Edward A. Zurndorfer
Social Security retirement benefits have been paid to eligible individuals for about 80 years. The Social Security program, created during the Franklin Roosevelt Administration’s New Deal program of the 1930’s, was and remains one of the most significant programs to protect Americans from the hazards and vicissitudes of life, offering social insurance through retirement income for individuals over age 65.
It is important to note that Social Security benefits were not initially available for state or local government employees because the public institutions they worked for often managed their own retirement (pension) programs for their employees. Keep In mind, that federal employees from the 1930’s to the early 1980’s were covered exclusively by the Civil Service Retirement System (CSRS) in which they receive a guaranteed pension (a CSRS annuity) upon retiring from federal service. They (and any current federal employees under CSRS) did not pay into the Social Security system. But federal, state and local employees could pay into the Social Security system by working in private industry employment before, during or after their federal employment. Members of the Uniformed Services have been covered by and have paid into the Social Security system since January 1, 1957.
The original Social Security retirement benefit formula did not account for government workers who had retirement income from both their pension plans (“non-covered” employees) including the federal government, state and local governments, and Social Security benefits through employers who did pay into Social Security. This is problematic because the manner in which Social Security retirement benefits are calculated by the Social Security Administration is to provide higher replacement (of pre-retirement salary/wage income)) rates for lower income workers. But the Social Security benefits calculation cannot distinguish between those individuals who actually had a lifetime of low income and those individuals who had lifetime earnings but whose income for “non-covered” jobs (such as federal employees covered by CSRS) was excluded from the Social Security benefit calculation. Accordingly, Congress felt those individuals eligible for both Social Security benefits and a non-covered guaranteed government pension (such as a CSRS annuity) were being awarded a higher Social Security benefits replacement rate than they should have been. Therefore, in 1983 Congress established the Windfall Elimination Provision (WEP) to adjust the Social Security benefit more fairly for these so-called “non-covered” employees who appeared, based only on their Social Security -covered earnings, to be “lower-income” than they had been during their working years.
While the number of individuals in The U.S. who are subject to the WEP (including CSRS annuitants and some CSRS -Offset annuitants) is small, it is becoming more common for financial advisors to have clients who are affected by the WEP as a greater number of public sector (federal, state and local government) employees who started their careers in non-covered Social Security employment are now retiring.
How the WEP Works
Before discussing the details of how the WEP works, it is important to briefly review how Social Security benefits are calculated.
Normally, when Social Security benefits are calculated, an individual’s Social Security earnings (salary/wages or self-employment net income) are indexed to the “average wage level” two years prior to the year of first eligibility. This is age 60 for an individual who first becomes eligible for Social Security retirement benefits at age 62. For years thereafter, annual income is factored into the earnings history at their actual amount (“Social Security Wages” which appears in Box 3 of an individual’s annual W-2 form). The sum of the highest 35 years of Social Security earnings are then divided by (12 months/year times 35 years) or 420. The result is the inflation-adjusted Average Indexed Monthly Earnings (AIME). The AIME is then applied to a formula using replacement rate multiple factors that calculates the individual’s Primary Insurance Amount (PIA). The PIA is defined as an individual’s Social Security monthly retirement benefit at the individual’s full retirement age (FRA). FRA is between age 65 and age 67 and depends on an individual’s year of birth.
The following examples will illustrate the quirks associated with the AIME when years of covered Social Security employment is mixed with years of non-covered Social Security employment.
Example 1. Thomas started his professional career and worked for about five years as a high-school English teacher, but in his late 30’s switched careers to a much higher paying job as a lawyer and worked part-time during his last three years of employment. Thomas’ average inflation-adjusted earnings over his entire lifetime was $4,837. After taking the average of the highest years of Social Security-indexed earnings, Thomas’ AIME is $5,368.
Example 2. Paul worked a similar career as Thomas and had similar earnings. But Paul worked as a teacher in a public school system. He therefore did not pay into Social Security municipal during the first 20 years of his working career and earned a municipal guaranteed pension. After 20 years as a teacher, he switched toa higher-paying private sector job and began to pay into Social Security. While Paul’s average lifetime earnings of $4,837 is the same as Thomas’, given Paul’s 20 years of non-covered employment, Paul’s AIME is only $3,860.
Example 3. Janet worked throughout her 35-year working career in lower-income jobs, working many years as a retail clerk until she worked her way up as a department store manager. Her average lifetime salary was $3,242 and her AIME is $3,860, the same as Paul’s, despite the fact that Paul earned far less in actual income.
Since Paul’s non-covered earnings were excluded in determining his AIME, his roughly 20 years of covered Social Security employment resulted in the same AIME as that for Janet, which was calculated based on Janet’s 35 years of covered Social Security employment.
The specific formula to determine the PIA depends on the individual’s year of retirement and consists of three ranges of AIME levels, separated by two threshold values called “bend points”. They are called “bend pints” because they “bend” the replacement rate.
The effect of these three “tiers” is that they provide low-income workers with a 90 percent replacement rate, middle-income workers with a 32 percent replacement rate, and high-income earners with a 15 percent replacement rate.
For workers retiring in 2021, the regular Social Security PIA is calculated from the formula as follows (showing 2021 bend points of $996 and $6,002).
Primary Insurance Amount (PIA) Calculation 2021
|Up to $996||x 90%||= ________ +|
|$997 – $6,002||x 32%||= ________ +|
|Over $6,002||x 15%||= ________ +|
Example. From Example 1 above, Thomas will retire in 2021. He has an AIME of $5,368 and his PIA is calculated as follows:
Thomas’ PIA Calculation
|$996||x 90%||= $896.40 +|
|$4,372||x 32%||= $1,399.04 +|
|$0||x 15%||= $0 +|
|AIME = $5,368||= $2,295.44|
How the WEP Adjusts Social Security Benefits Based on Years of Substantial Service
The WEP compensates for an individual worker with “non-covered” earnings (covered by a pension in which they did not pay into Social Security, such as a CSRS annuitant) that results in the individual worker receiving a reduced AIME. The manner in which the WEP compensates is through a reduction in the replacement rate in the benefit formula, resulting in a lower PIA.
The alternate formula for the Windfall Elimination Provision is identical to the regular formula, with one small difference. The 90 percent crediting factor applied to the first tier of AIME is reduced by a WEP penalty factor that is determined by the number of “years of substantial service”. For an individual with 20 years or less of substantial earnings, the full penalty applies, and the 90 percent crediting factor is applied with a 40 percent multiplier. This means that for 2021, the maximum WEP reduction that can be made is:
(90% x $996) less (40% x $996) = $498 per month
Example. Paul (introduced in Example 2 above) had the exact average earnings as Thomas, in Example 1, but starting his working career with 20 years of non-covered employment. He spent the last 20 years of his career with a covered employer. Therefore, Paul’s AIME, ($3,860) was much lower than Thomas’ AIME ($5,368).
Since Paul had only 20 years of covered Social Security employment, the first $996 of his AIME is multiplied by the WEP-adjusted multiplier of 40% instead of the 90% used when no WEP adjustment is required. The following is Paul’s PIA calculation for 2021 when he retires:
|$996||x 40%||= $398.40 +|
|$3,860 – $996||x 32%||= $916.48 +|
|$0||x 15%||= $0 +|
|AIME = $3,860||= $1,314.88|
Note that without the WEP Paul’s PIA would have been $1,314.88 + $498 = $1,812.88.
Paul is losing $498 per month or approximately $6,000 per year as a result of the WEP. It needs to be emphasized that the WEP reduces an individual’s Social Security benefit. It does not eliminate an individual’s Social Security benefit
Each year the Social Security Administration defines what constitutes a year of “substantial” Social Security-covered earnings for that year. Table 1 illustrates for the years 1989 – 2020 what constitutes “substantial” earnings.
Table 1. “Substantial” Social Security earnings by year, as defined by the Social Security Administration*
|Year||“Substantial” earnings||Year||“Substantial” earnings|
|1994||11,250||2009 – 2011||$19,800|
How does an individual who is receiving a public pension such as a CSRS annuity, in which the individual did not pay into Social Security, determine how the WEP will affect his or her Social Security benefits? The first step is to figure out how many years of “substantial earnings” they have under Social Security. To do so, they must look at their Social Security statement, obtainable online here, and look at the amount of their “Social Security wages” they have earned through the years in Social Security-covered employment. This information has been sent to the SSA each year on behalf of the individual by the individual’s employer via the W-2 form (Box 3 – “Social Security wages”). Here is an example:
Norman, age 62, retired from federal service in 2018 as a CSRS employee with 40 years of service. During the period 1989 – 2014, Norman worked a second job. His reported Social Security earnings during his working career are summarized in the following table:
|Year||Norman’s Social Security Wages (W-2, Box 3)||“Substantial” Earnings (per Table 1)||Count as a “Substantial” Year?|
Table 2 below shows the percentage used to multiply the first “bend point” depending on the number of years of “substantial” earnings. If one has 21 to 29 years of “substantial” earnings, the 90 percent figure is reduced to between 45 and 85 percent. If one has 20 or less substantial years of earnings, 40 percent is used to multiply the first “bend” point.
Table 2. Percentage used to multiply the first “bend point” *
|Years of “Substantial” Earnings||Percentage|
|30 or more||90 percent|
|20 or less||40 percent|
Returning to the example above with Norman’s 18 years of “substantial” Social Security earnings: If Norman’s AIME is $2,000, then the formula to compute Norman’s PIA in 2020 would be:
(0.40 x $960) + [0.32 x ($2,000 – $960)] =$716.80
Note that if Norman were covered by a public pension plan in which he also paid into Social Security (such as FERS), he would not be affected by the WEP. Norman’s formula to compute his Social Security benefit would then be:
(0.90 x $960) + [0.32 x ($2,000 – $960)] = $1,196.80
The difference is $1,196.80 less $716.80, or $480.
SSA has a chart on its Web site that presents the maximum amount an affected individual’s Social Security benefit could be reduced as a result of the WEP, based on the individual’s number of years of “substantial” earnings and the year the individual becomes age 62. The chart may be found here.
Other Items Regarding the WEP That Should Be Noted
- The WEP reduction applies to the Social Security retirement benefit of the individual affected by the WEP and to any family members (spouse, children, a parent) who are also receiving a family benefit based on the affected individual’s Social Security earnings record.
- The WEP reduction does not apply to the Social Security benefit of an individual who continues to work for the government in which the individual will receive a public pension once he or she retires but did not pay into Social Security while working for that government. The following example illustrates:
- Nancy, age 69, is a CSRS-covered employee with 38 years of federal service under CSRS. Nancy worked in several private industry jobs that allowed her to accumulate 15 years of Social Security-covered employment. She is “fully insured” with respect to Social Security retirement benefits and has elected to start receiving her Social Security monthly benefit of $650 per month. The $650 per month is not subject to any WEP reduction because Nancy is still working in federal service. But once Nancy retires from federal service, she will be subject to the WEP and lose 50 percent of $816, or $408, resulting in an adjusted WEP-based monthly benefit of $650 less $408, or $242 per month.
- A Social Security survivor benefit is not subject to the WEP. The WEP reduction ends upon the death of the individual upon whom the survivor benefit is based and who is subject to the WEP. The following example illustrates:
- Same facts as above with Nancy. Nancy is married to Allan, also age 69. While Nancy is a CSRS employee and receiving her monthly Social Security benefit of $650 per month, Allan (not a federal employee) is eligible for half of Nancy’s benefit of $650, or $325 per month. If Nancy were to refire from federal service and therefore her Social Security benefit would be subject to the full WEP, resulting in a monthly benefit of $242 (see above), then Allan’s spousal Social Security benefit, 50 percent of Nancy’s, would be reduced 50 percent of $242, or $121 per month. If Nancy were to predecease Allan, then Allan would be eligible to receive the full widower Social Security benefit of $650 (no reduction for WEP).
- The “WEP guarantee” rule. The one exception to the alternate formula is the “WEP guarantee” rule which protects the benefit of an individual with some non-covered Social Security employment. The logic behind the “WEP guarantee” rule is that a small amount of non-covered Social Security employment that did not generate much of a pension in the first place should not materially impair a near lifetime of Social Security-covered employment. Under the “WEP guarantee” rule, an individual’s Social Security benefit cannot be reduced by more than half the amount of their non-covered pension, regardless of the WEP calculation amounts. The following example illustrates:
- Morris will become age 62 in September 2021. He was a federal employee between 1983 and 1989, leaving federal service in 1989 after six years under CSRS. Upon leaving Federal service, Morris did not withdraw his CSS contributions and is therefore eligible for a deferred CSRS annuity, starting in September 2021 when Morris becomes age 62. His calculated CSRS annuity starting in October 2021 will be $3,600 annually, or $300 per month. From 1989 through 2020, Morris has worked in covered Social Security employment and current PIA is $3,000 per month. Under WEP “guarantee rule”, the maximum WEP reduction to Morris’ Social Security will be 50 percent of $300 or $250 per month. This is regardless of the WEP calculation amounts.
- It is important that when looking at one’s Social Security benefit statement (individuals can look at their statements at any time by setting up their own Social Security account here), that the monthly benefits shown for various ages (at age 62, full retirement age and at age 70, as well as family and survivor benefits) are determined using the full 90% replacement rate for the first tier, not the reduced rate which ca be as low as 40%. This is because the Social Security Administration (who calculates the benefits) is not aware of which years, if any, include non-covered Social Security wage earnings..
- In most years, Social Security recipients receive a cost-of-living adjustment (COLAs) that results in a Social Security recipient’s monthly benefit for that year. But the COLA is not applied to the WEP. Once the WEP is determined, it is not adjusted by any COLA.
- Depending on when (what age) an individual affected by the WEP files for Social Security benefits early (before full retirement age or FRA) or filing late (after FRA until age 70) can affect the dollar difference between a WEP affected monthly benefit and a non-WEP affected monthly benefit. The WEP reduces the benefit amount before it is adjusted for early or delayed retirement credits. It is the WEP-reduced benefit that becomes the new WEP-adjusted PIA, and that PIA is then adjusted according to the filing age. The following example illustrates:
- Sharon is a CSRS annuitant and has a full retirement of age 66. Sharon is entitled to a Social Security monthly benefit of $1,463 (subject to the WEP). Sharon has 20 years of “substantial” Social Security earnings, so that the maximum WEP penalty (for 2021) of 50% of $996, or $498, is applied to Sharon’s Social Security monthly benefit reducing her PIA to $1,463 – $498, or to $965.
What would be the reduction to Sharon’s benefit if she applied for her Social Security benefit early, like age 62? Her benefit would be reduced for the WEP first, and then reduced based on her filing age.
Sharon’s WEP-reduced net benefit (early retirement)
|Full retirement age benefit|
Benefit after WEP Penalty
Reduction (25 percent) for filing 48 months early
Benefit after WEP penalty and filing age adjustment
How would Sharon’s benefit be affected if she decided to start receiving her Social Security benefit at age 70 (the maximum increase of 32 percent). Her total benefit reduced by the WEP rule and adjusted for her delayed retirement is calculated as follows:
Sharon’s WEP-reduced net benefit (delayed retirement)
| $1,463 |
|Full retirement age benefit|
Benefit after WEP penalty
Increase (32 percent) for filing 48 months later
Benefit after WEP penalty and filing age adjustment
The following chart summarizes Sharon’s Social Security retirement benefits as a result of the WEP penalty and the age she decides to start receiving her benefit.
Sharon’s starting monthly Social Security (net) benefit
|Filing Age||No WEP Penalty (1)||With WEP Penalty (2)||Difference of No WEP/With WEP (1-2)|
The effect of decreasing the full retirement age benefit with the WEP penalty before age-based increases or reductions are applied means that slightly different calculations must be used when figuring benefits at different ages. Note that the longer an individual delays the start of his or her WEP-affected Social Security monthly benefit, the larger the difference between no-WEP penalty affected monthly benefit and the WEP-affected monthly benefit.
Reducing the WEP Penalty
The most obvious way to mitigate or reduce the WEP penalty is to accumulate additional years of “substantial” earnings. The WEP penalty starts to decrease when an affected individual has 21 years of substantial earnings (see Table 2 above) and goes away completely with 30 years of “substantial” earnings. Even working part time and earning the minimum required in a particular year in order to count that year as a “substantial” year of earnings will go a long way to reducing and perhaps eliminating the WEP penalty. Note that the Social Security Administration at the beginning of each year lists on its web site what is considered “substantial” earnings for that year (see Table 1 above). An individual would have to earn just that minimum amount in order to count that year as a “substantial” year of earning. For example, during 2021 earning $26,550 through a salary or through net-self-employment income will count the year 2021 as a “substantial” year.
Finally, Congressman Richard Neal reintroduced legislation on April 6, 2021 to reform the WEP. If passed, the Public Servants Protection and Fairness Act of 2021 (H.R. 2337) would establish “a new, fairer formula that will pay Social Security benefits in proportional to the share of a worker’s earnings that was covered for Social Security purposes.
Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While the employees of Serving Those, Who Serve are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.