Social Security's Earnings Test Has 1 Major Flaw

There are many elements of Social Security that are surprisingly flexible. Take claiming benefits, for example.

You can file for Social Security at any point once you turn 62. And you can also earn delayed retirement credits that boost your monthly benefits if you wait beyond full retirement age to sign up.

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Social Security also allows recipients to collect benefits even if they're still working. And once full retirement age arrives, you can earn any amount of money without a negative impact.

If you're not yet at full retirement age and you decide to work while receiving Social Security, you'll be subject to an earnings test whose limits change every year. And exceeding the earnings-test limits could mean having some of your Social Security benefits withheld.

In reality, that's not necessarily a terrible thing. But the fact that the Social Security earnings test is often misunderstood is actually a huge problem.

A big flaw in the system

The way Social Security's earnings test works is simple. If you've reached full retirement age, you're not subject to it. If you haven't gotten to full retirement age and your income exceeds a certain threshold that changes from year to year, you'll have some of your Social Security benefits withheld temporarily.

One big misconception about the earnings test is that exceeding its limits results in forfeited benefits. But benefits that are withheld under the earnings test are returned to you later on. Specifically, once you reach full retirement age, your benefits will be recalculated, and you should be in line for larger checks.

The problem with the earnings test, aside from this misconception, is it may discourage seniors on Social Security from pursuing work opportunities. And that alone is an issue -- one that should perhaps prompt lawmakers to rethink the earnings test in the first place.

Working as a retiree comes with a number of benefits. For one thing, many people need the money from a job because they don't have enough in retirement savings. Disincentivizing seniors to work by complicating matters with an earnings test could mean hurting them financially.

There are also social and emotional benefits to holding down a job. A lot of people end up bored and lonely in retirement.

Work can serve as a social outlet, giving seniors a reason to leave the house. It could also help anchor their days and help them avoid feeling restless.

But because there's an earnings test to worry about, some seniors may opt not to work if they don't absolutely need the money. That could mean missing out on the chance to meet new people and stay busy.

Will lawmakers do away with the earnings test?

There's a lot of pressure on lawmakers to make changes to Social Security. One major point of contention is the way the program's annual cost-of-living adjustments, or COLAs, are calculated.

Social Security COLAs are based on third-quarter changes to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-W, however, is not particularly reflective of the costs Social Security recipients tend to face, since many are not, in fact, employed, and many don't live in urban areas. So there's pressure to change that COLA formula.

Similarly, some advocates feel that Social Security's earnings test discourages participation in the workforce once benefits are claimed. And so in time, the pressure might mount to reconsider the earnings test -- if not do away with it, then perhaps at least make some changes.

Should you continue to work if it means being subject to the earnings test?

If you're collecting Social Security before having reached full retirement age, you may be wondering if it pays to work, given that you might have benefits withheld. But one thing to realize is that the earnings-test limits may be more generous than you'd think.

This year, for example, you can earn up to $23,400, or up to $62,160 if you'll reach full retirement age by Dec. 31, without having any Social Security withheld. Beyond these limits, you'll have $1 in Social Security withheld per $2 or $3 of earnings, depending on when you'll reach full retirement age.

Put another way, if you're 65 collecting Social Security and you earn $1,000 a month, the earnings test isn't something to worry about. So if you want to work, and you need to work, you shouldn't let it stop you from doing so. The key, however, is to understand the rules, so there are no unwanted surprises.

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