How the Windfall Elimination Provision can impact your clients’ Social Security benefits.
Many advisors assist clients who worked as public employees in jobs not covered by Social Security. However, such public employees or their spouses may also be entitled to Social Security benefits earned in jobs that are covered by Social Security. In talking with these clients, the advisor should be aware of Social Security rules that may cause many to have reduced Social Security benefits. The two rules affecting these clients are the Windfall Elimination Provision (WEP) and the Government Pension Offset (GPO).
This article covers the WEP; a follow-up article will detail the GPO.
Who Does WEP Affect?
WEP affects people who:
- Worked for a state or local government or a public agency in non-Social Security covered employment, and
- Are entitled to a government pension from that employment, and
- Are also entitled to a Social Security benefit from Social Security-covered employment.
Exceptions to WEP include:
- Federal workers first hired after December 31, 1983
- Workers employed on December 31, 1983, by a nonprofit organization that did not withhold Social Security taxes from pay prior to that date but then began withholding Social Security taxes from pay after December 31, 1983
- Workers for whom the only pension is based on railroad employment
- Workers for whom the only non-Social Security work was before 1957
- Workers with 30 or more years of substantial earnings under Social Security (workers having more than 20, but less than 30, get a partial exemption)
WEP does not apply to survivor benefits. However, benefits may be reduced for widows or widowers because of the Government Pension Offset (GPO), addressed in a follow-up article. When Congress passed the Social Security Act in 1935, it excluded federal, state, and local government employees from mandatory coverage. The exclusion for state and local public employees was based on constitutional concerns about whether the federal government could impose taxes on state governments. Many of these entities established their own pension plans intended to operate separately from Social Security.
In the early 1950s, Congress passed a law that allowed state and local government employees to be covered if they voluntarily chose coverage in a referendum. While many small and large government agencies did not accept Social Security coverage, over the years a high percentage of all state and local public employees have opted to join the Social Security system. In 1983, sweeping changes altered the Social Security landscape following the recommendations of a presidential commission. All federal employees hired after December 31, 1983, were included in Social Security, as were members of Congress, the president, and the vice president. State and local government employees were forbidden to terminate Social Security coverage after April 20, 1983. So today, railroad workers, a diminishing number of older federal government employees, and an estimated 30 percent of state and local public employees are the only large groups of workers in the United States not covered by Social Security.
Currently, 14 states have state or local government or public agency retirement plans not covered by Social Security: Alaska, California, Colorado, Connecticut, Illinois, Kentucky, Louisiana, Maine, Massachusetts, Minnesota, Missouri, Nevada, Ohio, and Texas.
Why Does the WEP Exist?
The Social Security Administration (SSA) uses a formula for computing Social Security benefits that provides individuals with low average lifetime wages a proportionally higher rate of return on their contributions to Social Security than individuals with relatively high average lifetime wages. Workers who have spent most of their careers in non-SS-covered employment with a state or local government – where they earned no Social Security wages – and a minimal amount of time in SS-covered employment appear to the SSA as lower-paid workers.
Congress enacted the WEP in the belief that one should not receive a Social Security benefit as a low-paid worker, plus receive a government pension from non-SS-covered employment.
How Does the WEP Work?
One of the public policy goals built into the Social Security system is to raise the standard of living of lower-income workers in retirement. This is accomplished through a benefit formula designed to give lower-paid workers a better deal than their more highly paid counterparts. Very low-paid workers could get a Social Security retirement benefit that represents up to 90 percent of their average lifetime earnings. Those with average incomes (the middle class) generally get a 40 percent replacement rate. Those with higher incomes get a rate of approximately 30 percent.
The theory behind the WEP is that government employees can generally be classified as having average incomes, so they should receive the same Social Security replacement rate paid to all middle-class workers. For public employees the desired effect is to eliminate the Social Security windfall paid to middle-class public employees usually intended for lower-class workers (thus the name windfall elimination provision).
Fortunately, there is a limit on the amount of WEP reduction: one-half of the pension. For example, if the pension (calculated without WEP) was $2,000 a month, then the Social Security benefits could be reduced by up to $1,000 a month.
Example: Bill is a public school teacher nearing retirement. He’s been a teacher all his working life, but in addition to teaching, he operated his own business after school hours, during school vacations, and during the summers. Bill’s school was part of a Public Employees Retirement System (PERS), so no Social Security taxes were paid on his teacher’s pay by either him or his employer. Bob did pay himself a salary out of his business, and both he and the business paid Social Security taxes on that. At retirement Bill will receive his school pension and Social Security. His Social Security benefit calculated without the WEP reduction would be $1,000, but because of the WEP rules, his Social Security benefit may be reduced by as much as $500 a month.
Where Can a Client Find More Information about the WEP?
The SSA has an interactive website with an online calculator and a PDF explanation of the Windfall Elimination Provision.
Lawrence J. Owens, JD, CLU, ChFC, MBA, FLMI
Director Midwest Region
Advanced Underwriting Consultants
Email: [email protected]