Windfall Elimination Provision (WEP): Why Your Social Security Benefits Could be Reduced?

Ken Weingarten |
Categories
Social Security

If you have worked for an employer where Social Security is not withheld, such as a government agency or an employer in another country, any retirement or disability pension you receive may could reduce your Social Security benefits. The Windfall Elimination Provision (WEP) was designed with the intention to prevent individuals from take advantage of both Social Security benefits AND non-Social Security taxed pensions (thus eliminating this “windfall”).

How The WEP Works

Before understanding how the WEP works, we should first understand how the Social Security Administration calculates your Full Retirement Age benefits (or Primary Insurance Amount (PIA)).

First, they calculate your Average Indexed Monthly Earnings (AIME) by taking your highest-earning 35 years of work history. Once this number has been determined, calculating the PIA can get a bit complex as a 4-tiered calculation is involved. Depending on your AIME, this figure is calculated by the following:

  1. The first $1,024 of AIME is multiplied by 90%
  2. The next level of AIME between $1,024 - $6,172 are multiplied by 32%.
  3. AIME above $6,172 is multiplied by 15%.
  4. The results of the first three calculations are added up which then determines your PIA.

For Example, if someone’s AIME were to be calculated as $6,500, then the PIA is calculated as follows:

  1. $1,024 x 90% = $921.60
  2. $6,172 – $1,024 = $5,148 x 32% = $1,647.36
  3. $6,500 - $6,172 = $328 x 15% = $49.20
  4. $921.60 + $1,647.36 + $49.20 = $2,618.16 - Primary Insurance Amount

Since this $2,618.16 will be the benefit received at Full Retirement Age, it can be lower or higher depending on when the filing application is submitted.

Where the WEP fits in is in the first calculation. The Social Security Administration has stated that if you have works for 30+ years, the 90% calculation will not be affected. Anything less than this will reduce this 90% by 5% to a minimum of 40%. The chart below breaks down what this percentage will be depending on your work history:

For example, if we were to use the same example above but an individual only had 20 years of work history, then the PIA would be the following:

  1. $1,024 x 40% = $409.60
  2. $6,172 – $1,024 = $5,148 x 32% = $1,647.36
  3. $6,500 - $6,172 = $328 x 15% = $49.20
  4. $409.60 + $1,647.36 + $49.20 = $2,106.16 - Primary Insurance Amount

This approx. $500/mo. ($6,000/yr.) difference is substantial over the course of one’s retirement. An obvious solution would be to work an additional 10 years to avoid this penalty but depending on one’s circumstances, it may not be an option.

Conclusion

On the surface, Social Security is a great way of supplementing retirement income. However, a peek behind the curtains reveals many intricacies involved that are overly complex. Having a fee-only financial advisor on your side to understand these mechanisms can help you navigate this area.

Weingarten Associates is an independent, fee-only Registered Investment Advisor in Lawrenceville, New Jersey serving Princeton, NJ as well as the Greater Mercer County/Bucks County region. We make a difference in the lives of our clients by providing them with exceptional financial planning, investment management, and tax advice.