For many families, the transition into retirement is more like a series of steps than a leap. Oftentimes, for example, Social Security is started even though an earner is still working. There are many reasons for this, including an interest in at least staying employed on a part-time basis, but needing Social Security to supplement their income.

In times like these, Social Security’s “earning test” may come into play.

What is the earnings test?

When you receive your Social Security benefits before your full retirement age and earn above a certain amount of wages, your Social Security benefit is temporarily reduced by $1 for every $2 your annual earnings exceed the earnings limit. For 2023, the earnings limit is $21,240.

Rather than being prorated across the year, your benefits are withheld completely until the required reduction is satisfied.

Example: Joe is 65 years old this year and two years away from his full retirement age. He decides to claim his Social Security benefit of $1,500 per month, but also continues to work part-time at his employer and earns $30,000. This is $8,760 in excess of the earnings limit ($30,000 - $21,240). As a result, Joe’s Social Security benefit will be reduced in 2023 by $4,380 (half of the $8,760 excess). Joe will receive no benefits in January, February, and March. When Joe reaches full retirement age, his benefits will be adjusted to pay back what was withheld plus his regular benefit.

Exceptions to the earnings test

As with most Social Security rules, there are exceptions. First, in the year after you’ve reached your full retirement age, you can earn as much as you’d like and your Social Security benefits won’t be reduced. In the example above, if Joe waited until age 68 to start his Social Security benefit, he would have no benefit reduction.

Second, it’s important to note that the earnings test only applies to wages and earnings from self-employment. This means that IRA distributions, pension income, dividends and capital gains do not count.

Example: Joe decides to retire at age 65 and claim his Social Security benefits, but being the financially astute guy that he is, decides to reduce his work hours to only earn $20,000 at his employer, keeping him under the $21,240 earnings limit for 2023. To supplement Joe’s income but not trigger the earnings test reduction, he withdraws $10,000 from his IRA. The IRA withdrawal does not count as income against the earnings test, so Joe is still under the earnings limit.

Third, the year in which you reach your full retirement age, the earnings test is more favorable. The earnings limit is increased to $56,520, and Social Security benefits are reduced by $1 for every $3 annual earnings exceed the earnings limit.

How does the earnings test affect spousal benefits?

In a previous article, I explained how spousal benefits work for Social Security. Are spousal benefits affected by the earnings test? They are, and here’s how.

As discussed in my previous article, spousal benefits and earners benefits are “linked” in a sense. If the earner spouse claims early then the earner’s benefit is permanently reduced. The spousal benefit, which is based on the earner’s benefit, is also reduced as a result.

Example: Joe is currently receiving his earned benefit of $1,500 and Pam is receiving her spousal benefit of $750 for a combined benefit of $2,250. Joe is 65 and decides to work part-time at his previous employer, earning $30,000. As with the earlier example, this is $8,760 in excess of the earnings limit ($30,000 - $21,240). As a result, Joe’s and Pam’s Social Security benefit will be reduced in 2023 by $4,380 (half of the $8,760 excess). Joe and Pam will receive no benefits in January and February.

What if Joe is over full retirement age, but Pam is not and decides to start working and exceeds the earnings test? The earnings test will still apply to Pam’s spousal benefit, so even though Joe will have no reduction, Pam will. As before, this withholding will be made up to Pam once she reaches her full retirement age.

I hope you’ve found this a helpful summary of Social Security’s earnings test. In general, retirees should consider the earnings test penalty more of a setback. Still, this reduction in Social Security can blindside unexpecting retirees, especially given that the withholding isn’t prorated across the entire year but results in a complete benefit reduction for the required period of time.

To avoid this, retirees should be thoughtful about when and how much they work prior to their full retirement age. In most cases, for those who prefer to work before their full retirement age but still may be up against the earnings test, IRA withdrawals are a reasonable way to supplement your retirement income to avoid earnings test reductions. Better yet, wait until at least your full retirement age to claim your Social Security benefit so the earnings test isn’t even a bother.