Retirees who have been government workers or whose spouses have been government workers may be in for a surprise when they file for Social Security retirement benefits. What they may not realize is that the benefit values listed on page two of their Social Security statement (downloadable at SSA.gov) are estimates only. These estimates can differ significantly from their actual benefits due to the effect of government employment.
There are two provisions to the administration of Social Security benefits, which may significantly reduce retirement benefits received by state or local government employees, such as teachers, police, firefighters or other government workers. The Windfall Elimination Provision (WEP) regulates the benefit received by the worker. The Government Pension Offset (GPO) is a separate provision, which regulates the spousal benefits being claimed by the spouse of a government worker.
First, a little background. In 1983, Congress enacted a number of modifications to the Social Security program to shore up the system in anticipation of the eventual Baby Boomer retirement wave. These changes included increasing the payroll tax, causing todays dramatic increase in the Social Security Trust Fund and the Windfall Elimination Provision.
The WEP potentially limits benefits paid out to a public-sector worker who is eligible for other government pensions for wages where they did not pay payroll tax. Since Social Security was designed to provide a safety net of incomenot a defined benefitCongress felt that the system was justified to limit benefits in situations where workers were already collecting substantial government pensions from state or local governments. The WEP does not apply to federal government employees who started work after 1983.
Usually, but not always, when a person works at a local or state government job offering a pension, they do not pay Social Security taxes. This worker would see many zeroes for annual income on page 3 of their statement. This should be a warning sign to expect a reduction in anticipated benefits and a good thing for planners to review with clients.
The actual reductions are limited by a number of factors, one being the years of paying Social Security payroll tax. Benefits are always based on the highest 35 years of inflation-adjusted income. The actual amount of the WEP reduction is based on a sliding scale depending on the number of years that the worker reported wages with payroll tax withheld. In 2014, the greatest possible WEP reduction was $408/month for a worker with 20 years or less of Social Security payroll tax wages. If a worker had 30 years or more of these wages, there is no WEP reduction. Between 20 and 30 years of payroll tax wages, the reduction is modified proportionally.
A 65-year-old worker was a teacher for 17 years paying no Social Security payroll tax. He worked for another 20 years in other jobs paying payroll tax. His current recent statement estimates an age 66 full retirement age benefit of $926. His approximate reduction would be $408, and his actual benefit would be approximately $518 ($926 408). If he worked five more years in another job that paid Social Security payroll tax, the reduction would only be $204 and his benefit would be $702.
The WEP reduction, however, cannot be more than one-half of the amount of a workers public sector pension.
A worker had a teachers pension of $600/month and an estimated benefit at full retirement age of $1,423/month. He also worked 20 years paying Social Security payroll taxes. The maximum WEP reduction of his benefit would be $300 (half of $600), not $408, regardless of how few years he paid payroll taxes. His benefit would be $1,123 ($1,423 - $300). His teachers pension would still be $600/month.
What about the spouse? Her benefits would, of course, be affected. If the spouse applied for benefits at her full retirement age, she would be eligible as usual for half of the workers full retirement age benefit, except that now the workers benefits have been reduced. In Example 1 above, the spousal benefit would be $256/month (half of $518), if the husband paid 20 years of payroll taxes, $351 (half of $702) for 25 years, or $463 (half of $926), if he paid 30 or more years of payroll taxes.
Importantly, the survivor benefit for the spouse is not affected by the WEP. In other words, when the husband passes away, the wife will collect the full survivor benefit equal to the husbands full benefit of $926 regardless of how much of a WEP had been applied during his lifetime. Essentially the WEP passes away when the worker does.
Remember, the feature that triggers a WEP reduction is not paying SS payroll taxes. Public-sector workers are the most common example of this situation, but the fact that they are public-sector workers, in itself, does not trigger the WEP.
In an upcoming post, I will review the other side of the coin, The Government Pension Offset. This provision potentially reduces spousal benefits when the spouse is the one who has significant non-Social Security payroll tax earnings and a public sector pension.
Paul Norr is a financial planner in Thousand Oaks, Calif., and writes about planning and retirement. His website is www.paulnorr.com.