If you have a pension from a job where you did not pay Social Security taxes, your benefit may be reduced by the Windfall Elimination Provision (WEP). How do you know if you’ll be impacted? Don’t expect it to be on your Social Security benefits statement. This may surprise you but your Social Security statement does not reflect any reduction in benefits due to this provision. The Social Security Administration will wait until you file to tell you how much the reduction is if you qualify for both Social Security and a non covered pension.
Understanding if a reduction in benefits will apply to you, and how much that will be, does not have to wait until you file for Social Security. You can find out today. It starts by understanding the mechanics of the Windfall Elimination Provision.
The Social Security Amendments of 1983 introduced the Windfall Elimination Provision (WEP) as part of an effort to keep individuals from “double dipping.” This was defined as receiving both a pension from a job where they did not pay Social Security taxes and a Social Security benefit.
This new provision began to reduce Social Security benefits for those who worked in a job in which:
1) They did not pay Social Security taxes
2) Qualified for a pension from that job.
Teachers are one of the most common groups to be impacted by this rule but it often includes other public sector workers like firefighters, police officers and numerous other state, county and local employees.
Non Covered Employment
In the beginning, Social Security didn’t cover any public sector employees. However, over the years, many states dropped their own pension plans and adopted coverage agreements with the Social Security Administration. However, there are still several states who do not participate in Social Security. Instead, they have their own state run pension plan. For workers in these states, the rules for collecting a non covered government pension and Social Security can be confusing and maddening.
That’s especially true if you’ve paid into the Social Security system for enough quarters to qualify for a benefit. It’s quiet common too. Many individuals find themself in this situation 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 “covered” job. Many teachers came to education as a second career, after they’ve spent years working in a job where Social Security taxes were withheld.
Windfall Elimination Provision Mechanics
The Windfall Elimination Provision (WEP) is simply a recalculation of your Social Security benefit if you also have a pension from “non-covered” work (no Social Security taxes paid). The normal Social Security calculation formula is substituted with a new calculation that results in a lower benefit amount.
Covering the topic exhaustively would require a multipage essay, but the necessary components of the WEP can be distilled to a few simple points:
- The maximum Social Security reduction will never be greater than one half of your pension amount. For those filing at full retirement age, this reduction is capped at a monthly reduction of $428 (for 2017).
- If you have more than 20 years of substantial covered earnings (where you paid Social Security tax), the impact of the WEP begins to diminish. At 30 years of substantial covered earnings, the WEP does not apply.
Source: Devin Carroll, Data: Social Security Administration
This phase-out of the WEP reduction offers an incredible planning opportunity if you have worked at a job where you paid Social Security tax. For example, if you worked as an engineer for 20 years before you began teaching, you may be able to do enough part time work between now and when you retire to completely eliminate the monthly WEP reduction. This phase-out of the WEP reduction offers a great planning opportunity if you have worked at a job where you paid Social Security tax.
Would it be worth it? If you consider how much more in benefits you could receive over your retirement lifetime, it could be worth $100,000 in extra income over a 20-year retirement. Obviously, not everyone has the option of accumulating enough years to wipe out the big monthly WEP reduction. But for those who do, or can get close, it’s worth taking a closer look.
For more information, see the Social Security Administration’s WEP Benefit Calculator.
How the WEP is Calculated
When Social Security benefits are calculated, the SSA inflates your historical earnings, takes your highest 35 years of earnings and divides by 420 (the number of months in 35 years). This gives them the inflation adjusted average indexed monthly earnings that are then applied to the formula. The result of this formula is your primary insurance amount (PIA) which is also known as your full retirement age benefit.
If you have a pension from work where no SS was paid, your benefits are calculated on an alternate formula. The result of this alternate formula is a lower benefit amount.
At first glance this alternate formula looks nearly identical to the the ‘normal’ formula. However, upon closer inspection you’ll notice that the earnings between $0 and $896 are credited to your final Social Security benefit at 40% instead of the 90% found in the normal formula.
When WEP Application Ends
There are a few circumstances where the application of the Windfall Elimination Provision will end. The result is a recalculation of benefits using the ‘normal’ calculation formula.
Here’s the section of the SSA website that discusses the circumstances of this recalculation.
The WEP computation is no longer used when:
- the entitlement to the pension payment ceases or the proration of a lump sum payment based on a specified period ends,
- the NH dies (in the month of the NH’s death, the PIA is recalculated without applying WEP), or
- the NH becomes eligible for the WEP exemption by earning 30 YOCs. (The system will automatically identify additional YOCs and consider a recomputation for WEP.)
The most notable point is the when an individual who is subject to the WEP dies. In this case, the survivor’s benefit is recalculated without the WEP.
For example, before Dave became a Texas teacher he worked for a large retailer for 19 years. Because of his teacher’s pension his SS benefit was subject to the alternate WEP calculation. What should have been a $1,500 SS benefit became a $1,100 benefit. Unfortunately, Dave died at 70. His wife fully expected to receive his $1,100 SS benefit as her widow’s benefit, but instead she found out that her benefit would be closer to $1,500. This was because the WEP penalty was removed when Dave died.
Effect of Filing Early or Filing Later
So what happens if you file early? Your benefit amount is reduced due to your age, but does the WEP penalty decrease as well? The same question could be asked about if you wait until beyond your full retirement age to file. Will your penalty amount increase? The Social Security Administration has a page where they discuss this, but it is not clearly written (no surprise).
Here’s what happens to your Windfall Elimination Provision penalty if you file before or after your full retirement age.
The Windfall Elimination Provision reduces your benefit amount before it is reduced or increased due to early retirement or delayed retirement credits. It is this WEP-reduced benefit that is increased, or decreased, due to filing age.
For example, let’s assume Sue is 66 and has a Social Security benefit of $1,428. The “maximum” WEP penalty that could be applied is $428. This gives her a WEP reduced benefit of $1,000 (1,428 – 428).
If Sue files for her benefits at 66, her benefit is $1,000.
If Sue files for benefits at 62, her benefit would be $750 ($1,000 WEP-Reduced Benefit – 25% Reduction for early filing)
If Sue files for benefits at 70, her benefit would be $1,320 ($1,000 WEP Reduced Benefit + 32% Increase for later filing)
See the chart below for the visual.
If your full retirement age is something other than age 66, your age based reductions and increases will be different.
Here’s where this gets interesting. While the Social Security Administration is fond of saying that the maximum WEP penalty is $428 (for 2016), the effective penalty could be higher than that.
If you compare the benefit amount of two individuals, one who is not subject to the Windfall Elimination Provision and one who is not. They both have an identical benefit amount and both wait until age 70 to file. While the penalty that is levied on the WEP individual is $428, the remainder of the formula increases the amount of actual penalty by an additional $107. The end result is that the individual who is subject to the WEP is receiving $535 less than he would have if he would not have been subject to the WEP.
This knife slices both directions. If an individual files early, the effective penalty is lower than the actual penalty of $428. Consider the same example of an two individuals who file at age 62. Again, the penalty that is levied on the WEP individual is $428 but the remainder of the formula decreases the amount of actual penalty by $107 to a total of $321 per month.
As with most things Social Security related, the “maximum” penalty is not always the end of the story.
Before you leave, I’d love to hear your thoughts.
How does this rule surprise you?
In what way is it more or less complicated than you have previously thought?
Also, you may want to check out this video I made on Social Security for Educators.