Pensions are a traditional source of retirement income for many Americans, but some pensions can affect Social Security benefits. If you’re an advisor who works with teachers, police officers, firefighters, government employees or the spouses of those workers, you need to be aware of these provisions and how they could affect your clients.
While the Government Pension Offset (GPO) and Windfall Elimination Provision (WEP) differ in who they affect and how they impact benefits, both are aimed at reducing Social Security benefits for people who receive a pension from work in which they did not pay into the Social Security system.
Government Pension Offset (GPO)
The GPO reduces a government employee’s Social Security spousal and survivor benefits by two-thirds of their government pension. Normally, the Social Security spousal benefit is equal up to 50% of the retired or disabled worker’s benefit and up to 100% of the deceased worker’s benefit. GPO reduces the spousal and survivor benefit for spouses who also qualify for a government pension by two- thirds of the pension amount. If the pension from non- covered work is sufficiently large in comparison to the Social Security spousal benefit, GPO may eliminate the entire spousal or survivor benefit.
For example, Cindy worked in non-covered jobs her entire career and has a $3,000 a month pension. Her husband Bruce worked enough in Social Security- covered employment and is eligible for a $2,500 per month Social Security Benefit if he elects at age 66. Cindy is, therefore, eligible for a spousal benefit of up to $1,250 under Bruce’s work history. However, under GPO Cindy’s spousal benefit is reduced to $0 because two-thirds of her pension ($2,000) is greater than her spousal benefit ($1,250).
Upon Bruce’s death, she would still get a survivor’s benefit, but it would only be $500, rather than the $2,500 (at her full retirement age) she would get if the GPO did not apply.
Windfall Elimination Provision (WEP)
The WEP reduces the Social Security benefits of people who qualify for both a Social Security benefit and a government pension based on their own earnings.
In order to understand how WEP affects benefits, you first need to understand the basics of how Security benefits are calculated. In general, a worker’s monthly Social Security benefit is based on his or her 35 highest-paid years in Social Security-covered employment. The worker’s earnings are indexed to wage growth to bring earlier years up to a current basis, then divided by 35 years, and divided again by 12 months per year to determine the Average Indexed Monthly Earnings (AIME). Once a worker’s AIME is established, the Social Security benefit formula is applied to arrive at their Primary Insurance Amount (PIA).
As you can see, the formula is progressive, which means workers with low average lifetime earnings will receive a larger proportion of their earnings as a Social Security benefit. For someone who worked in the private sector for 10 years then changed careers to become a public employee who didn’t pay Social Security taxes, their AIME would be relatively low because their 10 years of income would be averaged over 35 years.
Therefore, the benefit formula would replace more of their earnings at 90% than someone who spent his or her full 35-year career in covered employment. This is known as a windfall. Under the WEP, instead of 90% of their first $767, this worker would only get 40%. Let’s look at an example of someone with an AIME of $1,500.
Regular Benefit Formula
Windfall Elimination Formula