Navigating Social Securitys Windfall Elimination Provision WEP With A Non-Covered Government Pension

21 Nov    Investing News

In the midst of America’s Great Depression (which spanned from the October 1929 “Black Tuesday” stock market crash to the end of the 1930’s), President Franklin D. Roosevelt enacted several “New Deal” programs to provide the country with relief (and to encourage recovery) from the poverty and high rates of unemployment facing Americans at the time. Social Security was (and remains) one of the most significant programs created as part of the New Deal, and was intended to protect Americans from the “hazards and vicissitudes of life”, offering them “general welfare” and “social insurance” through retirement income for those over age 65.

However, Social Security benefits were not initially available for state or local government employees because the institutions they worked for often managed their own retirement (pension) programs for employees. To address the concern that state/local government employees were ‘missing out’ on Social Security, and in part to allow states to shift a portion of the retirement burden to the Federal government, Congress passed Section 218 of the Social Security Act in 1951, providing Social Security benefits to public employees in states that entered into a voluntary (but irrevocable) agreement with the Social Security Administration to coordinate state/Federal government benefits.

But the original Social Security retirement benefit formula did not account for workers who had retirement income from both their pension plans through “non-covered” employers (i.e., state or local government employers who did not pay into Social Security), and Social Security benefits through employers who did pay into Social Security. Which was problematic, because Social Security is designed to provide higher replacement rates for lower income workers, but couldn’t distinguish between those who actually had a lifetime of low income, and those who had high lifetime earnings but whose income from “non-covered” state or local government jobs (with its own pension instead) was excluded from the Social Security benefit calculation. Accordingly, policymakers felt that these workers eligible for both Social Security and a non-covered pension benefit were being awarded a higher Social Security replacement rate than they should have been. Thus, in 1983, Congress established the Windfall Elimination Provision (WEP) to more fairly adjust the Social Security benefit for these “non-covered” workers who appeared, based only on their Social-Security-covered earnings, to be lower-income than they actually had been in their working years.

While the number of workers in the United States who are subject to the WEP is relatively small,  it’s becoming more common for advisors to run across clients who are affected by WEP as a greater number of public sector employees who started their careers in non-covered jobs are now approaching retirement.

Fortunately, while the WEP can significantly alter an individual’s total retirement income, there are several strategies that an advisor can employ to minimize that impact, including increasing the number of years with “substantial” earnings from a “covered” employer, or taking a lump-sum distribution of a non-covered pension before becoming eligible for the benefit (thus reducing the length of time the WEP penalty is applied to the Social Security benefit).

Ultimately, the key point is that advisors should be aware of the circumstances under which the Windfall Elimination Provision applies to a retiree’s benefits, and the various rules around how their client’s total retirement benefit (as well as any family/auxiliary Social Security benefits based on the client’s own record) may be impacted by the WEP.  At a minimum, it’s crucial to be aware of the WEP to ensure that assumed Social Security benefits are adjusted properly for planning purposes (especially since the WEP adjustment is typically not reflected on the worker’s Social Security statement). And while not all of the WEP penalty can always be unwound even with proactive planning (as might be the case for someone who had a non-covered position early in their career), at the very least, there are a few strategies that advisors have at their disposal to help reduce its overall impact.

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