What You Need to Know About Working While Collecting Social Security

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For many older workers, the opportunity to collect Social Security before you fully retire, while still bringing in a paycheck seems like a boon. You get to supplement your work income with a monthly check from Uncle Sam — who doesn't want that?

Unfortunately, working while collecting a Social Security benefit before you reach your full retirement age can take a pretty hefty bite out of your Social Security checks. Here's what you need to know about how working affects your benefits. (See also: 5 Questions to Ask Before You Start Claiming Your Social Security Benefits)

Understanding the earnings test

Your full retirement age is the point at which you receive your full Social Security benefits. Taking benefits before full retirement age means receiving a reduced benefit, and waiting to take benefits until after your full retirement age means getting 8 percent more per year in your benefits, until you reach age 70. Your specific full retirement age depends on what year you were born, but it will be between ages 66 and 67.

Before you reach your full retirement age, your earned income (meaning money you earn through working, rather than money from investments) negatively affects your Social Security benefits. The amount of impact is determined through what is known as "the earnings test."

Specifically, the earnings test stipulates that if you are working and you start drawing your Social Security benefits before you have reached your full retirement age (FRA), you will see $1 deducted from your benefits for every $2 you earn over $17,040 (for 2018).

Beneficiaries who begin drawing their Social Security benefits during the same year that they will attain their full retirement age, but before actually hitting their FRA birthday, are still subject to an earnings test. But the income limit is much higher — $45,360 as of 2018 — and the benefit reduction is lower — $1 reduction for every $3 earned over the limit.

For instance, Frederica is 62 and earns $23,500 per year at her job. If she starts taking her Social Security benefits in 2018, her income will be $6,460 over the earnings limit ($23,500 - $17,040 = $6,460). That means she would have $3,230 total withheld from her Social Security benefits — which equals $1 for every $2 Frederica earns over the threshold, or half of $6,460.

Frederica's sister Serena is a little older, and will reach her full retirement age of 66 later in 2018. Serena earns $52,000 per year, making her income $6,640 above the earnings test threshold for those within a year of reaching their FRA ($52,000 - $45,360 = $6,640). If Serena were to take her Social Security benefits before reaching her full retirement age, she would have $1 withheld for every $3 she earns over the limit, meaning $2,213 (or â…“ of $6,640) would be withheld.

Once Frederica and Serena reach their full retirement ages, however, they can earn as much as they like from work and it will have no effect on their Social Security benefits.

The Social Security Administration doesn't prorate deductions

What makes the earnings test particularly tough for beneficiaries who need their benefits in order to make ends meet is the fact that the Social Security Administration does not prorate the deductions to your benefits. If you make more than the income limit in earnings, the Social Security Administration will withhold your entire benefit until the full benefit reduction amount has been satisfied. This means that beneficiaries who are working and are required to have benefits withheld will go several months without receiving Social Security benefits at the beginning of each year.

In Frederica's case, let's say she's eligible for a Social Security benefit of $733 per month. If she has $3,230 withheld from her Social Security benefits, she will not receive her $733 monthly benefit for January, February, March, or April in order to make up for the amount she owes Social Security. But rather than give Frederica a partial check in May, Social Security will simply withhold her entire $733 benefit check for that month, which means she will have had $3,665 total withheld from her benefits ($733 x 5 = $3,665). She will not see the leftover $435 she is owed by the Social Security Administration until January of the following year.

The same will be true for Serena, should she decide to take her benefits before reaching her FRA in 2018. Let's say her benefit is $1,500 per month. She will have $2,213 withheld from her benefits because of the earnings test. That means she will not receive any Social Security benefits for two months, and Social Security will withhold $3,000 total. Serena will receive the $787 she is owed the following January.

The good news for Serena is that as soon as she reaches the month of her full retirement age, she can keep every single penny of her benefits, no matter how much she earns elsewhere. All Social Security beneficiaries are immune to the earnings test as soon as they have hit their full retirement age.

Your withheld benefits aren't gone forever

There is a small cherry on top of this sundae of bad news: The Social Security Administration does give you some credit for the months your benefit was withheld. At that point, Social Security basically treats you as if you waited to file your benefits for the number of months your benefits were withheld.

At age 62, Frederica is entitled to a benefit equal to 73.33 percent of the benefit she would have received at her full retirement age. Her full benefit would have been $1,000 at her FRA, which is why she receives a benefit of $733 per month as of age 62.

Each year before her FRA of 66, Frederica does not receive benefits for five months because of the earnings test. As of the month that Frederica reaches her FRA (i.e., the month of her 66th birthday), Social Security will treat her benefits as if she had waited 20 months (five months of withheld benefits for the four years between age 62 and 66) to file for her benefits.

This means that as of her FRA, she'll see her benefit amount increase by 9.06 percent, because not receiving benefits for 20 months is worth a 9.06 percent increase, according to the calculations we've made using the Social Security Administration's website. In other words, she will receive 82.39 percent (73.33 percent + 9.06 percent = 82.39 percent) of the $1,000 she would have earned if she'd waited until age 66 to start taking Social Security. Because of that, Frederica will begin receiving monthly benefits totaling $823.90 (82.39 percent of $1,000) as of her full retirement age.

In addition, if the time she spends working plus getting Social Security benefits turn out to be her highest earnings years, or if she did not have 35 full years of job earnings before she started taking benefits, the Social Security Administration will recalculate her monthly benefit based on these earnings from work each year.

Avoiding the earnings test

The best way to avoid the earnings test altogether is to wait for full retirement age to collect your Social Security benefits. (As we mentioned earlier, this age differs depending on the year you were born.) Not only will that keep you from having to figure out how to manage without your benefits when they are withheld, but it will ultimately increase the amount you receive each month from Social Security.

However, if you can't avoid taking benefits before reaching your full retirement age and while you're still working, it's important for you to understand what to expect and plan ahead for it.

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