Dual income couples complicate Social Security earnings test

Benefits of one — or both — could be reduced due to excess earnings

By Mary Beth Franklin

Jul 6, 2017 @ 7:12 pm EST

With so many people planning to work beyond normal retirement age, dual-income couples face a challenge when it comes to choosing a Social Security claiming strategy.

Anyone who claims Social Security benefits before full retirement age while continuing to work could lose some or all of their benefits — at least temporarily — if they earn too much. In 2017, "too much" is defined as $16,920 if someone is under full retirement age for the entire year. They would lose $1 in benefits for every $2 earned over that limit.

In the year someone reaches full retirement, during the months before their 66th birthday, a more generous earnings test applies. They would lose $1 in benefits for every $3 earned over $44,880 in 2017. Once someone (who was born from 1943 through 1954) reaches 66, the earnings test disappears. Benefits lost due to excess earnings are automatically restored at full retirement age in the form of higher monthly benefits. The full retirement age is gradually increasing to 67 for those born in 1960 or later.

For a married couple, determining how the earnings test reductions are applied depends on whose earnings record the Social Security benefits are based and who has excess earnings. For divorced couples, one ex-spouse's excess earnings will not reduce the benefits of the other former spouse.

One adviser wrote to me recently with questions about his clients. The husband is 62 and still working. The wife is 66. Not only is she no longer subject to the earnings test because she has reached her full retirement age, she is also old enough to restrict her claim to spousal benefits and collect half of her husband's full retirement age benefit amount while her own retirement benefit continues to grow up to age 70.

The husband's primary insurance amount, or PIA, is $2,700 per month if he claimed benefits at 66. But he wants to claim now at 62 to trigger spousal benefits for his wife. Because he is claiming four years early, his benefit would be reduced by 25% to $2,025 ($2,700 x 0.75). However, his wife would still receive half of his PIA — $1,350 — because she is full retirement age. Together, they would collect $3,375 per month on his earnings record.

But there is a problem with this scenario. The husband is still working and is subject to the earnings test. If his benefits are reduced, so are his wife's benefits because she is claiming spousal benefits on his record. If she were claiming benefits on her own earnings record, rather than as a spouse, her Social Security benefits would not be affected by her husband's earnings.

Assume he earns $50,000 per year. That is $33,080 over the 2017 earnings cap ($50,000 - $16,920). So, he would lose half of the excess amount — $16,540 ($33,080/2) in Social Security benefits this year. If he were the only one collecting benefits, it would take nine months of forfeited benefits to satisfy the earnings test. He would receive his full $2,025 payment during the remaining three months of the year.

But because his wife would also be collecting benefits on his earnings record, their combined $3,375 a month in benefits would be used to satisfy the excess earnings test more quickly. Both of their benefits would be withheld for five months. After that, they both would receive their full benefits for the remainder of the year. The earnings test clock restarts each year that the husband continues to work while under full retirement age and collecting benefits.

Once the husband reaches his full retirement age, Social Security will recalculate his benefits to restore the amounts he lost to the earnings cap. In this case, he forfeited five months of benefits for each of the first three years, and let's say he forfeited two months in the year he reaches full retirement age due to a higher earnings test that year. Social Security will recalculate his benefit by adding those 17 months of forfeited benefits to his original claiming age of 62 and going forward, pay his benefits as if he had first claimed at age 63 and 5 months.

When the husband is 66, his wife would be 70 and can switch to her own maximum retirement benefit which would be worth 132% of her full retirement age amount, including four years of delayed retirement credits. The wife would not receive a bump up in spousal benefits because she would be collecting a larger retirement benefit on her own earnings record. In the interim, she would have collected about $38,000 in spousal benefits during that four-year period (after deducting the 20 months of her benefits that were withheld).

For those whose priority it is to maximize monthly cashflow now rather than holding out for the biggest monthly benefit later, the combination of working and collecting some Social Security benefits may be their best option.

(Questions about Social Security? Find the answers in my new ebook.)

Mary Beth Franklin is a certified financial planner.

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