Not the honor system

Although you will be asked to estimate your earnings, your projection isn't the final word. When you file your tax return, the Internal Revenue System lets the Social Security Administration know exactly how much wage and self-employment earnings you report.

That figure is compared with your estimate, and the government reconciles the books by either sending you a check -- if your estimate of earnings was too high and the earnings test clawed back too much of your benefits -- or dunning you for a balance due.

This final point is particularly important if you unexpectedly return to work while you're subject to the earnings test. You should let the Social Security agency know of the change in circumstances as soon as possible so that your benefits can be trimmed if you run afoul of the earnings test. Failing to do so could come back to haunt you later. If the tax return you file shows earnings that should have triggered reduced benefits, you'll be asked to pay back the excess in a lump sum or see future benefits reduced.

A silver lining in the earnings test

Although the earnings test is often derided as an unconscionable 50% surtax -- because $2 in earnings can cost you $1 in benefits -- it's not as evil as critics complain. Benefits lost to the test are not gone forever. Instead, the law is designed to ensure that you recover any forfeited amount via higher monthly benefits later.

Remember, if you claim benefits before your full retirement age, your benefits will be permanently reduced (see the table below). But for any month you lose benefits to the earnings test, the Social Security agency will ratchet up future benefits.

Say you retire at 62, happy to accept the 25% haircut in benefits in exchange for collecting four years early. Then you have to go back to work and wind up forfeiting 12 months' worth of benefits. Basically, when recalculating your benefits at your full retirement age, you'll be treated as though you claimed benefits three years early, not four. Instead of having your lifetime benefits reduced by 25%, in this example you'd suffer about a 20% reduction going forward.

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And if your earnings during your period of forced re-employment are higher than one of the 35 years of earnings originally used by Social Security to compute your benefit, your monthly payments could rise even more.

The earliest age for full benefits

Through most of Social Security's history, 65 was the magic age. Claiming retirement benefits before then -- and you can start as early as age 62 -- meant accepting a lifetime reduction in benefits.

For folks retiring this year, though, the magic age is 66. And the age at which you can start collecting benefits without being docked for starting early -- or being threatened by the earnings test -- is increasing.

Birth yearFull retirement ageCut in monthly benefits if claimed at 62
195566 and 2 months25.83%
195666 and 4 months26.67%
195766 and 6 months27.5%
195866 and 8 months28.33%
195966 and 10 months29.17%

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