The ideal situation for those saving for retirement is to have a combination of Social Security, a pension from your work, and a nest egg of your own. Most people are covered by Social Security, and its retirement benefits will give you a stable monthly income that will last as long as you live as well as provide a survivor benefit if you're married and your spouse outlives you. Your pension can add to your regular monthly income, while your outside savings can let you address unexpected expenses or let you add some luxuries to your life during retirement.

Yet what many people don't realize is that those who receive pensions from their past employers can end up missing out on some of their Social Security benefits. The way that Social Security and pensions interact can cause you to see what you get from Social Security reduced or even eliminated in certain circumstances. The key question, though, is whether your pension came from private-sector or public-sector employment and whether you paid Social Security payroll taxes on your income during your career. In some cases, rules like the Windfall Elimination Provision and the Government Pension Offset can take away some of the income you'd otherwise get from Social Security.

Social Security card embedded in a spread-out pile of money.

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What is a pension and is there a difference between private and public pensions?

A pension is an amount of money that your former employer pays to you after you've retired. Most employers that have pension plans give employees one of two options when they retire: They can either take a lump sum amount that they can roll over into an individual retirement account of their own, or they can elect to take monthly payments that typically pay out for the remainder of their lives. When people talk about having a pension, they're usually referring to the monthly payment option.

For purposes of Social Security, it's critically important to distinguish private pensions from public pensions. What makes a pension private or public depends on the type of employer you work for. If you work for a business in the private sector that offers a pension plan, then what you'll get in retirement is called a private pension. Conversely, if you work for a public sector employer, such as a state or local government entity or a public school, then you'll typically receive what's called a public pension.

The reason why the distinction between private and public pensions is important is that Social Security treats the two types of pensions very differently. In general, those who receive private pensions won't see any adverse impact on their Social Security benefits as a result of receiving monthly pension income in retirement. Those who get public pensions, on the other hand, often will see their Social Security benefits reduced once their pension payments begin.

Why does the government treat private and public pensions differently?

The key policy reason why Social Security benefits get reduced in cases involving public pensions has to do with how Social Security gets its funding. Those who work for private employers pay Social Security payroll taxes that help to pay out benefits for current retirees and other Social Security recipients. This amount, which is equal to 6.2% of your wages up to a certain annual maximum each year, ensures that Social Security, in general, remains financially viable. Your private employer pays a matching 6.2% tax into the Social Security system as well.

Many public employees, on the other hand, don't have to pay into the Social Security system through payroll taxes. Instead, they often have money withheld that goes to provide funding for the public pensions that they receive. Letting public employees get their pension and Social Security even though they didn't pay Social Security payroll taxes would give them an unfair extra benefit that they didn't pay for, according to policymakers, and so having provisions to reduce any Social Security to which they'd otherwise be entitled is a reasonable trade-off in their view.

The types of benefits that a pension can affect

There are two different categories of Social Security benefits on which a pension can have a negative impact. Many workers have multiple jobs during their careers, and some split their time between public and private employers. Therefore, they pay Social Security payroll taxes for part of their careers, but then stop paying them and instead pay into a public pension plan for the remainder of their working lives. If you worked long enough in the private sector to be eligible for retirement benefits on your own work history, then you'd ordinarily be able to claim Social Security in your own name when you retire. However, as you'll see in more detail below, one set of rules governing Social Security benefits can take away some of what you'd typically get as your retirement benefit.

The other benefits that a pension can affect are the benefits that you're entitled to receive as a spouse. Spousal benefits are ordinarily available to those who are married to someone currently receiving retirement benefits under Social Security. If your spouse dies and was eligible to receive Social Security retirement benefits, then you can claim survivor benefits based on your deceased spouse's work history as well. Again, if you're receiving a public pension, the government sees any spousal or survivor benefits under Social Security as potentially being an unfair double dip -- due largely to the fact that you didn't pay payroll taxes into the Social Security system on your own wages during your career.

The Windfall Elimination Provision

The Windfall Elimination Provision allows the Social Security Administration to reduce the amount of Social Security retirement benefits you're eligible to receive if you worked both for a public-sector employer and in the private sector at different points during your career. Specifically, if your public-sector employment involved earning wages that weren't subject to Social Security payroll taxes and also resulted in your earning a public pension, then the Windfall Elimination Provision acts to avoid your getting what the government would call an unfair windfall.

The reason why the Windfall Elimination Provision exists has to do with the way that Social Security calculates your retirement benefits. Typically, Social Security looks at up to 35 years of work history, taking your earnings and adjusting them to reflect the inflation that happened between your early career and the end of your career. It picks the 35 top-earning years, calculates the average monthly earnings after adjusting for inflation, and then pays benefits based on a formula that uses that average. The formula is progressive, meaning that those with lower average incomes get a higher percentage of their income replaced than those with higher income levels. Specifically, for the first $895 of monthly average earnings, you'll typically get 90% of those earnings as your benefits. Above $895, much lower percentages of 32% and 15% apply.

If you didn't work for 35 years, then the years you didn't work are filled in with zeros for purposes of calculating average earnings. However, because of the progressive nature of Social Security's benefit formula, you're not penalized as much for working a shorter career as what you might expect. For example, someone who made the inflation-adjusted equivalent of $40,000 a year for 10 years would still get more than half the monthly Social Security benefit of someone who worked a full 35-year career for the same wage. For those who work many of those years outside the Social Security system and get a public pension on top of their Social Security benefits, getting that big of a boost from the progressive formula is seen as unfair.

The way that the Windfall Elimination Provision addresses that situation is to reduce the 90% factor that goes into the formula for calculating benefits. The factor used instead depends on how many years you worked in a job that was covered under Social Security for which you paid payroll taxes into the system and earned what the SSA calls "substantial earnings." If you worked 30 or more years in a Social Security-eligible job, then no reduction is made. For every year below 30, the 90% factor gets cut by 5 percentage points. The minimum factor is 40%, which applies if you worked 20 or fewer years in a Social Security-eligible job.

For example, using the same numbers as the example above, say that you initially worked in the public sector at the beginning of your career, and then switched to work 10 years in a job where you paid Social Security payroll taxes and earned an average $40,000 a year. Your average monthly earnings for Social Security purposes would be $953 ($40,000 multiplied by 10 years, then divided by the 35-year career that Social Security assumes and then divided by 12 for a monthly amount), and the benefit you'd be entitled to receive from Social Security at full retirement age would be $824 a month ($895 multiplied by 90%, plus the remaining $58 multiplied by 32%). However, under the Windfall Elimination Provision, that 90% factor would be reduced to 40%. So according to the formula, you'd only get $895 multiplied by 40% plus $58 multiplied by 32%, or $377 a month. That's a reduction of $447 per month.

There are a couple of protections that apply with the Windfall Elimination Provision. First, there's a chart from the SSA that sets out a maximum reduction amount that applies depending on what year you turn 62 years old and how many years of substantial earnings in a Social Security-eligible job you had in your career. Second, the Windfall Elimination Provision will never reduce your Social Security by more than half of whatever you get from your public pension. So in the example above, if you get a $500 monthly pension from your public-sector job, your Social Security would be reduced only by $250, and you'd get $574 a month instead of $447.

The Government Pension Offset

The Government Pension Offset allows the SSA to reduce what you get from Social Security in the form of spousal or survivor benefits if you also receive a pension payment from public-sector employment. Unlike the Windfall Elimination Provision, the Government Pension Offset is aimed at what you'd otherwise be entitled to receive from Social Security based on someone else's work record, rather than the retirement benefits you generate from your own work.

The reason why the Government Pension Offset exists is a little bit different from the reasoning behind the Windfall Elimination Provision. The benefits that Social Security pays to spouses of retired workers, both in the form of spousal benefits while the worker is still alive and in survivor benefits after the worker passes away, were originally intended to be what the SSA calls "dependent benefits." When Social Security began more than 80 years ago, it was common for families to have a single working spouse, and the non-working spouse was often completely dependent on the working spouse financially. Now, with more families having two earners, it's common for each spouse to have a retirement benefit they can claim.

The two-earner family scenario can now create an unfair situation. Ordinarily, if both spouses worked in private-sector jobs that paid into Social Security through payroll taxes and made roughly the same amount, then neither spouse will end up getting anything extra from spousal or survivor benefits. That's because their own individual benefits will be as big or bigger as what they'd get from spousal or survivor benefits, and Social Security rules only let you claim the larger of the two, not both. However, if one spouse worked in the public sector throughout an entire career and got an equivalent public pension, that spouse wouldn't have a retirement benefit under Social Security. That would leave someone potentially being able to claim both a public pension and a spousal benefit under Social Security. In other words, the public sector spouse would get extra money that a spouse who worked in the private sector wouldn't be able to get.

The Government Pension Offset handles this situation with a simple rule: It reduces your Social Security payment by two-thirds of whatever you get from your public pension. There's no limit on the amount by which your Social Security can be reduced, so if your pension is big enough compared to your Social Security benefit, the Government Pension Offset can entirely wipe out your Social Security.

Keep in mind that this only applies to reduce your spousal or survivor benefits under Social Security. If you had a mixed career between public and private service, as in the Windfall Elimination Provision example above, then you'd still be entitled to your Social Security retirement benefits under your own work record. However, if the spousal or survivor amount is greater, then the Government Pension Offset could still affect you adversely.

Why timing is key when you start receiving Social Security and your pension

The way that public pension income can affect your Social Security makes it critical to be smart in choosing when to start taking benefits. The most important element of the rules governing Social Security and public pensions is that they'll only be effective during periods when you're receiving both your pension and your Social Security at the same time. That can create planning opportunities in which by staggering when you claim various public pension and Social Security benefits, you can avoid the full impact of the Windfall Elimination Provision or the Government Pension Offset.

For instance, if your public pension kicks in at an early age -- 62 or earlier -- then it might make sense not to take Social Security as early as you'd otherwise be able to start getting monthly benefits. By claiming Social Security at 62, you'll receive a smaller benefit than you would if you waited until your full retirement age to start getting monthly checks. If you're subject to the Government Pension Offset, then it's more likely that a smaller Social Security check could get entirely wiped out by the reduction of two-thirds of your pension check. By waiting, your monthly benefit would grow, and that could leave you at least some money left over after taking the Government Pension Offset amount into account. Although the calculations of the Windfall Elimination Provision are a bit more complicated, the same general rule can apply, and that can make it smarter to hold off on your Social Security benefits.

If you have the choice to wait until later in your retirement to start collecting your public pension, on the other hand, it can be smarter to hurry up and claim any Social Security to which you're entitled as early as possible. That's especially true if your public pension will be relatively large compared to any Social Security benefits, because once that pension starts, you might receive little or nothing from Social Security as a result of the reductions associated with your pension payments. You'll get smaller monthly payments from Social Security if you claim early, but you'll get more of them, and getting something rather than nothing is a good result.

Finally, it's important to remember that because private pensions don't affect your Social Security, those who've earned private pensions can generally do their Social Security planning the same way they would if they weren't getting a pension at all. Having the extra monthly income available from a private pension can give you more financial flexibility than others have in considering certain alternatives, such as delaying Social Security in order to get larger monthly payments once it does kick in. However, because you've paid Social Security taxes already on the wages that help you build up your private pension, the government doesn't penalize you the same way it does those getting public pensions. That's why the planning opportunities differ.

Count yourself lucky

If you're fortunate enough to have both pension income and Social Security to go along with any retirement savings you've accumulated, you should realize that your situation is becoming increasingly rare. For the most part, private-sector employers have moved away from having private pension plans in favor of using defined contribution plans like 401(k) retirement accounts. This can help workers create a separate pool of retirement savings, but 401(k)s typically don't automatically provide streams of monthly income for retirees after the end of their careers. Even employers who have offered private pension plans in the past have started to limit access for new hires, restricting eligibility to longtime employees.

Even in the public sector, pensions have become less common. Strains on state and local government budgets have required lawmakers to cut costs where they can, and the obligation to make pension payments is a burden that fewer government entities can afford.

As a result of these trends, most people have no access to pensions either in the public or private sectors, and so they won't have to deal with seeing a pension payment potentially lead to decreased payments for Social Security. Yet even if your Social Security benefits do get reduced to some extent, having multiple sources of retirement income can give you a big leg up over those who have to make do with just Social Security and their hard-earned savings.

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