In today’s retirement landscape, working during retirement and while claiming Social Security benefits has become a relatively common occurrence—but what are the rules when only one spouse continues to work during retirement? And how do modern complications such as divorce and dual earnings records factor in?
While the basic rules for taxing Social Security benefits during a working retirement are relatively straightforward, when modern day complications are factored into the equation the results are anything but simple. This magnifies the importance of the advisor’s role in providing guidance on the impact of simultaneously working and claiming Social Security benefits in order to maximize Social Security during a working retirement.
The Working Retirement Social Security Tax
As is becoming extremely common, a client can begin to collect Social Security benefits even while he or she continues to work and earn income. However, a portion of that benefit will be subject to tax rules that differ from the otherwise applicable tax rates.
In 2017, if a client is younger than full retirement age, collects Social Security early and earns more than $16,920, his or her Social Security benefit will be reduced by $1 for every $2 that he or she earns over that limit. This earnings limit is applied on a calendar year basis (January-December), rather than based on the individual client’s birthday. The limit is also indexed annually for inflation (the amount for 2016 was $15,720).
During the year in which the client reaches full retirement age, the lower $16,920 amount is increased to $44,880 in the months prior to the month in which the client actually reaches full retirement age. Further, during those months, his or her Social Security benefits are only reduced by $1 for every $3 that is earned above the $44,880 limit. For example, if the client reaches full retirement age in September, his or her benefit will be reduced during the months of January through August, assuming his or her earned income exceeds $44,880.
Once the client reaches full retirement age, his or her benefit is no longer reduced regardless of earned income.
The Spousal Income Complication
The complication that arises in applying the earnings tests discussed above is that, in many cases, both spouses in a marriage have their own independent earnings records upon which Social Security benefits can be based. Further, it is entirely possible that only one spouse will continue to work during retirement, so that uncertainty can arise over whether and when the earnings test will apply to reduce benefits.
Generally, the reduction, or working retirement tax, on Social Security benefits will only apply if the spouse whose earnings record is used to determine the amount of the benefits is also the spouse who continues to work.
However, added complications can arise when one spouse decides to file a restricted application (an option that remains even after the phase-out of “file and suspend”) in order to cease receiving his or her own benefits and collect half of the other spouse’s available benefit. This strategy can prove useful in situations where it is beneficial to allow the “restricting” spouse’s benefit to grow until he or she reaches age 70.
In this case, the spousal benefit that is received is based on the spouse’s earnings record, so if that spouse continues to work, the earnings test and applicable taxes will apply even though the spouse who is actually collecting the benefits has reached full retirement age (so is no longer subject to the earnings test) and does not work.
However, once the working spouse reaches full retirement age, the Social Security Administration recalculates his or her benefits to treat that spouse as though he or she had waited to claim benefits (i.e., if the earnings test results in three months’ worth of lost benefits for three years, the client will be treated as though he or she had begun claiming benefits nine months after the actual claim was made).
With divorced spouses, the continued earnings of a former spouse does not impact the ability of the other ex-spouse to claim benefits based on that working ex-spouse’s earnings record, however.
The rules governing the impact of a working retirement on Social Security can be anything but simple—but with informed professional guidance, a client can more accurately gauge how one spouse’s continued earnings will impact current Social Security benefit entitlement.
Check out previous coverage of Social Security planning in Advisor’s Journal.
For in-depth analysis of the rules governing Social Security, see Advisor’s Main Library.