
and Diane D. Pattison, PhD, is the codirector,
accountancy programs, and a professor of accountancy, both at the
school of business administration, University of San Diego, San