When it comes to computing Social Security payouts, government employees have some special issues to consider that can often affect how they should take their benefits. There are many instances where government employees will not receive the standard full payout of these benefits the way workers in the private sector do. Advisors who work with government employees need to be familiar with the rules that determine the percentage of their full Social Security benefits to which they are entitled.
Government Pension Offset
The Government Pension Offset (GPO) is a rule that applies to government employees and public servants such as policemen, firefighters and teachers. This provision reduces the Social Security spousal and survivor benefits of a government pension by two-thirds of their normal amounts. Of course, the normal spousal Social Security benefit can equal up to half of the retiree’s or disabled worker’s full benefit, and the survivor benefit can equal the entire retirement benefit in some cases. But the GPO can completely eliminate both benefits in cases where the pension being received by the retired worker is large enough compared to the Social Security spousal or survivor benefit. (For more, see: How Married Couples Can Maximize Social Security.)
Example: Doreen has worked as a teacher all of her life and now receives a pension of $3,600 per month during retirement. Her husband receives $5,000 per month of Social Security benefits. Normally, Doreen would be entitled to a spousal benefit of up to $2,500 from her husband’s earnings if he elects to receive his normal full Social Security benefit at age 66, but she will only receive $100 per month, because her Social Security benefit is reduced by two-thirds of the amount of her pension ($2,500 - $2,400). If her husband predeceases her, she will also only receive $1,400 per month for a survivor benefit ($5,000 - $3,600).
Windfall Elimination Provision
The Windfall Elimination Provision (WEP) applies to workers who are eligible to receive both Social Security benefits and a pension and how it works is a bit more complex than the GPO. A worker’s monthly Social Security benefit is calculated by taking the highest-paid 35 years of eligible earnings for which Social Security was collected. The formula uses an indexing method that brings earlier years up to the current time based upon wage growth, and then the total is divided by 35 and then 12. The final quotient is known as the Average Indexed Monthly Earnings (AIME). The second part of the formula is used to calculate the worker’s Primary Insurance Amount (PIA). This part of the formula is progressive and is shown as follows: (For more, see: Top Tips for Maximizing Social Security.)
Average Indexed Monthly Earnings (AIME)
90% First $767
32% $768 to $4,264
15% $4,265 and above
Because this formula is progressive, it means that workers with lower earnings will be paid a greater percentage of their earnings by Social Security in retirement. Therefore, workers who only worked a few years in jobs where Social Security was taken out of their pay will have more years over which to divide those earnings. For example, a worker works as a policeman for 25 years and then decides to start his own practice as a private detective. He does this for 15 years and then retires. Under the Social Security AIME formula, he will divide his 15 years of earnings from his private practice over 35 years, thus giving him a relatively low AIME. His benefit will therefore be comprised of a higher percentage of his earnings from his practice than someone who worked in the private sector all of their life. WEP will step in at this point and reduce the percentage upon which the first tier is paid out. (For more, see: Top Tips for Minimizing Taxes on Social Security.)
Example: Bob has an AIME of $2,000. Here’s how his payout will be calculated under the WEP versus the regular way.
90% of the first $767: $690.30
32% of earnings from $768 to $4,264: $394.56
15% of earnings from $4,265 and up: $0
Total Social Security benefit: $1,084.56
Under the WEP, Bob might only receive 40% of his AIME in the first tier. This would reduce his benefit by $345.15 per month. However, WEP cannot reduce a worker’s benefit by more than 50%, and workers with more than 30 years of service under the Social Security system are unaffected by WEP. And workers who have more than 20 years of service in the Social Security system can increase their WEP percentage by 5% per year for each additional year worked.
The Bottom line
Although the percentage of workers who are affected by GPO and WEP is relatively low, there are indications that the number of people who are affected are higher than the government has estimated. Planners who work with clients who are affected by these provisions need to understand how they work in order to advise their clients effectively. (For more, see: 5 Social Security Changes to Expect in 2016.)