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Don't Let This Misunderstood Social Security Rule Reduce Your Retirement Income

By Christy Bieber – Sep 10, 2020 at 9:25AM

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Is this common mistake holding back your earning potential?

Social Security rules can be complicated, and that's a problem if misunderstanding them affects your ability to have a comfortable retirement. 

Unfortunately, a recent report from the Bipartisan Policy Center revealed that a key point of confusion about the retirement earnings test could be preventing millions of seniors from making a financially optimal choice. 

Senior woman working stocking shelves.

Image source: Getty Images.

Seniors don't understand the RET, and it's a big problem

The Retirement Earnings Test, or RET, applies when seniors want to claim Social Security before their full retirement age (FRA) but also keep working and earning income. The rules allow retirees to both work and get Social Security checks, but some benefits are withheld for those who earn above a certain earnings threshold.  

Unfortunately, most older workers don't understand the implications of this. In fact, the Bipartisan Policy Center indicates seniors commonly mistake the withholding of benefits for a tax, which causes them to drop out of the labor force to avoid it. 

This might seem like a rational financial move, as the Center's report reveals that if it were a tax, it would impose a marginal tax rate of between 33% and 50%. But, since the RET isn't actually a tax, seniors who opt out of working to avoid losing benefits to the IRS are doing so based on a misunderstanding. 

The reality is that when you forfeit some of your benefits because you earn too much while working prior to FRA, it is not a tax at all. Instead, when you reach your full retirement age, the amount of your benefit is recalculated to account for income you missed.

When the RET results in benefits forfeiture, the SSA withholds full monthly checks until you've covered the amount. At FRA, you are credited back the early filing penalty for each month you didn't receive a check. This causes future benefits to be higher. 

Sadly, the fact that many seniors don't understand this probably results in a substantial number of people dropping out of the workforce who otherwise wouldn't. As the Bipartisan Policy Center explains, when the rules changed in 2000 and workers between FRA and 70 could work as much as desired with no earnings test, labor force participation among them rose between one and four percentage points. Earnings also went up between 15% to 20% for seniors who'd been close to the RET, which suggests many people were limiting the amount they made to avoid forfeiting benefits. 

The misconception that the RET is a tax actually benefits some workers because it causes them to put off claiming benefits until they stop working -- and delaying benefits as long as possible is often the financially optimal choice. But it hurts those who give up a paycheck they may need (or want) out of fear of a tax that doesn't exist. 

Since research has shown that even part-time work could improve retirement readiness, especially among seniors with limited income, confusion about the RET may not just affect seniors in the years they could have been working -- it could also have a long-term effect.

Many older Americans benefit in multiple ways by continuing to hold a job. They could preserve their savings and potentially add to it by bringing in a paycheck, and could raise future Social Security checks by deferring benefits until later. But they're likely losing out on this chance since they simply don't understand the rules. 

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