THE IMPACT OF YOUR PENSION
On Your Social Security Benefits
Many public sector workers do not pay into Social Security because they pay into a separate state or local pension fund. Since Social Security benefits are based on the Social Security wages earned during working years, public-sector workers who do not pay into Social Security will not be eligible for Social Security benefits at retirement.
There are other public sector workers however, who have paid into the Social Security pool because they work second jobs or began working in the public sector later in life or retired and began a second career. Public sector workers who have paid into Social Security can qualify for benefits on top of their pension, but those benefits may be reduced based on the number of years they paid into Social Security.
How Are Social Security Benefits Calculated?
Social Security benefits are based on your average wages for your 35 highest earning years. If you pay into Social Security for 29 years, your benefits will be calculated using the 29 working years plus 6 years of zero wages. Your annual wages are also adjusted for inflation to prevent your early earning years from hurting your benefits.
After adjusting for inflation and averaging your 35 highest years, your annual wages are divided by 12 to produce your Average Indexed Monthly Earnings (AIME). Your monthly benefits are calculated using 3 percentage brackets of your AIME: 90% of the first $926 of AIME, 32% of the next $4,657 of AIME and 15% of AIME after that.
Example: If you work for 35 years and have average adjusted wages of $72,000 per year, your Social Security benefit calculation will use $6,000 for your Average Indexed Monthly Earnings and calculate your benefits as follows:
$926 x 90% = $833.40
+ $4,657 x 32% = $1,490.24
+ $417 x 15% = $62.55_____
$6,000 = $2,386.19 monthly benefits
How Your Pension May Limit
Your Social Security Benefits
If you receive a pension from an employer that does not withhold Social Security taxes, your benefits may be reduced by the Windfall Elimination Provision (WEP).
This provision reduces monthly benefits by reducing the first bracket benefits from 90% down to 40% in 5% increments depending on the number of years worked. If you paid into Social Security for at least 30 years with "substantial earnings," then the WEP limitation will not apply. But if you paid in for less than 30 years of substantial earnings the first bracket percentage will be reduced by 5% for each year under 30 until it bottoms out at 40% for 20 years of contributions. This limitation can reduce your base Social Security benefits by as much as $5,500 per year.
Example: To demonstrate how this limitation reduces your benefits we have calculated the monthly benefits you would receive if your AIME was $6,000 under two scenarios: 1) where you have 30 years of substantial Social Security wages and 2) where you only have 20 years of substantial Social Security wages:
The lower percentage applied to the first $926 of wages when the WEP limitation applies reduces your benefits by $463 per month or $5,556 per year.
What Can You Do to Eliminate the Pension Penalty?
The Equal Treatment of Public Servants Act of 2019 was recently introduced in congress to repeal the WEP limitations by replacing them with a new formula that treats public servants more favorably. With the bill’s future uncertain, we want to focus on steps you can take right now.
The first step in the process is to determine your Social Security benefits by creating an account at www.ssa.gov. This account will allow you to view your estimated benefits based on your prior work history. Be aware that the estimates provided by the Social Security Administration will not account for any WEP limitation that may apply to you.
After you find your estimated benefits you will need to subtract $46.30 per month for every year short of the 30-year window of substantial earnings. If you are more than 10 years short of the 30 year mark, only subtract amounts for the first 10 years that you are short.
If you are short of the 30-year threshold, you may want to consider working a few extra years at a part-time job or starting a new career at retirement. These additional years of contributions will not only increase your potential Social Security benefit, they will also decrease the limitation put on those benefits by the Windfall Elimination Provision.
What Constitutes "Substantial Earnings"
Substantial Earnings are a separate calculation from the calculation of year paid into Social Security. To qualify for a year’s worth of Social Security earnings, you only need to earn $5,880 of wages. To qualify for substantial earnings, you need a total of 26,550 of wages subject to Social Security. The table below will show the substantial earnings test.
To discuss this further, please reach out to one of our team members at (847) 923-9015.
Failing to order your affairs to minimize your tax burden could cost you significant money - so don't wait to take action. If you have additional questions or need some planning help, please reach out to us.