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Tuesday, April 15, 2014

PSPRS Members: What is the Windfall Elimination Provision (WEP) and how will it affect your Social Security benefits?

This post is not specifically about PSPRS, but it may be relevant to many of you.  (It is also April 15th so a tax-related topic is probably a fitting topic for today.)  If you worked for a while in other jobs prior to entering public safety or currently work a side or post-retirement job into which you pay into Social Security, there are two Social Security policies you should be familiar with: the Windfall Elimination Provision and the Government Pension Offset.  These can both affect your retirement income after you become eligible to draw Social Security, but in this post we will focus on the Windfall Elimination Provision.

You become eligible for Social Security when you have worked 40 quarters.  It is called a quarter because you can only earn a maximum of four quarters in a year.  However, it only takes $1,200 to earn one Social Security quarter in 2014, so you only need to earn $4,800 in Social Security-taxable earnings in 2014 to earn the maximum four quarters.  Any amount over this will not earn anymore quarters nor carry over into future years.  The amount necessary to earn a quarter was set at $250 in 1978 and has grown with wage inflation to its current  amount.  What it comes down to is that if you have worked for at least 10 years in jobs where you paid into Social Security, you have probably earned enough quarters to draw some amount of Social Security.

The age when you can start drawing your full Social Security benefit is determined by your date of birth.  If you were born in 1960 or later, you can start drawing your full benefit at age 67.  If you were born between 1943 and 1959, you can start drawing your full benefit sometime after your 66th birthday; anyone born prior to 1943 could have started sometime after their 65th birthday.  Social Security allows you take a reduced benefit if you start drawing benefits before full retirement age, and an increased benefit if you delay drawing benefits after full retirement age.  Both reductions and increases are done on a sliding scale.  For someone born in 1960 or later, starting to draw at 62 will reduce your benefit by 30%; waiting until 70 will increase your benefit by 24%.  Your Social Security Administration (SSA) statement will give you an estimated monthly retirement benefit at 62, full retirement age, and 70.  These statements used to be mailed to everyone around their birthday. Now a single statement is a mailed at age 25 with annual mailed statements not resuming until a person turns 60.

The Windfall Elimination Provision (WEP) will affect almost all PSPRS members who are eligible to draw Social Security.  The name is a bit misleading (and a little insulting) when one considers how modest the benefits are, but a little background is necessary.   Social Security benefits are not calculated like a PSPRS retirement, which uses a straight percentage formula to determine your monthly retirement check.  The SSA uses a special formula based on your average monthly earnings (indexed to wage inflation) over 35 years to determine your monthly benefit.  For someone reaching full retirement age in 2014 the monthly benefit equals 90% of the first $816 of average monthly earnings plus 32% of the next $4,101 plus 15% of any amount over that.  For someone whose average monthly earnings were $3,000, the monthly benefit would be $1,786, while someone whose average monthly earnings were $8,886 would get a monthly benefit of $2,642, which is the maximum monthly Social Security benefit for 2014.  For a more complete explanation of the WEP, including certain exceptions, see this SSA document.

The SSA's formula produces only an $856 monthly gain for someone who averaged $106,632 or more per year versus someone who averaged $36,000 per year.  The obvious goal of this progressive formula is to replace a higher percentage of the pre-retirement earnings of the lower-earning worker.  This is where the "windfall" aspect comes into play for those like PSPRS members who participate in a government pensions and do not contribute to Social Security.  The WEP changes the progressive formula used by the SSA in only one way--instead of using 90% of the first $816, it uses only 40% of the first $816.  The other two calculations remain the same, but this change can still reduce someone's  Social Security benefit by up to $408 every month.  This is done because the SSA uses the average indexed monthly earnings (AIME) for the highest 35 years.  If a PSPRS member joined an Arizona public safety department after working 10, 15, or even 20 years in another job where he paid into Social Security, the next 25, 20, or 15 years he worked as a PSPRS member could show zero or very low income earned during his time working in public safety.  These zero or low income years would figure into his AIME, and since the SSA does not distinguish between someone who contributed to Social Security as a full-time worker for only a short time and someone who had low earnings for the entire 35 years, the PSPRS member will have his Social Security benefits calculated as if he were a low earner.  This was not the intent of the progressive formula.

If we take a hypothetical PSPRS member who earned $300,000 over 15 years in jobs where he paid Social Security tax then worked another 20 years in public safety, his career earnings over the 40 years of work would appear in the SSA's system as $300,000.  While he actually earned an average of $20,000 during his first 15 years of work plus his much-higher public safety salary over the next 20 years, the SSA would record his annual earnings as only $8,571 over the high 35 years.  At this $8,571 annual earnings, his AIME would appear to be only $714, even though his true AIME is much higher.  The intent of Social Security is to replace a higher proportion of lower earnings and taper off as a worker's earnings increase.  Since the situation with our hypothetical PSPRS member incorrectly makes him appear to have low career earnings when he actually earned much more, the WEP is necessary to bring fairness back to the calculations.

Many public sector employees and their unions are up in arms about the WEP, thinking it is an unfair reduction of an already small Social Security benefit.  It is true that public employees will often have a small Social Security benefit, and the WEP appears to disproportionately hit the small benefit payments hard.  However, this fails to take into account the aforementioned methodology and purpose of Social Security.  It also looks at the wrong dollar figure.  While it is easy for these public employees to focus on the amount they feel they are being unfairly denied, it is more appropriate for them to consider the amount they are getting.  By comparing their final Social Security benefit to what they paid in taxes in their lifetime, I think that most would probably find that their benefit is fair.

For PSPRS members interested in getting an estimate of their Social Security benefit, you will need a copy of your Social Security statement.  If you do not have a paper copy, you can obtain one online from the SSA here.  With that statement you can use the WEP calculator to see how much your Social Security benefit will be reduced by the WEP.

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