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Many retirees supplement their income through work. That work may affect their Social Security retirement check because current law imposes an earnings limitation for those drawing those benefits. The limit applies solely to earned income, which is defined as wages from a job. Earned income does NOT include (pay attention as these exceptions are important) any income received from pensions, IRA/retirement plan withdrawals, deferred compensation from previous employment, rental income, interest, dividends, or capital gains. Earned income for Social Security purposes is income derived solely through gainful employment, and nothing else. Many get confused over this issue, but it's quite simple. If you work while retired and get paid for that work, then you have earned income. If you don't work and your income comes from sources such as interest, dividends, IRAs, pensions, and retirement plans, then you don't have earned income. Yes, the latter will be included on your income tax return for taxation purposes, but it is not included in any earnings limitation test for Social Security purposes. Now that we have that out of the way, let's see how earned income affects Social Security retirement benefits.
Social Security earnings limitations on retirement benefits change annually based on inflation, and they only affect retirees younger than age 70. Further, only the benefit of the person working is affected, not that paid to other family members. This year, those who are between the ages of 62 and 65 may earn up to $10,080 per year without losing any part of a Social Security retirement benefit. If they exceed that amount, though, they will lose $1 in benefits for every $2 of the excess. The point at which you would lose all of your benefits is easy to determine. Simply multiply your annual benefit by two, and then add $10,080 to that result. As an example, this year the average Social Security retirement benefit is $804 per month, or $9,648 per year. Multiply $9,648 by two, and you get $19,296. Adding $10,080 to that result gives you $29,376, the point at which total forfeiture occurs this year for someone younger than age 65 who draws the average benefit. Your personal total forfeiture point may be lower or higher depending on the size of your retirement benefit. And remember, you may work at a job and earn right up to $10,080 without losing one cent of your Social Security check.
Retirees who are at least age 65 but younger than age 70 may earn up to $17,000 this year with no forfeiture. Above that amount, they lose $1 for every $3 of the excess. Using the average benefit this year of $9,648, just multiply by three to get $28,944. Adding $17,000 to that result gives you $45,944, the total forfeiture point this year for someone drawing the average benefit between ages 65 and 70. Congress is considering eliminating the forfeiture for those between ages 65 and 70. Chances for ultimate passage and enactment look good. However, a similar exemption is neither pending nor contemplated for those who are at least age 62 but younger than age 65.
Let's turn to the comment I made last week concerning Mrs. Pixy, who wishes to retire at age 62. Should she draw on her work record or mine? Well, she can't draw on my record until I actually retire and begin to draw those benefits. Thus, in her case she must first draw benefits based on her own work history. And to do so, she must have paid into the Social Security system for at least 40 quarters (10 years). Unless she has done so, she can't draw a benefit until I do. Mrs. Pixy has sufficient quarters to draw her own retirement benefit, so that's what she will do. However, she's also entitled to a spousal benefit based on my work record, and that's higher than her own. What happens?
When I retire, Mrs. Pixy will receive that higher spousal payment. How it gets paid, though, might be confusing. No spouse is entitled to both the spousal benefit and an individual retirement benefit. Instead, the spouse is entitled to a payment that equals the highest benefit for which he or she is eligible. And in drawing that benefit, part or all of the payment will always come from that spouse's own work record, supplemented only as needed from the other spouse's work record. In Mrs. Pixy's case, she still will draw a benefit on her own work record first, but an additional amount will be added to that payment to increase her benefit to the level she is eligible for as a spouse on my record alone. Nevertheless, because she retired early, her final benefit will not be based on 50% of what I receive at full retirement age. Instead, her retirement benefit will be a reduced spousal benefit based on her early retirement. If her own reduced benefit were higher than the reduced spousal benefit, then she would continue to draw on her own work record alone. Gosh, this stuff is fun, isn't it?
Onward we stagger, folks, to the subject of taxation of Social Security. Yes, your Social Security retirement benefit can be taxed depending on your overall income level. I could describe how, but I already did that in "What Uncle Sam Taketh" (Step 9 of our 13 Steps to Foolish Retirement Planning). I also provided some examples of how the Infernal (sic) Revenue Service rules work in the column "It's Income Tax Time" back in January. Therefore, rather than repeat what has already been written, I'll just refer all interested persons to those two links. That way I save myself some keyboard time (I'm really a very lazy guy), and I'll stay within this column's space limits at the same time. I just love it when a plan comes together. It leaves me that much more extra time for 'Net surfing and goofing off.
So ends another column. As always, post your comments and questions on the Retired Fools board. Also, if you haven't already, please let us know your desires by casting your vote in the reader-initiated Retirement Seminar Poll I mentioned last week. Whatever the count is as of March 27 will determine the recommendation I make to the powers that be concerning such a seminar.
Best to all... Pixy
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