Financial Fingerprint: How to Approach Your Retirement Questions presented by William D. Connor, Financial Advisor at Meld Financial. The webinar will be held on July 13th at 3:00 PM Central Time. There is no cost to attend, but you must register in advance.
Social Security is an employment based federal insurance program that provides income support to working people and their eligible family members upon the employee’s retirement, or in the event of disability, or death. While most working individuals are covered by Social Security, there is a small number of workers who are excluded.
Examples of excluded workers include certain state and local government employees who are covered by alternative retirement systems, most permanent civilian federal employees who were hired before 1984, and other low-income workers. It is these excluded workers and their spouses that should be aware of the Windfall Elimination Provision [WEP] and the Government Pension Offset [GPO] and how these rules can impact their retirement plan.
What are WEP and GPO?
The Windfall Elimination Provision [WEP] and the Government Pension Offset [GPO] are two separate provisions that can reduce regular Social Security benefits for workers and their eligible family members. These rules apply if the worker is entitled to a pension based on earnings from employment that is not covered by Social Security.
The WEP and GPO rules are incredibly confusing, so it’s important to review them in detail. To add to this confusion, the Social Security Statements sent to workers do not consider WEP and GPO until the person applies for benefits. This means that at the time of application many individuals, who may have carefully planned for their retirement but overlooked WEP and GPO, may learn they will not receive as much income as expected – this news can be devastating.
Which retirees are impacted by the Windfall Elimination Provision [WEP]?
The WEP applies to Social Security beneficiaries in several categories. First, any eligible retiree who paid into a pension and Social Security taxes were not withheld. Jobs that typically fall into this category include teachers, government workers, etc., who did not pay into Social Security during employment.
Next, the WEP can also apply if after 1985 a person turned 62 or became disabled and became eligible for monthly pension from a job where Social Security taxes were not paid. This applies even if the person continues to work.
Finally, the WEP can affect benefits for federal employees who served under the Civil Service Retirement System (CSRS) after 1956.
How to calculate the impact of WEP on Social Security Benefits
Calculating the impact of WEP can be complicated, but in short, it requires modifying the standard Social Security benefits calculation in a way that reduces the benefit by no more than one half of the pension an individual receives from “non-covered” work. To understand this calculation, you need to be aware of 2 key terms, “Average Indexed Monthly Earnings” [AIME] and “Primary Insurance Amount” [PIA]. Once you understand these terms, you may have an easier time calculating the WEP.
To illustrate how WEP might impact your Social Security Benefits, let’s first look at how your PIA is calculated. If you were born in 1959 and had a maximum Social Security earnings every year since age 22, your career-average earnings in covered employment, or Average Indexed Monthly Earnings [AIME] would be $11,098. From this, the Social Security Administration calculates your PIA using three bend-points. In 2021, the first $996 of your AIME is multiplied by 90%, your AIME between $996 and $6,002 is multiplied by 32%, and any remaining AIME over $6,002 is multiplied by 15%.
The PIA in this case, for someone not subject to WEP, would then be as follows:
$996 x .90 = $896.40
$5,006 x .32 = $1601.92 ($6,002 – $996 = $5,006)
$5,096 x .15 = $764.40 ($11,098 – $6,002 = $5,096)
Total = $3,262.72
Your PIA of $3,262.72 is the amount you would receive at your Full Retirement Age.
The WEP affects the first bend point if you worked less than 30 years without Substantial Earnings ($26,550 in 2021) in a job covered by Social Security. The first bend point multiplier will be between .40 and .90, depending upon your earnings and the number of years you paid into Social Security.
Individuals Working Less Than 20 Years
If a person worked less than 20 years in a Social Security covered job, the first bend point would be multiplied by .40, rather than .90, which is the difference of .50. With the previous example, the first bend point would become $996 x .40 = $398.40, reducing the worker’s Social Security by $498 ($896.40 – $398.40)
Naturally, there are adjustments for PIA based on claiming age and survivor benefits, as each situation is unique. Additional information is available through the Social Security Administration for more details.
Which retirees are impacted by the Government Pension Offset [GPO] and how is GPO calculated?
The GPO is a rule that can affect spouses and widow(er)s of Social Security beneficiaries when the spouse or widow(er) receives pension from a government job. This provision reduces Social Security spousal or survivor benefits by two-thirds of the beneficiary’s pension amount when applicable.
Generally, spouses are eligible to receive up to 50% of the employed family member’s PIA, whereas widow(er)s receive up to 100%. When the GPO applies, spousal and survivor benefits are reduced by two-thirds of the offsetting pension amount, which can often reduce spousal benefits to zero.
To estimate how much Social Security benefits will be reduced by GPO, calculate two-thirds of the offsetting government pension. For example, if the pension amount is $2400, two-thirds of that figure equals a reduction of $1,600. In that same example, let’s assume the spousal benefit is $1000. If that benefit will be reduced by $1600, which is more than the $1,000 benefit, this situation would reduce the spousal benefits to $0.
It’s also important to note that if a pension is received as a lump sum, the Social Security Administration will calculate it as an annuity. In addition, be mindful that the GPO provision doesn’t apply until a client is entitled to the pension benefits, which is usually at retirement.
Spousal benefits and the Reasoning Behind GPO
Spousal benefits were established to pay spouses who were financially dependent on the working spouse. The reasoning was that those who stayed home to raise their family would be devoid of resources without their spouse’s income.
Now that both spouses commonly work in a household, each person is likely earning his or her own retirement benefit through Social Security or other means. With the GPO law, the spousal benefit must be offset by the amount of their own benefit.
Is it possible to avoid WEP and GPO?
There are some situations that can prevent an individual’s Social Security spousal or widow(er) benefits from being reduced. While each situation is unique, circumstances that exempt a spouse or widow(er) from these rules may include:
- individuals receiving a government pension not based on one’s own earnings.
- government employees with a pension that included paying Social Security taxes.
- federal employees who switched from the Civil Service Retirement System to the Federal Employees’ Retirement System after December 31, 1987.
- individuals eligible to receive a government pension prior to December 1982 and meeting requirements for spousal benefits effective January 1977.
- individuals eligible to receive a government pension prior to July 1, 1983, while receiving one-half support from your spouse.
Your Financial Fingerprint™ Evaluates Exposure to WEP and GPO
At Meld Financial, our financial professionals will work to alleviate many of the stresses related to your retirement planning, such as accounting for the WEP and GPO provisions. In over 30 years of managing our clients’ wealth we’ve developed a unique process called Financial Fingerprint™ that simplifies the wealth management process. In short, your Financial Fingerprint™ is a comprehensive financial plan that is quick to assemble, easy to understand and simple to modify as your circumstances change.
So, if you are looking for guidance in managing your wealth and preparing for your retirement, contact us today. As the name ‘Meld’ indicates, we bring it all together, and our team of financial, legal and tax professionals look forward to working with you.