In a recent letter to the editor of Tax Notes Federal, we addressed a widespread misperception about Social Security that prevents workers from making sound decisions about their retirement. Many recipients mistakenly view the Social Security earnings test as a tax on their wages, which may discourage them from continuing to work. Although many financial advisers and the Social Security Administration (SSA) are providing better information about the earnings test than they have in the past, more should be done to correct this misperception. Ultimately, the best way to dispel the confusion about the earnings test would be for Congress to repeal the provision entirely.
While Social Security recipients can claim retirement benefits as early as age 62, they have the option to delay claiming them up to age 70 in exchange for higher monthly benefits. Extensive research—including some studies by one of us—has shown that, due to the increase in future benefits, delaying claiming increases total lifetime benefits for many recipients.
A provision known as the earnings test applies to Social Security recipients who work between age 62 and an age that Congress has designated as the full retirement age (between 66 and 67, depending on the recipient’s birth year). In 2021, the earnings test generally withholds one dollar of benefits for every two dollars of labor earnings above $18,960, although the rules are more lenient in the year that the recipient reaches the full retirement age. The earnings test does not apply after the recipient reaches the full retirement age.
The earnings test appears to impose a severe penalty on Social Security recipients who continue to work by adding a 50% tax to the other taxes they already face on their wages. However, the reality is quite different. Recipients whose benefits are withheld due to the earnings test are compensated with higher future monthly benefits, in the same manner as those who delay claiming benefits. In effect, the earnings test requires recipients who work to defer their benefits on the same (often attractive) terms available to individuals who voluntarily delay claiming. Therefore, being hit with the earnings test need not lower lifetime benefits—indeed, it likely increases lifetime benefits for many recipients.
In 2008, our American Enterprise Institute colleague Andrew Biggs observed that many financial advisers inaccurately described the earnings test by telling readers about the initial benefit reduction but not the future benefit increases. Social Security beneficiaries exposed to this misinformation would be likely to conclude—incorrectly—that the earnings test is a tax on work. Indeed, two statistical studies, published in 2000 and 2007, found that people who were subject to the earnings test reduced their labor supply, treating it as though it were a tax on earnings.
The misinformation appears to be less rampant today. Our recent online search suggests that the majority of financial advisers who discuss the earnings test do mention the increase in benefits. Nevertheless, some advisers continue to overlook the future benefit increase and incorrectly frame the earnings test as a severe tax on work. And public misperception of the earnings test remains widespread. According to a 2015 survey conducted by AARP, the majority of people who understand that the earnings test reduced benefits incorrectly believe that those benefits are permanently lost.
The SSA, which administers the program, should do more to combat this misperception. In the FAQs on its main page about retirement benefits, the agency’s answer to the question, “What happens if I work and get Social Security retirement benefits?” mentions the initial benefit reduction, but not the compensating increase in future benefits.
On a more encouraging note, an SSA publication, titled “When to Start Receiving Retirement Benefits,” provides a good explanation of the earnings test, clearly stating:
“This doesn’t mean you must try to limit your earnings. If we withhold some of your benefits because you continue to work, we’ll pay you a higher monthly benefit when you reach your full retirement age. So, if you work and earn more than the exempt amount, it won’t, on average, decrease the total value of your lifetime benefits from Social Security—and can increase them.”
The SSA publication “How Work Affects Your Benefits” provides a similarly clear explanation. However, it would be better if SSA highlighted the correct information in its FAQs, which is likely to be the first place an individual approaching retirement would look.
As one of us recently pointed out on Bloomberg Tax, Congress should repeal the earnings test, which discourages work like a tax but does not raise net revenue.
Until repeal happens, recipients need accurate information about the earnings test. Financial advisers should prominently describe the compensating increase in future benefits, and the SSA should revise its FAQ page on work and benefits to highlight that information.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Sita Nataraj Slavov is a visiting scholar at the American Enterprise Institute, where she specializes in public finance and the economics of aging (including older people’s work and retirement decisions, Social Security, and tax policy). She is concurrently a professor of public policy at the Schar School of Policy and Government at George Mason University.
Alan D. Viard is a resident scholar at the American Enterprise Institute.
Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.