Understanding Social Security’s Windfall Elimination Provision

By Elaine Floyd, CFP

Some government and nonprofit workers could have their Social Security benefits offset considerably—a fact they may not be aware of until they retire. Here’s a primer on who is affected,
how their benefits are reduced, and how it applies to spouses and
survivors.

In 1983 it came to the attention of Congress that some government employees
who had never paid into Social Security were retiring in their 40s or 50s with
large government pensions and then going to work in Social Security-covered jobs
and building earnings credits for substantial Social Security benefits.

Since Social Security is supposed to be a safety net that replaces only a
portion of a retiree’s income, it didn’t seem fair that a person could get a
large pension from non-Social Security-covered earnings and also receive a big
Social Security check. So in 1983 Congress passed the Windfall Elimination
Provision that takes away a portion of their Social Security benefit.

Clients affected

The Windfall Elimination Provision (WEP) affects anyone who has earned a
pension from working in a job where Social Security taxes were not withheld—such
as a state or local government agency, a nonprofit organization, or a position
in another country—and also worked in other jobs long enough to qualify for
Social Security retirement benefits. Teachers, firefighters, police officers,
and other civil service employees may be subject to the Windfall Elimination
Provision.

Many clients are not aware that when the time comes for them to collect
Social Security, their benefits could be lower than the amount shown on their
annual benefit estimate or computed by the online calculators. In other words,
the WEP reduction does not occur until people apply for benefits and the Social
Security Administration finds out that they are entitled to a pension. Then a
formula is applied to determine the WEP reduction. This can be a rude awakening
for clients who thought their retirement income plans were all set with a
certain amount of Social Security income.

Other clients may be aware of the Windfall Elimination Provision but not know
how it works. So let’s set the record straight.

When WEP applies

The first thing is to determine if a client is subject to the Windfall
Elimination Provision. There are two conditions:

1. The client is eligible for a monthly pension based on work where he did not
   pay Social Security taxes. State and local government agency jobs covered under
   the Civil Service Retirement System (CSRS) are the most common types of jobs
   where people accrue pensions without paying into Social Security. In contrast,
   federal jobs under the Federal Employees Retirement System (FERS) are covered by
   Social Security, so the WEP does not apply. In 1984, the federal government
   switched from CSRS to FERS. Employees hired in 1984 or later are covered under
   FERS and therefore are entitled to full Social Security benefits with no WEP
   reduction. Those hired before 1984 had a choice—if they stayed with CSRS, they
   may be subject to the WEP.
2. In addition to working long enough to qualify for a pension, the client had
   “substantial earnings” in a Social Security-covered job. These are shown in
   Table 1. It doesn’t matter in which order the work occurred. Whether a person
   worked as a police officer and then retired to the private sector, or worked in
   the private sector and retired to become a teacher, the effect is the same. If
   he or she had substantial earnings in any Social Security-covered job, the
   person may be subject to the Windfall Elimination Provision.

Table 1: Substantial Earnings in Social Security-Covered Job for WEP Test
Year	Substantial earnings	Year	Substantial earnings	Year	Substantial earnings
1937-50	$900	1981	$5,550	1995	$11,325
1951-54	$900	1982	$6,075	1996	$11,625
1955-58	$1,050	1983	$6,675	1997	$12,150
1966-67	$1,200	1984	$7,050	1998	$12,675
1968-71	$1,650	1985	$7,425	1999	$13,425
1972	$1,950	1986	$7,875	2000	$14,175
1973	$2,250	1987	$8,175	2001	$14,925
1974	$2,700	1988	$8,400	2002	$15,750
1975	$3,300	1989	$8,925	2003	$16,125
1976	$3,525	1990	$9,525	2004	$16,275
1977	$3,825	1991	$9,900	2005	$16,725
1978	$4,125	1992	$10,350	2006	$17,475
1979	$4,425	1993	$10,725	2007	$18,150
1980	$4,725	1994	$11,250	2008	$18,975

 

Calculating the reduction

The WEP reduction occurs in the calculation of the primary insurance amount,
or PIA. Social Security calculates a person’s PIA by first determining his or
her average indexed monthly earnings (AIME). They take each year’s actual Social
Security-covered earnings (not the earnings from the non-Social Security-covered
government job) and multiply it by an index factor to reflect wage growth over
the years. The highest 35 years of indexed earnings are totaled and divided by
420, which is the number of months in 35 years, to arrive at the average monthly
earnings. Let’s say a person’s AIME is $6,000.

Next, Social Security calculates the PIA by applying three different “bend
points” to the AIME. The bend points are adjusted each year for inflation. In
2008, the formula is:

• The first $711 of the AIME is multiplied by 90%.
• The amount between $711 and $4,288 ($3,577) is multiplied by 32%.
• The amount over $4,288 ($6,000 – $4,288 = $1,712, in this case) is multiplied
  by 15%.

So for a person with AIME of $6,000, the normal PIA—without the WEP
reduction—would be:

$711 x .90 = $639.90

$3,577 x .32 = $1,144.64

$1,712 x .15 = $256.80

• Total: $2,041.34

For people who are affected by the Windfall Elimination Provision, the first
bend point in the computation of the PIA is reduced from 90% to as little as
40%. So continuing with our example using $6,000 of AIME, the PIA for a person
subject to the maximum WEP reduction would be:

$711 x .40 = $284.40

$3,577 x .32 = $1,144.64

$1,712 x .15 = $256.80

• Total: $1,685.84

So the difference is:

• Without WEP reduction: $2,041.34
• With WEP reduction: $1,685.84
• Difference: $355.50

Because the WEP reduction affects the first $711 in earnings, anyone with
AIME of at least $711 who is subject to the maximum WEP reduction would see his
or her benefit reduced by $355.50. If a person’s AIME is only $711, the cut
turns out to be pretty severe. Going from $639.90 (90% of $711) to $284.40 (40%
of $711) is a much bigger drop (56%) than going from $2,041 to $1,685 (17%) for
a person with an AIME of $6,000.

Not everyone will have the first bend point reduced to 40%. The reduction may
be anywhere between 40% and 90%, depending on how long the person worked in the
Social Security-covered job. The longer he worked, the less the reduction will
be. After all, it is possible for a person to have worked for a relatively short
time in a civil service-covered job and be entitled to a small pension, and then
go on to work 30 years in a Social Security-covered job. In that case there
would be no WEP reduction.

Table 2: Number of Years of Substantial Social Security-Covered Earnings for WEP Test
Years	Percentage applied to 1st bend point in computing PIA
30 or more	90
29	85
28	80
27	75
26	70
25	65
24	60
23	55
22	50
21	45
20 or less	40

 

Key points

The Windfall Elimination Provision is explained in more detail on the Social Security
website, and there are calculators that
can help you estimate the reduction. Here are a few key points:

• Survivor benefits are exempt, but spousal benefits are not.
• There is a limit to the WEP reduction for people with very low pensions. The
  reduction cannot be more than one-half of the amount of the pension.
• Taking the government pension as a lump sum does not eliminate the WEP.
  Social Security will prorate it and calculate the WEP reduction as if the
  pension were received as a monthly annuity.
• Non-Social Security-covered earnings from military reserve service are exempt
  from the WEP. Here is a list of
  earnings that may or may not be covered by Social Security.

Government pension offset

The Government Pension Offset provision is similar to the WEP but affects
spouses and widows who qualify for their own pension in a non-Social
Security-covered job and also qualify for spousal or survivor benefits. In this
case, the spousal or survivor benefit will be reduced by two-thirds of the
amount of the pension. For example, if a spouse is entitled to a pension of $600
per month, two-thirds of that is $400. If she is entitled to a spousal benefit
of $500, it will be reduced by $400 to give her a spousal benefit of $100. As
with the WEP, if she takes her pension annuity in a lump sum, Social Security
will still calculate the reduction as if she had chosen to get monthly benefit
payments from the government work.

There seems to be some confusion between the Windfall Elimination Provision
and the Government Pension Offset. The thing to remember is that the WEP applies
if the worker has the pension from non-Social Security-covered earnings, while
the GPO applies if the spouse or survivor has the pension. If the worker has the
pension, the spouse’s benefits will be reduced under the WEP. However, if the
worker dies, the survivor benefit will be recalculated to remove the WEP
reduction. If the spouse or survivor has the pension, spousal or survivor
benefits will be reduced by two-thirds of the amount of the pension, as noted
above.