The complexity of the social security system is truly mind numbing. Even the method to calculate your eligible benefits involves a series of complex calculations.
In it's simplest terms, your benefits are based on your highest 35 years of averaged indexed monthly earnings (AIME). Social security records your highest 35 years of earnings, indexes them into present day values and then calculates a monthly average.
But they don't stop there. To determine your Primary Insurance Amount (PIA), the monthly benefit you will be eligible to receive at full retirement age (age 66 for most retirees today), they then apply three "bends points" to your AIME in order to calculate your PIA. For example, if your AIME is $9,000 in 2015, in order to calculate your PIA they take 90% of the first $826 of AIME, then 32% of the next $4,154 and then 15% of any amount above $4,980. Wow!
So what's the point of knowing the inner workings of your PIA calculation? Well, if you are a police officer, fire fighter or any other worker (such as some teachers and government workers) who have a social security benefit and also contribute to a non-covered pension then this becomes an important matter indeed.
Social security benefits were designed to replace a percentage of a workers earnings. It was also designed to afford a lower wage earner a higher percentage of their pre-retirement earnings than it does for high wage earners. In general, it is designed to provide lower wage earners with about 55% of their pre-retirement income compared to about 25% for higher paid workers.
However, an inequity in the system arose regarding workers whose primary income was from a job where they didn't pay into social security while still working for a smaller income from a social security covered job. Because their recorded social security earnings were low they were being treated as a low income earner (even though their total combined earnings were high) and, as such, were paid a higher percentage of replacement income from social security than they should be paid.
These workers were deemed to be "double dipping", having an unfair advantage over workers who had the same amount of aggregate income but worked only in a job (or jobs) where they paid into social security on all of their earnings.
As such, in 1983 Congress passed the Windfall Elimination Provision (WEP) to remove that advantage. The WEP in these cases reduces the PIA to create a level playing field between those whose work history includes both covered and non-covered employment and those who work exclusively in covered positions.
Without getting into the complex details of the calculations involved in applying the WEP, one point to note is that the first "bend point" could drop to as low as 40% from 90%. Therefore, the effect of the WEP could reduce an affected worker's social security benefit by as much as $400 per month or more. In addition, it also reduces the amount a spouse would be eligible to receive for spousal benefits affected by WEP. The combination of both reductions could substantially reduce a couples social security benefits in retirement.
Separately and in addition to the WEP, there is yet another provision called the Government Pension Offset (GPO) which also affects these same workers who have social security and non-social security covered wages. The GPO will be the topic of my blog next week but it's impact could be as important or possibly more important than the WEP.
So, is there any way to mitigate the effects of the WEP? Yes, in some cases it may be possible but to do so involves a detailed understanding of the rules and careful planning. If you are a police officer, fire fighter, government worker, teacher or other type of worker who does not pay into social security then it critical to know exactly how your social security benefits may be affected by the WEP. With the assistance of a social security income specialist you may be able to reduce or perhaps even eliminate the impact of the WEP.
Ash Ahluwalia, NSSA, CCSCA, MBA