If you work as a public employee for a state or local government, you may notice that Social Security taxes aren’t being deducted your paycheck.
This isn’t a mistake. Fifteen states, including Massachusetts, Connecticut and some parts of Rhode Island don’t collect Social Security taxes from public sector employees.
Instead, most of these states or towns deduct a portfolio of employees’ income to fund future retirement benefits they’ll receive from their state-run pension plan.
If you’ve worked for one of these states your entire career, you probably won’t be eligible for Social Security. That’s because workers must pay Social Security taxes for at least 10 years before they can be eligible for benefits.
The potential pension penalty
If you worked at least 10 years in jobs where Social Security taxes were deducted from your paycheck, you will be eligible for benefits.
However, if you also spent a good portion of your career working in a state or local government job where you never paid Social Security taxes, Uncle Sam expects that your state pension will provide most of the income you would have otherwise received from Social Security.
So, when you start receiving Social Security benefits, your monthly check may be significantly reduced if you’re also getting monthly pension checks.
This is because of the Windfall Elimination Provision (WEP), a rule designed to keep some pensioned public sector employees from receiving maximum Social Security benefits.
How big is the potential WEP impact? That depends on how many years you paid Social Security taxes. If you paid them for 30 years or more, your Social Security benefits won’t be reduced at all. That’s good news for people who were employed in the private sector for most of their career and chose to complete their career working for their state or town.
Likewise, if you paid Social Security taxes for less than 10 years, there won’t be any WEP impact simply because you won’t be entitled to any Social Security benefits.
So where does that leave those in the middle—workers who paid Social Security taxes for anywhere between 10 to 30 years? To put it simply, the more years you pay these taxes, the lower your WEP penalty will be.
The formula for calculating WEP is very complicated. (If you really want the details, view the Social Security’s administration’s explanation).
In a nutshell, the maximum amount that WEP can cut your monthly Social Security check by is either 50% of the value of your monthly pension payment or $512, whichever is less. Fortunately, WEP can never zero out your monthly Social Security benefit.
GPO: The other pension penalty
What if you are or were a state or local employee who receives a pension and want to claim spousal Social Security benefits rather than your own?
The answer is that there’s good news and bad news.
The good news is that WEP will not reduce your benefits, since it only applies to Social Security benefits you’ve earned through your own work experience.
The bad news is that your monthly spousal benefits may instead be reduced by what’s known as the Government Pension Offset, or GPO.
To keep it simple, the GPO may reduce your spousal Social Security check by two-thirds of your monthly pension payment. Unlike WEP, this is a fixed percentage.
Here’s an example, straight from the Social Security Administration. Say you’re entitled to a monthly state pension payment of $600 and you’re also eligible for a monthly $900 spousal Social Security benefit. The GPO would end up deducting $400 ($600 x 2/3 = $400) from your Social Security benefit, resulting in a net payment of $500 ($900-$400). That would leave you with a net combined monthly benefit of $1,100 ($600+$500).
And, unlike WEP, there's no maximum cap on the GPO. Using the example above, if your monthly spousal Social Security benefit were $400 instead of $900, the $400 GPO pension penalty with leave you with no benefit at all. If there's any silver lining here, it's that if the GPO pushes your Social Security benefit into negative territory, you won't have to "pay back" the difference from your pension payments.
Confusing enough? Wait, there more!
If WEP and GPO weren’t confusing enough on their own, what makes them even more complicated are the number of exceptions to the rules.
According to the Social Security administration, WEP doesn’t apply under any of the following conditions:
- You are or were a federal worker first hired after December 31, 1983.
- Your only pension is for railroad employment.
- The only work you performed for which you didn’t pay Social Security taxes was before 1957.
Likewise, GPO doesn’t apply if:
- You are or were a federal, state, or local government employee and your pension comes from a job where you did pay Social Security taxes; or
- Your monthly pension benefits aren’t based on your earnings.
Do something--or do nothing?
If you’re thinking of retiring from your state or local government job and you believe your net Social Security benefits could be impacted by either WEP or GPO, you may have some critical decisions to make, such as:
- Should I leave my job now and work a few more years in a job where I pay Social Security taxes to reduce the potential WEP impact on my benefits?
- If I’m a few years short of becoming eligible for Social Security benefits, is it worth it for me to switch to a private sector job and pay Social Security taxes until I reach the 10-year minimum threshold?
- From a pension penalty viewpoint, will I receive more monthly net income if I apply for my own Social Security benefits or apply for spousal benefits?
Other factors may come into play when you’re contemplating your options, such as the age you plan on retiring, what your living expenses will be during retirement, and how much income you’ll receive from other sources, such as IRAs and other defined contribution plans you’ve participated in throughout your career. You may end deciding that you don't need to do anything at all.
If all of this seems overwhelming, considering meeting with both an accountant and a financial advisor to create a more cohesive financial plan for your retirement.
This material has been provided for general informational purposes only and does not constitute tax or retirement planning advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer and financial advisor.
This article was authored by Dan Flanagan and Jeffrey Briskin. Dan is a financial advisor and Partner located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 508.598.1082 or firstname.lastname@example.org Jeffrey Briskin is Director of Marketing at Canby Financial Advisors.
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