SLEDGE: Can I invest my earnings to avoid “too much income”?

Ned Sledge is a Social Security Public Affairs Specialist in Richmond. Questions about Social Security issues may be directed to him by e-mailing
Published: October 15, 2008

Q: If I put the earning into my 401K so I do not exceed the $13,560 would I have the issue of too much income to receive Social Security benefits? — Nancy C.
A: Actually, that’s very smart — and it’s something I don’t think I’ve ever heard anyone come up with before. My hat’s off to you for original thinking!
Unfortunately, I have to deliver the sad news. What you do with the money you earn doesn’t affect the way it’s treated by SSA for purposes of the earnings test. Rolling all or part of your earnings into a 401K will not exclude it from FICA taxes — i.e., the Social Security tax that’s withheld from your wages by your employer or that must be paid by a self-employed worker. If it’s earned income — gross wages from employment, remember, or net earnings from self-employment — the earnings must be reported, the tax must be paid, and the earnings test will be applied to those reported earnings.
No kidding, though, that’s very thoughtful of you. I can see how diverting wages into a 401K could seem like it might serve as the kind of tax-sheltered protection against the Social Security earnings test that the 401K provides against income tax. Alas, though, I’m afraid it doesn’t. — Ned
Q: Read your article on working affecting benefits and found it interesting. You mention holding back benefits if someone exceeds the limit and I’m wondering what happens to this money withheld. Does it eventually get paid to the individual when he reaches full retirement age? Please explain. — Tom F.
A: Interesting question — what does happen to benefits that are withheld when a beneficiary’s earnings exceed the allowed limits? I don’t believe I’ve ever had this one before, although I’d say it’s closely related to another question I’ve been asked many times: what becomes of my benefits if I die before I can collect them?
The answer is the same in both cases. Benefits are paid from the Social Security trust funds, of which there are two: one (by far the larger) from which benefits to retirement beneficiaries and their entitled dependents or survivors are paid; and the smaller trust fund for payments to disability beneficiaries and their entitled dependents. When benefits are not issued because the worker died prior to applying for them — or when, to answer your question, part of an entitled beneficiary’s payments were withheld due to his excess earnings — that money remains in these pooled trust funds and is available for those beneficiaries to whom payments can be made.
The second part of your question - are the withheld benefits paid to the individual when he reaches his full retirement age - is also one I’ve never encountered before, but the answer, I’m afraid, is all too easy. No. At least, not so long as the original determination regarding the excess earnings stands. Now if this determination was to be revised — say, if the beneficiary successfully argued that the earnings were posted to his record incorrectly, either because the money was actually earned in an earlier year, or because the earnings belonged to another worker altogether — then upon correction the withheld benefits would be repaid.
Now here’s an interesting sidebar that relates to what we’re talking about. The earnings limits would apply in the first place because a beneficiary had become entitled to benefits prior to his full retirement age. This early entitlement, of course, results in a reduction in payments. The reduction factor that’s applied to his record is based on the number of months entitlement began before that full retirement age. And normally this reduction is permanent. But not always. For example, if you became entitled at age 63, 36 months before your full retirement age (assuming that age is 66), then a reduction factor of 36 is imposed, one for each month prior to age 66. Now a 36-month reduction factor means a 20% reduction in benefits. But then when you reach age 66, the computer automatically reviews your record and asks: In how many months prior to his full retirement age did he actually receive a Social Security benefit? If the answer is less than 36 because some of those payments were withheld due to earnings above the allowed limit, then the reduction factor is revised to reflect only the number of months in which you actually received a benefit payment. And if, say, during that 36-month period before your full retirement age you’d only received 24 payments, then your reduction factor would be revised from 36 to 24. The result? Your benefits would be now reduced by about 13.3%, rather than the initial 20%.
Even then, though, the benefits that had been withheld prior to the full retirement age based on a 36-month reduction would not be paid. The increase in benefit due to the decrease in the reduction would apply only to the period from full retirement age on. — Ned
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