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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.
Question: I have a client who is receiving Social Security benefits prior to full retirement age. The client is still working part-time, and is worried that benefits might be reduced due to his earnings. Can the client reduce earnings by contributing to a qualified plan?
Answer: Probably not.
If earnings are too high during a calendar year before an early retiree reaches full retirement age, the benefit for that year may be reduced. Starting with the month a retiree reaches full retirement age (66 for those retiring in 2012), the retiree can earn as much as possible without having a reduction in benefits. In general, an early retiree who earns too much will have social security retirement benefits reduced by $1 for every $2 of excess earnings in a calendar year.
Here’s how the Social Security website defines earnings for this purpose:
If you work for someone else, only your wages count toward Social Security’s earnings limits. If you are self-employed, we count only your net earnings from self-employment. We do not count income such as other government benefits, investment earnings, interest, pensions, annuities, and capital gains. However, we do count an employee’s contribution to a pension or retirement plan if the contribution amount is included in the employee’s gross wages.
If you work for wages, income counts when it is earned, not when it is paid. If you have income that you earned in one year, but the payment was made in the following year, it should not be counted as earnings for the year you receive it. Some examples are accumulated sick or vacation pay and bonuses.
If you are self-employed, income counts when you receive it—not when you earn it—unless it is paid in a year after you become entitled to Social Security and earned before you became entitled.
Therefore, employee elective deferrals to a pension count as earnings (in a SIMPLE or 401K plan, for example). However, employer contributions (as in a SEP or defined benefit plan) do not. So if you have a client who is self-employed, he may be able to reduce earnings by establishing a SEP and making employer contributions to it.
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