Most advisers know that if their clients continue to work while collecting Social Security benefits before full retirement age, their benefits may be reduced if their earnings exceed an annual limit.
In 2014, retirees who are younger than full retirement age (66 for anyone born from 1943 through 1954) lose $1 in benefits for every $2 they earn over $15,480. The earnings test is more lenient in the months leading up to a retiree's 66th birthday and completely disappears once the person reaches full retirement age. Those turning 66 this year will lose $1 in benefits for every $3 earned above $41,400 until their birthday.
But what happens if your client retires and subsequently receives payments from a former employer in the form of severance pay, unused vacation days, accumulated sick leave or commissions?
In most cases, such payments are considered “special payments” and will not affect Social Security benefits.
(See also: For (almost) every rule there are exceptions)
“If you worked for wages, income received after retirement counts as a special payment if the last thing you did to earn the payment was completed before you stopped working,” according to the Social Security fact sheet, Special Payments after Retirement.
“Some special payments to employees include bonuses, accumulated vacation or sick pay, severance pay, back pay, standby pay, sales commission and retirement payments or deferred compensation reported on a W-2 form for one year, but earned in a previous year,” according to the fact sheet.
For example, assume your client retired at 62 in November 2013 and began to receive Social Security benefits. In January 2014, he received a check from his employer for $17,000 for his leftover vacation time. Because the vacation pay was accumulated before he retired, Social Security will consider it a special payment and will not count it toward the earnings limit for 2014.
For self-employed individuals, any net income received after the first year of retirement counts as a special payment if the individual performed “substantial services in self-employment” to earn the payment before he or she was entitled to receive Social Security benefits.
Special rules apply to insurance salespeople who continue to receive commissions for policies they sold prior to retirement. This income will not affect their Social Security benefits as long as the income was the result of work done before they retired.
If your client receives income after retirement that qualifies as a special payment, he or she should contact the Social Security Administration. If the agency agrees, those payments will not count as part of earnings subject to the annual earnings limit.
But some post-retirement earnings do not qualify for the special payments exemption.
For example, one adviser emailed me recently to ask about his client who retired at 62 and continued to receive royalties from a book he wrote before he retired. According to SSA, royalties received before full retirement age are subject to annual earnings cap limits.
“Royalties are earned income and included in net earnings from self-employment and also count toward the annual earnings limit,” Social Security spokesman William Jarrett confirmed via e-mail. Presumably that's because the sales of the book that generated royalties occurred after retirement.
(Questions about Social Security? Find the answers in my new e-book.)