The Windfall Elimination Provision (WEP) repeal is now a step closer to reality.
That’s right. If you haven’t already heard, Congress is considering a new way to calculate Social Security benefits for those who have both covered and non-covered earnings. You should watch this closely if you’re a teacher, firefighter, police officer, or other public servant in one of the states that do not participate in Social Security.
The Equal Treatment of Public Servants Act of 2015
Recently, Representatives Kevin Brady (R-TX) and Richard Neal (D-MA) co-sponsored the Equal Treatment of Public Servants Act of 2015 (H.R. 711). This legislation proposes a completely new calculation that is intended to correct the inequality toward public servants in Social Security benefits. If this bill is passed, the WEP formula will be replaced with what’s being called the “Public Servant Fairness Formula” (PSF).
Although this bill was introduced in 2015, it is quickly gaining traction for 2016 action. The House Ways and Means Subcommittee on Social Security held a hearing to discuss this bill on March 22, 2016.
You may be thinking that you’ve heard all this talk about Social Security fairness before. You’re right – it’s been discussed for years. But this measure has a really good chance of passing for three reasons.
- The bill will save the SSA money – This isn’t the first time that an effort to repeal the WEP has surfaced. There have been many such attempts in years past. None of those ever made it far in the lawmaking process due to the very high cost of a full WEP repeal. However, this bill would not increase the deficit. In fact, the Social Security Administration’s Office of the Chief Actuary found that these changes would actually have a positive financial effect!
- The bill’s sponsor is the chairperson – There’s often a lot of excitement over the introduction of a new piece of legislation, but sadly, most bills die in committee and never make make it to the House floor. In this case though, the bill’s sponsor is also the chairperson of the committee that is considering it. I think it’s a fair assumption that this bill will make it out of committee to the House floor.
- The bill has bipartisan support – Currently, the sponsors of this bill are almost evenly divided between Democrats and Republicans. As divided as politics are today, that can’t hurt the chances of a successful outcome.
Why the Windfall Elimination Provision Should be Repealed
It’s past time for the WEP to be overturned. Here are two great reasons:
1. It’s overly punitive.
The Windfall Elimination Provision was introduced to ensure the fair treatment between individuals who have covered earnings (paid Social Security tax) and those who have non-covered earnings (paid no Social Security tax). When the WEP rule was initiated, legislators thought that individuals were “double-dipping” if they received both a pension from a job where they did not pay Social Security taxes and a Social Security benefit.
In a way, they were correct. From the beginning, Social Security benefits were intended as an income safety net for retirees. The formula by which benefits are determined is set up to calculate an individual’s benefits based on a replacement rate of pre-retirement earnings. This formula is progressive in that it delivers higher replacement rates for lower income earners and lower replacement rates for higher income earners.
For example, a 65-year-old with average earnings of $20,830 in 2014 would receive approximately $11,124 per year in Social Security benefits which would replace about 53 percent of pre-retirement earnings. A higher income earner with average earnings of $74,063 would receive about $24,288 which would replace about 33 percent of prior earnings.
This skewing toward lower income earners became a problem for public servants with mixed employment (covered and non-covered) because the Social Security benefit’s formula uses 35 years of earnings history to calculate the average pre-retirement earnings. For public servants who work in jobs where no Social Security tax is withheld, these years show up as a zero in the calculation. As you may suspect, zeros in any average calculation tend to lower the overall average.
Here’s an example of how benefits were calculated prior to 1983 and the inception of the WEP.
Sue worked as nurse for 15 years and paid Social Security tax. She decided to leave nursing and became a teacher in one of the states that do not participate in Social Security. After teaching for 20 years, Sue retired. When the Social Security Administration calculated her benefits from the covered employment, they counted 15 years of earnings (her nurse work) and 20 years of zeros (her work where no Social Security tax was paid). Based on this earnings record alone, it appeared that Sue was a low income worker. As a result of this the formula created a higher replacement rate than should have been awarded for someone with her historical total earnings.
It’s this calculation error that became known as a “windfall.” In 1983 it was fixed with the Windfall Elimination Provision.
Now, more than 30 years after the rule’s introduction, there’s enough data to understand that this provision does not always function as intended. If things were equal, everyone would have the same replacement rate for the same amount of covered earnings and that’s not how the formula works today.
For an example, let’s consider the case of two individual workers.
In the first example, the worker earned an adjusted average of $45,000 per year of covered employment. When their Social Security benefit was computed through the bend point formulas, he received a replacement rate on pre-retirement earnings of 45%.
In the second example, the earner worked both covered and non-covered employment. Their adjusted average annual covered earnings were also $45,000 per year. However, since they received a pension from their non-covered job, they were subject to the WEP. This meant that their Social Security benefit formula is completely different than the first worker who only had covered earnings. Once their benefit was calculated they only received a replacement rate of 34% for the identical amount of covered earnings!
2. It’s overly complicated.
The WEP is not an issue for an individual who spends their entire career in a job where they do not pay Social Security tax. However, for those who have also worked at a job where they did pay Social Security tax, the rule is confusing and maddening. Many individuals find themselves with this “mixed employment” for a variety of reasons.
For example, firefighters often work second jobs where they pay Social Security tax. Police officers will often retire at an early age and move on to another job that is covered by Social Security. Many teachers came to education as a second career, after they’ve spent years working in a job where Social Security taxes were withheld.
Because of the complexity, the WEP makes it extremely difficult to plan for a successful retirement. Most Social Security technicians – let alone financial advisors – understand the nuances of how the WEP is applied and can explain it adequately.
It’s easy to understand why the WEP often feels like a penalty for public service.
What You Should Know and Expect
I’m sure that between now and the eventual passing of this law the details will change. The changes may be slight, or drastic. However, in the bill’s current form this is what you can expect . . . .
A New Penalty Formula
The Public Servant Fairness Formula is meant to make the Social Security benefit formula one that is proportional. In the new calculation, the replacement rate would be applied to the proportionate amount of pre-retirement earnings that were from covered employment. This change would allow for the use of one benefit calculation formula for all Social Security beneficiaries and should be easier to understand.
Here are the steps in the formula:
- All years of employment (both covered and non-covered) are used in the average indexed monthly earnings (AIME) calculation (which determines pre-retirement average income).
- Using the AIME of all historical earnings, the primary insurance amount (PIA) is computed through the bend point formula.
- Replacement rate for all earnings is calculated by dividing the PIA by the AIME.
- AIME for only the covered years is calculated (for example, 30 total years with 15 covered and 15 non-covered equals 1/2 PIA under the proportional Public Servant Fairness Formula).
- Replacement rate for all earnings is multiplied by new AIME (proportional covered only) for new effective PIA.
Here’s an example:
A Larger Affected Group
In the past, one of the basic requirements for the WEP penalty was to have not only worked in non-covered employment, but to have qualified for a pension from that work. Under the new formula, that requirement would go away. Moving forward, the only requirement to have the PSF applied would be one year of non-covered earnings. This new requirement will dramatically expand the group that is subject to a Social Security benefit reduction. The Social Security Office of the Chief Actuary said: “Our estimate reflects small benefit reductions from the PSF for a relatively large number of workers who would not be reduced by the WEP.”
This expansion to a larger pool of individuals is one of the main areas that makes this new law cost-neutral. In fact, the actuary’s report states that adding the one year requirement will increase revenue by $2.7 billion for years 2017-2023!
Although many will be happy the new rule is increasing their benefits, many will begin to see a reduction in benefits for the first time.
A Rollout Period (and Some That Aren’t Included)
As currently written, the new rule will be fully effective for those turning 62 in 2017 or later.
Here’s the breakdown:
- Turning age 62 prior to 2017 – For those turning 62 prior to 2017, the old WEP rules will still apply. However, the bill would reduce the current WEP penalty on Social Security benefits. How much they will be reduced is uncertain, but the reduction could be as much as 50%. Based on 2016 penalty numbers, this could be an extra $206.50 in benefits per month for someone that was subject to the full WEP penalty! The exact percentage of the penalty reduction will be determined later by the Social Security Administration’s actuarial department. Also, the reduction will not be retroactive and will only apply to payments in 2017.
- Turning age 62 in or after 2017: The Windfall Elimination Provision would not apply to individuals who are turning age 62 in or after 2017. Instead, the new Public Servant Fairness Formula would apply.
Summary of HR 711
I’m happy that the topic of Social Security fairness is receiving much needed attention. The WEP and GPO need to be fixed! However, this is not the way to do it!
According to Dr. Andy Szakmary, a Professor of Finance at Richmond University, there will be 11 losers for every winner under this legislation.
He went on to say.
“14 MILLION PEOPLE (according to Goss’ testimony) will become newly subject to the WEP and have their SS benefit reduced, versus 1.25 million people who will receive a higher benefit than under the current formula – so there will be 11 losers for every winner. This is why the bill is much more than revenue neutral – it actually saves SS tons of money. But it does so on the backs of many millions of innocent people who did nothing wrong, in most cases having worked in government or non-profit employment for only a few years, and who cannot now travel back in time and retroactively change their work histories. It would be one thing to pass a bill stating that, from this point forward, if you work in non-covered employment your SS benefit will be 1/35 = 2.86% lower for each year that you do so, but to completely alter the formula, suddenly remove all exemptions and dramatically change the rules for a 61-year-old right before he/she becomes eligible for benefits (as HR 711 does) is infinitely more unfair than sticking with the current system, which has been in place since 1983 and for which current retirees arguably should be prepared. At least President Obama’s proposal, which is similar to HR 711 in its formula, would not be implemented until 2027 and thus would not impact anyone currently close to retirement.”
Click HERE to read the rest of his comments on this bill
It sounds like our legislators need to keep working on a solution to fix this.
Contact me today to better understand the implications of this proposed bill and how the current law affects your Social Security benefits.