The Windfall Elimination Provision
The Windfall Elimination Provision has the potential to reduce Social Security benefits paid to individuals who worked for an employer that didn't withhold Social Security taxes. This is fairly common for US government workers, police officers and city and local governments. It also affects people who spent much of their lives working for foreign companies. Specifically, the provision applies if the individual's pension results from income that wasn't subject to Social Security tax, but also had income from other jobs that did have Social Security tax withheld.
To understand why the Windfall Elimination Provision is necessary, you must first understand how Social Security benefits are calculated.
Social Security is designed to benefit lower-income individuals more than higher-income ones. Essentially, your highest 35 years of Social Security-taxed earnings are indexed for inflation and then averaged to determine your lifetime average monthly earnings. Based on that amount, the following factors are applied to calculate your monthly benefit amount at full retirement age, also known as your primary insurance amount (PIA).
- 90% of average monthly earnings up to $885
- 32% of average monthly earnings from $886 to $5,336
- 15% of average monthly earnings above $5,336
For example, if a worker's average monthly earnings for Social Security purposes were $2,000, he or she would be entitled to a monthly benefit of $1,153 per month, or 58% of their average earnings. However, another worker who averaged $6,000 per month would receive $2,319 per month, or just 39% of their average monthly earnings.
So, how does the Windfall Elimination Provision affect the above mentioned figures? Basically, the provision reduces the amount of your monthly earnings that fall within the 90% multiplying factor. That multiplying factor can be reduced to 40%, which is determined by the amount of years you had substantial earnings and paid into the Social Security system. For example, you worked for various companies where you had substantial earnings and paid into the Social Security system for 25 years. Then you shifted gears and took a job with a Government agency where you didn't contribute to Social Security for the remainder of your career. Based on the table below, your 90% multiplying factor on the first $886 will be be reduced to a multiplying factor of 65%
Using the same average monthly earnings history as before, a person averaging $2,000 per month would be entitled to $932, because the first $885 is multiplied by 65% vs. 90%. This constitutes a $221 reduction because of the Windfall Elimination Provision. The worker averaging $6,000 per month will be receive $2,098 per month instead of the $2,319 because of the provision.
The Social Security Administration provides a chart that defines what qualifies as substantial earnings in any given year. Substantial earnings for 2017 is defined as $23,625, and prior years are reduced to reflect the effects of inflation. If you achieved substantial earnings in 30 or more years of your working lifetime, the Windfall Elimination Provision doesn't apply to you. On the other hand, if you had fewer than 30 years of substantial earnings and paid into the Social Security system, the 90% multiplier that would normally be used to determine your Social Security benefit will be reduced according to the following chart.
If you had this many years of "substantial earnings"...
...then your 90% multiplier is reduced to...
30 or more
20 or less
The bottom line
If you worked for employers and paid into the Social Security system, and worked for a local, state or federal government agency, then the Windfall Elimination provision could potentially affect you. Social Security will undoubtably play a major role in your retirement income planning. It is imperative to know the facts about the WEP provision and plan accordingly.
If you have any questions about this information, please don't hesitate to call me at 317-507-1825.