A Windfall That Will Blow You Away

Most people would love to have a financial windfall. A chunk of unexpected money that appears out of nowwhere. But there is another kind of windfall. It is a formula that can eat into the Social Security benefit anticipated by tens of thousands of long-time (CSRS) federal workers, school teachers and employees of some nonprofits.

Most Americans pay into the Social Security system by having the Federal Insurance Contribution Act (FICA) tax deducted from their paychecks. Currently, the FICA tax of 6.2 percent is applied to an employee’s wages. During 2008, FICA tax is withheld on the first $102,000 of an employee’s wages.

Many individuals, including federal employees covered by the Civil Service Retirement System (CSRS), Americans employed in foreign countries by foreign employers, and some state public employees do not contribute to Social Security. In spite of their not being able to contribute to the Social Security system in their jobs, many of the aforementioned individuals have at some time during their working careers been able to earn the required minimum 40 “quarters of coverage” or credits to qualify for Social Security retirement payments. Before 1983, these workers were able to receive the maximum benefits from both Social Security and their public pensions.

However, in 1983 Congress passed the “Windfall Elimination Provision” (WEP) in order to eliminate this advantage. In particular, if an individual is covered by a public pension plan (such as CSRS) and has less than 30 years of “substantial” Social Security covered earnings while working in the private sector, the amount of Social Security benefits they receive will be reduced. The Social Security benefits are reduced for affected individuals; those:

• reaching age 62 after December 31, 1985;
• becoming disabled after December 31, 1985; or
• becoming first eligible for a monthly pension after December 31, 1985 based on non-covered Social Security employment.

Why did Congress create the WEP in 1983? Perhaps the motivation to create it was to remove any possible inequalities of Social Security benefits of employees not paying into Social Security but paying into a government retirement plan. These employees would earn their 40 credits outside of federal service and subsequently earn Social Security benefits that are as relatively high as those benefits earned by employees who paid into Social Security their entire working careers. The “inequality” problem occurs because the threshold for coverage of Social Security retirement benefits is rather low and monthly retirement benefits accrue rather quickly at the lower end of the earnings scale.

For 2008, full retirement benefits accrue at 90 percent of the first $711 of an individual’s average indexed monthly earnings (AIME) and then accrue at a lesser rate of 32 percent, finally reaching an accrual rate of 15 percent. The most important thing for federal employees to understand is that the WEP will reduce, but will not eliminate, an individual’s Social Security benefit by as much as 55 percent.

Which federal workers are affected by the WEP and how do they determine how the WEP affects their Social Security benefits? The Social Security Administration (SSA) has a publication, SSA Publication No. 05-10045 (downloadable at www.ssa.gov) which explains the WEP. Perhaps the most important portion in the SSA publication is the table (reproduced below) that shows the effect of the WEP on an affected annuitant’s Social Security benefits.

CSRS and CSRS-Offset employees, and “Trans-FERS” (employees who joined FERS in 1987 or 1998 after working at least five years under CSRS), could be affected by the WEP. FERS-covered employees are not affected by the WEP because they have regularly paid into Social Security. With respect to CSRS-Offset employees (many of whom are entitled to two Social Security checks – one check based on federal CSRS Offset service and the other check based on non-federal service), the WEP could affect the Social Security retirement check that is based solely on non-federal service.

To calculate the potential reduction of the WEP on affected individual’s Social Security retirement benefit, he or she needs to reference two tables on the SSA Web site at www.ssa.gov and follow these three steps.

Step 1.

Determine the number of years of “substantial” earnings. An individual needs to look at his or her Social Security statement (received annually) and determine how many years of “substantial” Social Security wages he or she has accumulated. The SSA has a table on its Web site (at www.ssa.gov/pubs/10045.html) that lists “substantial” earnings per year since 1937. For example, “substantial earnings” during 2005 was $16,725.

Step 2.

Once the number of years of substantial earnings has been established, the reduction in benefits is found by referring to the WEP chart on the SSA Web site at www.ssa.gov/retire2/wep-chart.htm. For example, suppose a 62 year CSRS annuitant (age 62 is the “eligibility year” or ELY) with 15 years of “substantial earnings” begins to receive Social Security during 2008. On the chart under “20 or less years” of substantial earnings, this individual’s Social Security would be reduced by $355.50. For example, if the individual was to receive a monthly benefit of $600, then the actual benefit due to the WEP reduction would be $600 less $355.50, or $244.50 per month.

Step 3.

There is a limit on the WEP reduction equal to 50 percent of the non-Social Security pension (e.g. CSRS). For example, if the CSRS annuitant above receives a CSRS annuity pension of $300 a month, the WEP reduction would be limited to $150.

Some other considerations about the WEP:

• The WEP does not affect an individual who continues to work and is drawing Social Security benefits. For example, a federal employee who has reached full retirement age continues to work for the federal government and is drawing his or her own Social Security retirement benefits. Those benefits will not be affected by the WEP. The WEP takes effect once the individual retires from federal service.
• If a federal annuitant affected by the WEP is married, then his or her spouse (or former spouse) is eligible for half of the annuitant’s Social Security retirement benefit (“spousal/former spousal” benefit). This assumes that the spouse’s or the former spouse’s own Social Security benefits are less than half of the annuitant’s Social Security benefits. However, spousal/formal spousal Social Security benefits are also affected by the WEP. If the annuitant dies and the spouse/former spouse is entitled to the deceased’s Social Security (“survivor” benefit), then the WEP no longer applies. In other words, the spouse/former is entitled to the deceased federal annuitant’s full Social Security benefit without a reduction for the WEP.

Because the effect of the WEP is not included on an individual’s Social Security annual reporting statement, many federal employees are shocked when they start receiving their Social Security retirement or disability benefits. As a result of Congressional hearings that provided woeful tales of individuals who expected Social Security payments based on the information provided by the SSA but ended up with much less, Congress passed the Social Security Protection Act of 2004. This law requires better disclosure of payment adjustments due to the WEP.

Ed Zurndorfer is a Certified Financial Planner and Enrolled Agent in Silver Spring, Maryland. He is also a registered representative with Multi-Financial Securities Corporation (Branch A9X), member FINRA/SIPC, also located in Silver Spring, Maryland.

Nearly Useless Factoid

Discover Magazine explains How to Turn Your Fist Into a Block-Breaking Machine. It’s pretty cool, but then I realized I couldn’t remember the last time I needed to chop a block in half.

To reach me: mcausey@federalnewsradio.com

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