Can you work while collecting Social Security benefits?

(MoneyWatch) Can you have your cake and eat it by working for wages and receiving your Social Security income at the same time? If so, is it a good idea? As with many financial questions, the answer isn't black or white -- the best answer is "It depends."

Welcome to my third post this week on the rules regarding Social Security benefits, as part of my 16-week course, Planning Your Retirement. You'll want to review my last two posts on worker's benefits and spouse's benefits for background to fully understand this post.

The earnings test

So can you work while collecting Social Security benefits? If you're receiving Social Security income before the year you attain your Full Retirement Age (FRA, which is currently age 66 for most people), your Social Security income might be reduced by the earnings test. If your wages or self-employment income exceed a certain threshold -- $15,120 per year in 2013 -- then your Social Security income is reduced by $1 for every $2 of earnings over the threshold.

The earnings test only considers gross wages before withholding for taxes and net earnings from self-employment income. The earnings test doesn't consider pension, interest, investment income or money from inheritances. Wages or self-employment income you earn after you reach your FRA, including the month of your birthday, also don't count toward the earnings test. This means you can earn as much money as you want after you reach your FRA, and your Social Security income won't be reduced.

Here's one example to help make things clear. Suppose you're age 63, three years younger than your FRA of age 66, and you've started your Social Security income. If you earn $17,120 in wages -- $2,000 more than the threshold -- then your Social Security benefits will be reduced by $1,000.

It's important to understand that the amount of benefits that are reduced is not "lost." Once you reach your FRA, your monthly Social Security income will be increased permanently to reflect the months that benefits were reduced.

One more thing: You'll still pay Social Security taxes on your wages or self-employment income, regardless of whether your Social Security benefit is reduced.

Special rule for the year you retire

Suppose you stop working full-time during a calendar year, say in July, while you're age 62, 63, 64 or 65 (all below your FRA) and you start Social Security benefits. The earnings test only applies to any wages or self-employment you earn after you retire and begin receiving Social Security income; your earnings in the months before your retirement don't count toward the earnings test. The annual threshold amount will be prorated to reflect just the months after you started your Social Security income; for example, if you retire mid-year in 2013, the threshold that would apply to you would be half of $15,120.

Special rule for the year you attain your FRA

A different test applies during the calendar year you attain your FRA. In this case, if you receive wages or self-employment income in the months leading up to the month you attain your NRA, the annual exempt amount of earnings in 2013 is $40,080, and the reduction in your benefits is $1 for every $3 in earnings over the threshold.

Here's an example. Suppose you turn age 66 in November 2013 and you earn $41,580 from January through October ($1,500 over the threshold of $40,080). Then your Social Security benefit would be reduced by $500 ($1,500/3). Any wages you earn in November or December wouldn't be subject to the earnings test.

How does the earnings test affect your spouse?

Your spouse is subject to the same work rules. If your spouse is receiving Social Security while working and has not yet reached his or her FRA, those wages earned can reduce your spouse's Social Security income, whether it's their own Social Security benefit or a spousal benefit based on your earnings record. But your spouse working would not affect any Social Security income you received that's based on your earnings record.

If you work before you hit your FRA, those earned wages can reduce not only your own Social Security based on your earnings record, but also the spousal benefit payable to your spouse based on your record. Remember that the earnings test applies only when the person working has not yet attained their FRA; after attaining your FRA, you can earn unlimited wages with no reduction to your Social Security income or the spousal benefit based on your earnings record.

What if you start receiving Social Security benefits and return to work later?

You are eligible for a "do over" if you notify the Social Security Administration that you're working again within 12 months of starting your Social Security income. You can pay back all the Social Security benefits you received, and you'll be treated as if you never started your Social Security income for the purpose of the earnings test and for the purposes of increases in your Social Security benefit due to delaying your benefit.

If more than 12 months have passed, then you won't be eligible for the "do over" and the earnings limit will apply. But as noted previously, the amount of the benefit reduction won't be lost permanently. (For a detailed explanation of the earnings test, here's a pamphlet from the Social Security Administration.)

The earnings test is a powerful reason for waiting at least until your FRA to begin your Social Security income. If you start your Social Security benefits before your FRA, then you'll want to monitor your earnings carefully and, if possible, keep them below the threshold that applies to you.

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