Retiring with a pension & Social Security: What you need to know

A pension provides a reliable source of income in your retirement years, making it easier to manage your expenses and enjoy the life you've always dreamed of. For most retirees, receiving a pension won't affect the amount of your Social Security payouts. You can enjoy both.

However, if your pension comes from a certain type of job, your benefits could be impacted. If you're retiring with a pension and Social Security, it's important to determine whether your benefits are affected so you can plan for a solid financial future.

As long as your employer withheld FICA taxes, which are the payroll taxes that pay for Social Security and Medicare, you're eligible to receive your full Social Security benefit. But if your employer didn't take FICA taxes out of your paycheck, the pension you receive from that employer is considered a "noncovered" pension.

That may be the case if you worked in a foreign country, your employer was a U.S. state or local government or you worked for the federal government several decades ago. If you were employed by a government entity that withheld FICA taxes, your Social Security benefit won't be affected.

Income from a noncovered pension can reduce your Social Security payout through one of two provisions:

The Windfall Elimination Provision (WEP) is a Social Security benefit deduction that comes into play if you claim benefits based on your own earnings. For the WEP to apply, you must have held one or more jobs that did withhold FICA taxes—in addition to your "noncovered" employment.

Under this provision, the Social Security Administration uses a slightly different formula when calculating your primary insurance amount (PIA), resulting in a smaller benefit. The WEP can cut your benefit by as much as half of your pension amount, although it can't bring your benefit all the way down to $0.

A separate provision, known as the Government Pension Offset (GPO), may reduce or eliminate your Social Security benefits if you receive a noncovered pension and are eligible for Social Security spousal or survivor benefits. This provision cuts your benefit by two-thirds of your pension amount, and you can end up with a $0 benefit if your pension is large enough.

To calculate your monthly benefits, the Social Security Administration (SSA) takes your average monthly earnings for the 35 years when your income was highest—if you worked in "covered" jobs that had FICA taxes withheld. It then adjusts that amount based on specific percentages, or "factors." The result is your primary insurance amount (PIA).

The amount you actually receive might be higher or lower than your PIA depending on your age when you claim Social Security. You can open an online account with the Social Security Administration to view your earnings history and get estimates of what your benefit amount will be depending on what age you start taking Social Security.

If you worked in a noncovered job, your Social Security amount can be reduced by the WEP or the GPO, regardless of when you first file for benefits:

When the Windfall Elimination Provision applies, the Social Security Administration typically reduces the factor by which it multiplies your average monthly earnings, resulting in a lower PIA. But the more years you have "substantial earnings" from a covered job, the less this reduction will be. And if you have 30 or more years of substantial earnings, the program won't lower your benefit amount at all.

The Social Security Administration offers a government and foreign pensions calculator that shows the maximum amount your monthly benefit can be reduced by the WEP. If you worked in one or more covered jobs throughout your career, you'll want to consult the SSA chart that shows how the number of years you earned substantial earnings will affect your reduction. The maximum amount that your Social Security benefit can be cut based on WEP is 50%.

If you receive Social Security benefits based on your spouse's or widow's earnings record, the SSA will reduce your benefits by two-thirds of your government pension. For instance, if you receive a pension of $2,400, you'll see a $1,600 reduction in your monthly Social Security payout.

In cases where two-thirds of your noncovered pension is greater than your Social Security benefit, the SSA would decrease your benefit to zero. The SSA calculator can help you determine the amount of the Social Security reduction based on your monthly pension benefit.

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Certain noncovered pensions aren't affected by the WEP or GPO, meaning there's no reduction in your Social Security benefit. Understanding these exemptions can help you better plan for your retirement income.

If any of these situations apply to you, then the WEP won't reduce your benefit:

• You work for the federal government and were hired in 1984 or later.
• You work for a nonprofit that was exempt from Social Security on Dec. 31, 1983, and meets some other conditions.
• You only have a railroad pension.
• Your earnings that weren't covered by FICA taxes were from before 1957.
• You have at least 30 years of substantial earnings on which FICA taxes were paid.

The GPO typically won't affect your benefit if any of the following are true:

• You get a government pension that isn't based on your earnings.
• You're a government employee, you have a government pension from work that was covered by FICA taxes and you meet one of a few other requirements.
• You work for the federal government, you switched from the Civil Service Retirement System to the Federal Employees' Retirement System after Dec. 31, 1987, and you meet one of a few other requirements.
• You received or were eligible for a government pension before December 1982, and you qualified for spousal benefits under the rules in place in January 1977.
• You received or were eligible for a government pension before July 1, 1983, and you had one-half support from a spouse.
  

The Social Security Administration doesn't view a pension as earned income. So you don't pay FICA taxes on your pension, and it doesn't add to your earnings record. That means a pension can't add to your Social Security credits, and it doesn't enter into the PIA formula or affect your benefit amount. Usually, receiving a pension doesn't change the Social Security benefits you're eligible to receive. As long as your employer withheld FICA taxes, which are the payroll taxes that pay for Social Security and Medicare, you're all set.

In general, the longer you wait to claim your Social Security benefit, the larger the monthly amount you'll receive. While you can file a Social Security claim as early as age 62, you won't receive your full PIA unless you hold off until your full retirement age—that's between 66 and 67, depending on when you were born. Your benefits continue to increase if you wait beyond that, until you reach age 70.

Delaying when you claim Social Security doesn't reduce the impact of WEP or GPO on your benefit calculation, but it can still affect your decision when to file. A financial advisor can help you determine the best time to start receiving benefits, based on your individual circumstances.