Impacts Of Windfall Elimination Provision And Government Pension Offset On Social Security Benefits

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Includes: FPIFX, FRIFX, PBP, PSL, VBINX, VSMGX
by: Charles Bolin
Summary

This article is about how the Windfall Elimination Provision and Government Pension Offset can impact Social Security Pensions.

It also touches on deferring Social Security Benefits until age 70, particularly survivor benefits and longevity, which are impacted by the Government Pension Offset.

The Investment Model shows deteriorating conditions.

Mutual funds and exchange traded funds with a moderate risk rating from Mutual Fund Observer are identified for Vanguard, Fidelity and exchange traded funds.

Many people think of Social Security only as a retirement program. But some of the Social Security taxes you pay go toward survivors benefits for workers and their families. In fact, the value of the survivors benefits you have under Social Security is probably more than the value of your individual life insurance. Survivor Benefits, Securing Today and Tomorrow.

The ideal situation for those saving for retirement is to have a combination of Social Security, a pension from your work, and a nest egg of your own... Yet what many people don't realize is that those who receive pensions from their past employers can end up missing out on some of their Social Security benefits. The way that Social Security and pensions interact can cause you to see what you get from Social Security reduced or even eliminated in certain circumstances. "Can My Pension Lower My Social Security Benefits?" by Dan Caplinger in The Motley Fool

Introduction

As I near retirement, I turn more of my attention to Retirement Planning. In November, I read "Get What's Yours, The Revised Secrets to Maxing Out Your Social Security" by Laurence J. Kotlikoff, Philip Moeller, and Paul Solman, and ordered several more books on financial planning for retirement. I also made an appointment with a Financial Planner.

Barron's recently ran "Watch Out for These 10 'Retirement Killer's" which describes a RAND Corporation and Max Planck Institute study of people in or near retirement. Many of these 10 dangers or regrets are the result of setbacks in life such as poor health and loss of employment. I find the controllable dangers to be particularly pertinent:

  1. Having low financial literacy
  2. Making bad investments
  3. Overestimating Social Security
  4. Not making long-term plans
  5. Procrastinating

This article looks at the impact of public pensions that did not contribute to Social Security on Social Security Benefits (NASDAQ:SSB) and how these benefits can be maximized. SSB is a substantial percentage of most retiree's income and should be incorporated into the overall financial plan.

According to "Understanding Social Security For The Public Sector: The Government Pension Offset" by Tom R. Hager in Forbes, the Windfall Elimination Provision affects your Social Security Benefit while the Government Pension Offset rules have a direct impact on spouses and survivors.

Today, there are 15 states that do not cover their public-sector employees through Social Security, including Alaska, California, Colorado, Connecticut, Georgia, Illinois, Kentucky, Louisiana, Maine, Massachusetts, Missouri, Nevada, Ohio, Rhode Island and Texas

The age that one chooses to begin drawing Social Security Benefits is a personal choice and sometimes is determined by necessity. Approximately a third of recipients start drawing social security at age 62. Only about ten percent of people (not including disability) start drawing Social Security Benefits after the full retirement age, but that percentage is rising.

When you factor in longevity, health care, and the cost of your expected lifestyle in retirement, your decision on whether or not to claim Social Security at age 62 may become clearer. "Should you take Social Security at 62?" Fidelity

Social Security Funding

The Social Security Trust Fund is projected to be exhausted in 2034, and they will be able to pay only 79 percent of expected benefits without changes to the program. The Social Security Reform Act of 1983 delayed cost-of-living benefits, increased Social Security taxes, and implemented the Windfall Elimination Provision (WEP) and Government Pension Offset (GPO) as a step to address shortfalls.

The "Bipartisan Budget Act of 2015" eliminated or reduced the ability to "File and Suspend". Taxes are being raised and benefits are being reduced by raising the maximum amount of earnings subject to Federal Insurance Contributions Act (FICA) from $128,400 to $132,900, raising the retirement age for those turning 62 in 2019 to 66 and six months, subjecting SSB of high income earners to paying taxes on 85% of benefits.

I have confidence that Social Security will remain a viable program, but most likely with higher taxes and/or with reduced benefits.

Windfall Elimination Provision

The "Windfall Elimination Provision" reduces the benefits to retirees that have pensions from both public pensions that that did contribute to Social Security and other employment that did. Social Security Benefits are reduced by half, up to $448 per month, of the pension that did not contribute. Spousal benefits are based on your benefits, but survivor benefits are not reduced.

Government Pension Offset (GPO)

The Congressional Research Service published "Social Security: The Government Pension Offset (GPO)" in June of 2018. There are over 6 million state and local government workers that are in non-Social Security-covered programs and about 682 thousand Social Security beneficiaries have spousal or widow(er)'s benefits reduced or eliminated.

In general, Social Security spousal and survivor benefits are paid to the spouses of retired, disabled, or deceased workers covered by Social Security. The spousal benefit equals 50% of a retired or disabled worker's benefit and the survivor benefit equals 100% of a deceased worker's benefit.

The GPO may reduce Social Security Benefits to your spouse if he or she was covered under a public pension plan that did not contribute Social Security taxes. Public sector employees that are subject to the Government Pension Offset have two thirds of their pension deducted from their spouses. For more information, I refer you to "Public Pensions Sock Social Security Benefits" by Rachel L. Sheedy at Kiplinger.

Social Security Spousal Benefits

Spouses may qualify for half of the amount of your Social Security Benefits. It depends upon their own work history and age. In many households, both spouses often work. A spouse may be able to claim their own Social Security benefits or half of their spouses, whichever is greater.

Social Security Survivor Benefits

Surviving spouses may apply for Social Security benefits upon the death of their loved one and receive the greater of their own Social Security benefits or 100 of his or her benefits. This depends upon their age and working history.

"Social Security Death Benefits" in SmartAsset describes that delaying Social Security Benefits until age 70 can increase the benefits for the surviving spouse.

If the higher-earning spouse delays until age 70, that sets the couple up for bigger benefits checks while both are living and for the surviving spouse to have higher widow/widowers' benefits, too. If the higher-earning spouse dies first, the surviving spouse will have higher death benefits if the higher-earning spouse waited until age 70 to claim.

Investment Model

The Investment Model showed a deterioration in November, but the risk of a recession is low in the near term. At the time of this writing, the S&P 500 has recovered 4% during the past week but is still down 4% for the past three months. I expect the recovery to continue over the next few months.

Source: Author's Calculations

Fund Spotlight

I continue to reduce risk in my portfolio. I use the Risk Rank from Mutual Fund Observer to categorize funds into a Bucket Strategy. For December, I reduce risk not by going to cash and bonds but by shifting funds from the Aggressive Risk Category to the Moderate Risk Category. I used the MultiSearch tool in Mutual Fund Observer to find two each of Vanguard, Fidelity and Exchange Traded Funds with lower drawdowns and Ulcer Index, and higher Martin Ratio over the past three years. These are shown below:

FPIFX Fidelity Freedom Index 2020 Inv Mixed-Asset Target 2020
FRIFX Fidelity Real Estate Income Real Estate
VBINX Vanguard Balanced Index Inv Mixed-Asset Alloc Growth
VSMGX Vanguard LifeStrategy Mod Growth Mixed-Asset Alloc Growth
PSL Invesco DWA Consumer Staples Mom Consumer Goods
PBP Invesco S&P 500 BuyWrite ETF Alt Long/Short Equity

Source: Mutual Fund Observer

I ran Portfolio Visualizer to see how the funds performed for the past year. As the stock market recovers, I am shifting from the pure equity funds into these types of Moderate Risk Funds. By comparison, the S&P 500 declined by 7% during the same time period.

Source: Portfolio Visualizer

Conclusion

I am personally impacted by the Government Offset Provision. I ran the calculations and believe that deferring Social Security Benefits until age 70 has benefits as insurance for longevity and Survivor Benefits for my wife. That is the path that I choose.

My holiday reading list includes "How to Make Your Money Last" by Jane Bryant Quinn which I am part way through, and "The New Rules of Retirement: Strategies for a Secure Future" by Robert C. Carlson.

I write one or two articles per month which involve investing according to the business cycle, managing risk and/or portfolio optimization. I write based on the topics that interest me, as someone approaching retirement. You are invited to click on the orange "Follow" button at the top of the article to follow or Read More Articles.

Disclaimer: I am an engineer with an MBA nearing retirement and not an economist nor an investment professional. The information provided is for educational purposes and should not be considered as advice. Investors should do their due diligence research and/or use an investment professional.

Disclosure: I am/we are long FRIFX, PSL, VBINX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.