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Filing for Social Security and starting to receive your benefits can be a stressful decision for people to make.  One of the rules that taxpayers need to be aware of when choosing to decide when to file for their benefit is the Earnings Test.  This article will discuss the Earnings Test and provide some examples to help illustrate how the rule works and give you an idea of whether it will impact you or not.

What Factors Determine if the Earnings Test Applies to You?

There are two main factors that will determine if you will be impacted by the Earnings Test:

• Are you filing for benefits before you reach your Full Retirement Age (FRA)?
• How much income will you earn?

The first factor is straightforward, if you are receiving your Social Security benefit and have not reached your FRA, you could be subject to the Earnings Test.  Individuals are eligible to start collecting their Social Security benefit once they reach age 62, but they do not get their full benefit unless they wait to file once they reach their FRA.  The chart below shows when you will reach your FRA:

Just because you have not reached FRA, does not mean you are subject to the Earnings Test yet, you still also have to have earned income that surpasses certain amounts, and the specific amount is determined by whether or not you will reach your FRA during the calendar year.  In 2019, the limit in any year you do not reach FRA is $17,640.  For the year in which you do reach your FRA, that limit is $46,290.

Scenario 1: Receiving Social Security Benefits in Any Year Before the Year You Reach FRA

If you file for Social Security benefits and are not yet at your FRA, the second step in determining if you are subject to the Earnings Test is looking at your income.  It is important to note that this income only includes earned income, that is, income that is generally reported on a W2 or self-employment income.  It does not include investment income, interest income, etc.  In 2019, for an individual who has not yet reached FRA, the Earnings Test will impact them if the individual earns more than $17,640.  For earnings above this amount, the Social Security benefit will be reduced by $1 for every $2 earned over $17,640.   Let’s look at an example:

A 64-year-old named John files for his social security benefit in January and qualifies for $1,000 per month in benefits.  He continues to work part-time throughout the year and his earned income at the end of the year is $20,000.  Since he has not yet reached FRA AND has earned income above $17,640, he will be subject to the Earnings Test.  John earned $2,360 above the limit of $17,640, therefore his benefits will be reduced by $1,680 for the year ($2,360/2). 

Scenario 2: Receiving Social Security Benefits in the Year You Reach FRA

We discussed how the Earnings Test is applied in the years before you reach FRA, but there is a separate standard that is applied in the year an individual does reach their FRA.  There are two distinct differences, the earnings limit is raised to $46,920 and the penalty is changed to a reduction of $1 for every $3 earned above the limit.  Let’s examine this with an example:

John has been receiving Social Security benefits for one year, and in June of 2019 will reach his FRA.  Since he is receiving benefits before his FRA, he is subject to the earnings test, but since he reached his FRA this year, the limit that is applied to him is $46,920.  It is also important to point out that the earnings limit only applies to the earnings prior to reaching FRA.  Prior to reaching FRA, John had earned $50,000 and since this exceeds the limit, he will be subject to the Earnings Test.  In this example, John has earned $3,080 over the limit and his benefits will be reduced by $1,027 ($3,080/3).  Since John reaches his FRA during the calendar year, the income he earns after he reaches FRA will not be included in the Earnings Test.

Scenario 3: Earnings Test and the “Grace Year”

One last aspect of the Earnings Test that we want to look at today is the “Grace Year” provision.  The Grace Year applies only when an individual is in the first year in which they are entitled to a benefit and earn less than the monthly limit in at least one month.  This exception recognizes that people retire at different times throughout the year and is meant to avoid penalizing someone who worked for a portion of the year before receiving their Social Security benefit.  Calculating the monthly limit is done by taking the yearly limit ($17,640 in 2019 for those before FRA and $46,920 for those in the year they reach their FRA) and dividing by twelve.  Let’s look at an example:

Kate, who is 64, retires from her full-time job in October and starts receiving her Social Security benefit of $1,000 per month in November.  Prior to retirement, Kate earned $110,000 from her full-time work.   Kate did not work in November or December.  Since Kate will not reach her FRA this year and will earn more than the $17,640, she would normally be subject to the Earnings Test, but since she is in her Grace Year, she can avoid the reduction in benefits if during at least one month of the year she earns less than the monthly limit.  Again, the monthly limit is the yearly limit ($17,640) divided by twelve, or $1,470.  Since Kate did not have any earned income in November or December, she will meet the requirements of the Grace Year and will not have her benefits reduced for the current year.

Deciding when to claim your Social Security benefits can be a complex and difficult decision to make.  It is important to remember that you do not have to struggle through this decision on your own, talk to an expert who can walk you through the rules and educate you on your options before making a decision.  Making informed decisions can help to ensure you get the full benefit you have earned and expect!

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