Windfall Elimination Provision might decrease benefits

If you are entitled to receive pension benefits from a job in which you pay no Social Security taxes, but you’ve also worked part-time or had a second career for which you did pay Social Security, the Windfall Elimination Provision could mean that your benefits might not be as much as you’re expecting. Jobs that don’t pay Social Security taxes include work for the federal government under the Civil Service Retirement System, your state government or for an employer in another country.

The Windfall Elimination Provision, which has been around for more than 20 years, is designed to eliminate some of the “double-dipping” for workers who might accrue modest amounts of Social Security benefits while working primarily in jobs not covered by Social Security. The issue is that Social Security benefits are skewed more heavily toward low-wage earners.

The law exempts some workers from the provision. Those hired by the federal government after 1983 are not subject to the limitation because they are under the Federal Employees Retirement System, which pays Social Security taxes. Also exempt are those whose noncovered work occurred before 1957; those whose only pension is based on railroad employment; or those who have managed to accumulate 30 years or more of “substantial earnings” under Social Security.

But many workers, primarily those in their 50s and 60s, with long careers in government, are affected by the Windfall Elimination Provision, and many don’t realize it. As a result, they are often less prepared financially for retirement than they might think. Currently, for example, the annual retirement benefit estimates sent to workers by Social Security don’t reflect any potential benefit loss because of the Windfall Elimination Provision.

To better inform Social Security recipients, the Social Security Protection Act of 2004 included two provisions. Beginning this year, employers not covered under Social Security must inform new hires from jobs that paid into Social Security about the Windfall Elimination Provision and its potential impact on their future Social Security benefits. Starting in 2007, the Social Security Administration must inform those potentially subject to the Windfall Elimination Provision how much their benefits might be reduced.

How, in the meantime, can you determine whether and to what extent the Windfall Elimination Provision might affect you?

Start with what Social Security considers “substantial earnings.” Each year, Social Security publishes the minimum amount of earnings necessary to qualify for a full year’s credit of substantial earnings. In 2004, a worker needed to earn $16,275 to qualify. In 1984, the amount was $7,050.

If you can accumulate 30 years of substantial earnings, through side jobs or years of full employment in jobs that paid Social Security taxes, you won’t be affected by the Windfall Elimination Provision. But if you have less than 30 years of substantial earnings, your benefits will be reduced. Let’s say that you retire at age 65 with 20 years of substantial earnings, and you’re eligible for $1,000 in monthly Social Security retirement benefits. According to Social Security tables, your monthly benefits would be reduced by $306. With 25 years of substantial earnings, you’d lose $153 a month.

The Windfall Elimination Provision limits the reduction of benefits to no more than 50 percent of the benefits you receive from a non-Social Security pension. This helps workers with small pensions. For example, if your noncovered pension is $400, your reduction in Social Security Benefits would be no more than $200, even if benefits would have been reduced more than that under the provision’s standard tables.

Keep in mind that the amount your Social Security benefits are reduced is the same every year. If you lose $153 a month during your first year of collecting Social Security, you’ll never lose more than that amount in the future, even though your overall Social Security payments rise with annual inflation adjustments.

While disclosure of the impact of the Windfall Elimination Provision will better alert future retirees, financial planners caution workers to keep a key point in mind: If you believe that you will be affected by the provision, adjust your retirement plans and savings efforts accordingly to make up the shortfall.

This article was produced by the Financial Planning Association and provided by William O. Woody of Stovall Woody Associates.