To fund Social Security while working you and your employer pay a portion of your wages into the Social Security system. Social Security by nature is designed to replace a higher percentage of working income for low-wage earners than for high-wage earners.
If you worked for an employer who provides you a pension for years of work where you did not contribute to the Social Security system then based only on your Social Security covered earnings you may be a “low wage earner” and so the default provision would mean Social Security would replace a significant portion of your working income. In reality you may be a higher wage earner with earnings that were not covered under Social Security.
This situation began to be described as a “windfall”. A modified set of formulas was designed to prevent someone in this situation from receiving excess Social Security benefits[26].
This provision of Social Security often affects fire fighters, law enforcement employees, postal workers and educators who work for government agencies or municipalities that have their own pension system and do not participate in Social Security.
For example, it affects teachers in fourteen states: Alaska, California, Colorado, Connecticut, Illinois, Kentucky, Louisiana, Maine, Massachusetts, Minnesota, Missouri, Nevada, Ohio, and Texas[27].
If you answer yes to any of the following questions, this section may apply to you:
Did you work for a government agency (federal, state or local)?
Did you work for an employer in another country?
If yes to either question above, do you receive a pension from this government agency or employer in another country?
Note for Federal Employees
If you were a federal employee after 1956 and were covered under the Civil Service Retirement System (CSRS) this provision will affect you.
If you were a federal employee covered under the Federal Employees’ Retirement System) (FERS) where Social Security taxes are withheld, this provision will not affect you.
There are two different rules:
Windfall Elimination Provision (WEP) – If you receive a pension from work that was not subject to Social Security taxes WEP may reduce your own Social Security benefit, and may affect your dependents benefits that are based on your earning’s record (such as a spousal benefit).
Government Pension Offset (GPO) – If you receive a pension from work that was not subject to Social Security taxes then GPO may reduce the Social Security spousal benefit you receive (or benefit you receive as an ex-spouse), and may reduce the Widow/Widower’s benefit you receive.
If you qualify for a pension[28] based on work where you had earnings not covered under Social Security, and you also had years of work with earnings that were covered under Social Security and qualify for a Social Security benefit too, then the Windfall Elimination Provision (WEP) may reduce the amount of Social Security that you qualify for.
Your Social Security statement will not reflect the deduction that may apply under WEP rules. Many people are caught off guard expecting to receive both their pension from government or foreign employment, and their full Social Security benefit. Instead, they receive a reduced Social Security amount.
The amount of the reduction depends on how many years of work you had that were covered under Social Security, and how much you made. If you have 30 or more years of substantial earnings for work covered under Social Security WEP will not affect you.
If the Windfall Elimination Provision does apply to you, a modified formula is used to determine the amount of your benefits.
For example, without WEP, your Social Security benefits are calculated by taking what is called your Average Indexed Monthly Earnings (AIME).
Then your AIME is used to calculate your PIA (benefit amount you receive at your Full Retirement Age) as shown in the formula below. (2015 numbers used):
You take 90% of the first $826 of AIME
You take 32% of the next $4,980 of AIME
You take 15% of any amount over the $4,980[29]
You total those three numbers and add up to about what you would expect to get at your FRA.
If the Windfall Elimination Provision applies to you then a lower number is inserted to replace the “90%” that you see in the formula. The lower number to use is determined by how many years of work you have that were covered under the Social Security system.
In the Windfall Elimination Provision pamphlet[30] available on the Social Security website it shows you what number to insert into the formula based on how many years of covered work and earnings that you have had.
Let’s look at an example. Assume Bob is making about $45,000 a year at age 60. Over his lifetime his average indexed monthly earnings (AIME) are calculated to be $4,525.
90% of the first $826 is $743
32% of the next $4,980 is $1,183[31]
Those total to $1,926
Normally $1,926 would be Bob’s PIA, or the amount he would expect to receive at his FRA.
Bob has worked for the state for the past 15 years. He will have a state pension and during his state employment he has not contributed to the Social Security system. However, prior to working for the state Bob had 23 years in the private employment sector and did participate in Social Security.
Bob has 23 years of what are deemed to be substantial earnings’ years where he did participate in Social Security, and so in the formula the first bend point percentage is reduced from 90% to 55%.
55% of the first $826 is $454
32% of the next $4,980 is $1,183
Those total to $1,637
Because of the WEP reduction Bob should expect $1,637 at his FRA, not $1,926.
You can use Social Security’s online WEP calculator to figure out your own benefit reduction.
The reduction in benefits can be as high as one half of the pension you receive, but not more than that. For example, if your pension was $2,000 a month, you could see your Social Security benefits reduced by $1,000 a month, but not by $1,100 a month.
Only pensions for work not covered under Social Security count - so if you had two pensions and one was from an employer where earnings were covered under Social Security that pension eligibility would not affect your Social Security benefits.
The WEP section of the Social Security website provides an excellent description of how this provision works and describes how the reduction formula works.
I say excellent because it explains the provision in language that you can actually understand. If you think WEP applies to you, I suggest you go online and read it.
If WEP does apply to you you’ll need to use your reduced Social Security amounts to build your plan and to decide on a claiming strategy.
How does the Windfall Elimination Provision affect benefits for your dependents?
The Windfall Elimination Provision changes your primary insurance amount (PIA) as shown in the prior calculation. Dependent benefits are calculated using your PIA as a starting place. If the Windfall Elimination Provision affects your benefits it will also affect dependents’ benefits that are calculated based on your record, however it will not affect a widow/widowers benefit that your spouse may receive after your death. The widow/widower’s benefit is recalculated without WEP upon your death.
Dependents can also be affected if the dependent receives their own pension from work not covered under Social Security. This is covered under a separate rule called the Government Pension Offset.
The Government Pension Offset (GPO) affects the benefit you might receive as a spouse, ex-spouse or widow/widower.
Same as the Windfall Elimination Provision, GPO applies if you receive a pension for years of work where you received earnings that were not subject to Social Security payroll taxes (also called OASDI “old age survivors and disability insurance”- the official name for Social Security).
If you are subject to the GPO rules your spousal or widow/widowers benefit will be reduced by two-thirds of the amount of your pension.
For example, if you will receive a pension of $900 a month that is from years of work that were not covered under Social Security then two-thirds of this amount (or $600) will be deducted from the spousal or widow/widower benefit that you would have otherwise received. If you were also eligible for a $1,600 widow/widower benefit, in this situation your widow/widower benefit would be $1,000 instead of the $1,600.
You can learn more on the Government Pension Offset page of the Social Security website.
If you are married and one of you is subject to GPO, you will need to factor this in before developing your own claiming plan. Assuming your spouse would be eligible for a full spousal or widow benefit would be incorrect if that spouse is subject to GPO.
If either WEP or GPO applies I would recommend using software that applies the relevant reduction factors and then calculates claiming choices for you.