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An Economist Takes on the Social Security Earnings Test
What is the impact on older adults? Millions of dollars, he says.
Social Security's Earnings Test tops my list for our government's most senseless and personally financially destructive policy. The Earnings Test is a massive tax that isn't. It's a tax that's levied and then secretly returned making no money on balance for the government (as measured on an actuarial present value basis). Its sole purpose is to con Social Security beneficiaries below age 67 into thinking that earning money beyond a di minimis amount will come at a huge loss in current net income as well as lifetime benefits.
Working and Getting Social Security at the Same Time
You can work and still get Social Security benefits. If you are at full retirement age or older, you may keep all your benefits no matter how much you earn ... If you are younger than full retirement age at any time in 2023, there is a limit to how much you can earn before we reduce your benefits ...
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The 2023 earnings limit for people under full retirement age all year is $21,240. We deduct $1 from your benefits in 2023 for each $2 you earn over $21,240.
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The 2023 earnings limit for people reaching full retirement age in $56,520. We deduct $1 from your benefits in 2023 for each $3 you earn over $56,520 until the month you reach full retirement age.
An Outdated ARF Formula
That's the entire description. There is no mention that benefits lost to the Earnings Test are fully restored at full retirement age (FRA) in the form of an inflation-adjusted, permanently higher benefit level. This tax rebate is called the Adjustment of the Reduction Factor (ARF). This rebate is meant to leave those hit by the Earnings Test with the same average lifetime benefits calculated on an actuarial present value basis. Actually, the ARF overcompensates for the tax. Why? Because the ARF formula was established years ago when mortality and interest rates were higher.
The ARF formula was established years ago when mortality and interest rates were higher.
The ARF's title is arcane. That's no accident. It was chosen to keep beneficiaries from learning that the Earnings Test tax, paid in the form of reduced benefits received, would be rebated. The term "benefit reduction" is, itself, tricky. If you take any of Social Security's benefits early — before your full retirement age — they are reduced in light of the fact that you'll receive more payments over the rest of your life than if you wait.
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But the Earnings Test's "reduced benefits" represent an additional reduction that kicks in if you not only take benefits early, but earn, prior to full retirement age, more than the Earnings Test's relevant threshold. Indeed, the Earnings Test's benefit reduction can be large enough to wipe out all benefits you'd otherwise receive in the years prior to reaching full retirement age. Those lost benefits would be lost for good were it not for the ARF.
Why is Social Security Maintaining Its Con Job?
The Earnings Test and ARF were part of Social Security's original design. The ostensible goal of the Earnings Test was to keep able-bodied people from taking benefits. i.e., Those who can work don't need to collect!
For early beneficiaries aware of the ARF as well as the Earnings Test, the policy comes down to reducing such beneficiaries' short-term cash flows.
But the system's architects didn't want to lower lifetime benefits of working beneficiaries. To prevent this outcome, they included the ARF. But in combination, the two provisions simply change the timing — the cash flows — of a working beneficiary's net benefits, giving them lower (if not zero) benefits before FRA and higher benefits thereafter.
Hence, for early beneficiaries aware of the ARF as well as the Earnings Test, the policy comes down to reducing such beneficiaries' short-term cash flows. But ARF-aware early beneficiaries who go back to work aren't likely to be severely cash-flow constrained since they are earning money. Hence, the policy devolved into lying by omission — intentionally not informing early beneficiaries about the ARF. Ostensibly, this would dissuade most abled-bodied older adults who could work from taking benefits.
As for those who took benefits anyway, "Well, too bad if they were dissuaded from working. They are trying to collect benefits when they can still earn money. Shame on them. Let's make earning more than peanuts appear worthless and con them into not working. But if they work anyway, they must be desperate, so let's secretly compensate them for lost benefits."
Those who know the precise twisted logic underlying the con job's origination are long dead. But by imposing and maintaining the con for decades, Social Security's has led tens of millions of early beneficiaries to falsely believe that earning more than a pittance is a fool's errand.
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