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The Special Social Security Rule You Need to Know Before You Retire

Social Security benefits are a vital aspect of most Americans' retirement, so it pays to understand how your benefits are calculated.

There are a lot of rules surrounding your monthly checks, though, so the program can be confusing. But there's one rule in particular that's important to understand before you retire, because it can impact how much you receive during your first year of retirement.

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The time of year you retire affects your benefits

The Social Security Administration sets annual earnings limits for retirees who claim benefits before they reach their full retirement age (FRA) -- which is either age 66, 67, or somewhere in between, depending on the year you were born. For 2020, the earnings limit is $18,240 during the years leading up to your FRA, and $48,600 for the year you reach your FRA. If your earnings surpass these limits, you could have a portion of your benefits withheld.

Typically, these limits only affect those who continue working part-time after they started claiming Social Security benefits. However, they can also affect you if you retire mid-year, because you may have already surpassed the annual earnings limit even if you don't continue to work part-time. That's when the special earnings limit rule will come into play.

This special rule applies for one year, typically the first year of retirement. Even if you've already reached the annual earnings limit, the Social Security Administration will not reduce your benefits -- as long as you meet certain requirements. If you won't reach your FRA the year you retire, the earnings limit is $1,520 per month. If you will reach your FRA the year you retire, that earnings limit jumps to $4,050 per month. (Also, "earnings" here refers only to income from a job. It does not include income from your retirement fund, pension, annuities, etc.)

Additionally, to avoid having your benefits withheld, you cannot perform "substantial services in self-employment" -- meaning you cannot work more than 45 hours per month while being self-employed, or between 15 and 45 hours per month in a highly skilled occupation like doctors or attorneys.

What this means for your retirement benefits

If you retire mid-year and don't continue working at all, you likely won't see your benefits reduced. But if you do decide to pick up a new job shortly after you retire, it could affect your monthly checks.

Say you retired in August at age 62, and you'd received $40,000 in income that year before you left your job. Even though that's significantly higher than the annual earnings limit of $18,240, because of the special earnings limit rule, your benefits will not be reduced as long as you're not self-employed and are earning less than $1,520 per month after you retired.

However, let's say that in November you decided to start your own business and began earning $1,600 per month. You're also working about 30 hours per week at this job, or 120 hours per month. Because you're earning more than the income limit and are working more than 45 hours per month, your benefits will be withheld in November and December.

Starting in January, you'll only be subject to the normal earnings limits. That is, in 2020, your benefits will be reduced by $1 for every $2 you earn more than $18,240 each year leading up to your FRA. Then in the year you reach your FRA, your checks will be reduced by $1 for every $3 you earn above $48,600.

Keep in mind, though, that these reductions are not permanent. Once you reach your FRA, the Social Security Administration will recalculate your benefit amount to account for the money that was withheld while you were working. Then in the years following your FRA, you can work as much as you'd like and your earnings won't affect your benefit amount.

Social Security can be a complex and confusing topic, and there are a lot of rules to consider if you want to make the most of your benefits. But by gaining a better understanding of these rules, you can ensure you're making the best decisions to maximize your monthly checks.

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