If you are a social security beneficiary under full retirement age (currently age 66), an earnings test determines whether your social security retirement benefits will be reduced because you earned more from a job or business than an annual exempt amount (discussed below). A different earnings test applies to individuals entitled to disability benefits.

As a general rule, the earnings test is based on income earned during the year as a whole, without regard to the amount you earned each month. However, in the first year you receive benefits, they are not reduced for any month in which you earn less than one-twelfth of the annual exempt amount.

One of the provisions of the Senior Citizens' Freedom to Work Act is that the social security retirement earnings test is eliminated in the calendar year in which you reach your full benefit retirement age for the month of, and months after, such attainment. In other words, once you reach your full benefit retirement age, there is no longer an earnings test to reduce your social security retirement benefits. However, the earnings test still applies for the years and months before the month you reach your full benefit retirement age.

Social security beneficiaries under the full benefit retirement age who have earnings in excess of the annual exempt amount are subject to a $1 reduction in benefits for each $2 earned over the exempt amount ($14,160 in 2009) for each year before the year during which they reach the full benefit retirement age (see the example in the next column). However, in the year beneficiaries reach their full benefit retirement age, earnings above a different annual exempt amount ($37,680 in 2009) are subject to a $1 reduction in benefits for each $3 earned over the exempt amount. Social security benefits are not affected by earned income beginning with the month the beneficiary reaches full benefit retirement age.

You would use the first exempt amount ($14,160 for 2009) from the year you reach age 62 through the year before the year you reach your full benefit retirement age. The second exempt amount ($37,680 in 2009) is used in the year you reach your full benefit retirement age. (However, social security benefits are not affected by earned income beginning with the month you reach your full benefit retirement age.)

Example: Applying the annual earnings test.

Linda retired in 2008 at age 63. In 2009, her social security retirement benefits are $1,200 per month, so she expects to receive benefits totaling $14,400 during the year. Linda's employer asks her to come back to work for four months during 2009 at a salary of $6,000 per month (a total of $24,000) and Linda accepts. Since she received $9,840 over the exempt amount ($24,000 - $14,160), her benefits are reduced by half that amount, or $4,920. Therefore, she will receive only $9,480 in social security benefits in 2009 ($14,400 - $4,920). The fact she worked only four months during the year is inconsequential. The results would be the same if Linda was self-employed, rather than an employee.

As you plan your retirement, be mindful that, as the example shows, working during retirement may reduce your social security benefits. This, in turn, could have a negative impact on your financial plans.

Please call us if you have questions on the taxability of social security benefits or any other tax planning or compliance issue.