Many of our grandparents worked for the same company for their entire careers. But for decades now, it’s been common to change careers, not just companies, multiple times.
Ken, for example, started work as a lawyer, switched to government service, and finally found his calling in financial planning. In the process, he’s earned credits under Social Security and one of Ohio’s five state pension systems. Social Security may pay him a reduced retirement benefit with his complicated work history and time earning a public pension.
While the rules reducing Social Security typically apply to certain public employees, anyone who has worked at a job where they didn’t pay into Social Security could be affected by them. Sure, that’s not most Americans, but if this applies to you—and as a public employee, it probably does—you need to know how Social Security adjusts your retirement benefit.
Again, many public employees are unaffected by these rules. For example, some states do not have pensions or require their employees to pay into both the state pension and Social Security. Federal employees hired after 1983 pay into both systems, so they are not subject to reductions. For those who are affected, here’s a brief overview of what’s involved.
Two special calculations
When you apply for your Social Security retirement benefit, they’ll ask if you ever worked at a job where you didn’t contribute to Social Security. Most Ohio public employees paid into systems like OPERS, STRS, and SERS instead.
But if they also worked long enough in the private sector, they’ll still get a Social Security statement showing a projected retirement benefit that does not account for the reduction. For most of these people, the number shown on that statement is more than they’ll actually receive.
Of course, Social Security is not just about your own career. You might be looking forward to a benefit as the spouse of someone who had a career in the private sector.
The amount of Social Security’s reduction depends on whether you’re looking at the amount you’ve expected from your own earnings, your spouse’s, or both.
Reduction based on your own earnings: Windfall Elimination
The Windfall Elimination Provision (WEP) is an adjustment to your own Social Security benefit, based on your own public pension. The theory behind it is that the Social Security formula provides a higher percentage income replacement for lower earners. The formula considers your years in the public sector as if you were unemployed and therefore provides a higher income replacement. WEP aims to compensate for this.
Your Social Security retirement benefit is based on a figure called your Primary Insurance Amount (PIA). It’s calculated based on your earnings over your entire career. The formula for PIA is pretty involved, but at its core, the WEP reduces your PIA by up to half the amount of your public pension.
Sometimes people think they can get around this by cashing in their public pension, but it doesn’t work that way—it’s not about whether you get a public pension. It’s about whether you had earnings from work where you didn’t pay into the Social Security system.1
There are some exceptions to the WEP: once you have more than 20 years of what the WEP formula calls substantial earnings, the penalty begins to phase out. Retirees with 30 or more years of substantial earnings under Social Security won’t experience the WEP at all. The threshold for substantial earnings is significantly higher than what you need to earn Social Security credits. However, it’s still pretty moderate: for instance, annual income of at least $5,100 in 1980 and $26,550 in 2021. If you’re already past 20 years of substantial earnings, continuing to work in the private sector could eliminate the WEP reduction.
Reduction based on your spouse’s earnings: Government Pension Offset
If your spouse worked under the Social Security system, you might be expecting Social Security to pay you a retirement benefit of about one-half of the amount your spouse receives. If you’d never worked at all or earned significantly less, that is likely what you could get.
But if you’re receiving a public pension, the benefit you get from your spouse’s Social Security record—whether that’s during their lifetime or widow or widower benefit—will be reduced under the Government Pension Offset (GPO) calculation. This one is simple: take two-thirds of your government pension and subtract it from your spousal (or widow/widower) Social Security benefit. What’s left is what you can expect from Social Security.
For example, if your spouse gets $2,400 from Social Security, you might be eligible for $1,200 as their spouse. But suppose you’re getting a public pension of $1,500/month based on your own work record. Two-thirds of $1,500 is $1,000. Since $1,200 - $1,000 = $200, that’s all you can expect in a Social Security benefit. And if your pension is just a bit bigger ($1,800/month or more), two-thirds of your pension would be as much or more than the amount initially calculated for your benefit. So you’d receive nothing as a spousal benefit from Social Security. (Be mindful that you may still be entitled to some benefit as a widow/widower even if you receive no spousal benefit.)
Notice that the WEP reduction was based on the fact that you’d worked for an employer who didn’t contribute to Social Security—the amount of your pension (unless it’s rather small) isn’t usually relevant. By contrast, the GPO calculation depends on the amount of your pension, and if it changes, so does your GPO reduction.
Social Security’s Calculations
the Social Security Administration (SSA) will apply the WEP calculation to the portion of your monthly benefit that’s based on your earnings history,
and will apply the GPO reduction against the portion of your Social Security payment that comes from your spouse’s work history.
Another important detail is that this is a specialized niche in the application of Social Security. Many SSA representatives are familiar with the idea of public pensioners getting a smaller benefit but don’t have enough experience with it to verify that the calculations have been done correctly. Consider working with a Social Security consultant who has experience independently verifying that your benefit has been accurately calculated.
For public employees, the complications of Social Security are even greater than for those in the private sector. There are limited opportunities to mitigate the impact of the WEP and GPO calculations, so research any strategies carefully and get expert guidance before taking any steps that may affect how Social Security calculates your benefits. SSA publishes fact sheets on WEP and GPO that are a good place to start.2
Want to know more about how your public pension affects what you can expect from Social Security? Give us a call.1 https://www.ssa.gov/benefits/retirement/planner/wep.html
2 https://www.ssa.gov/pubs/EN-05-10045.pdf and https://www.ssa.gov/pubs/EN-05-10007.pdf
This content is developed from sources believed to be providing accurate information and is provided by Practical Financial Planning, Inc. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. Original content of Practical Financial Planning, Inc. only is copyright © 2021 by Practical Financial Planning, Inc.