Older workers may soon make
more -- and pay more taxes
By Kay Bell • Bankrate.com

In an amazing show of political amity, legislation to let older workers earn more money without worrying about losing retirement income sailed through Congress and was signed into law on April 7, 2000.

Thanks to the Senior Citizen's Freedom to Work Act of 2000, the earnings of an estimated 800,000 older workers is now unlimited and the employees won't lose any of their Social Security payments. With seniors living longer and many wanting -- or needing -- to work beyond traditional retirement age, the earnings limit has come under fire in recent years.

But not all retirees should start updating their resumes. While many will profit from bringing home a bigger paycheck to supplement retirement benefits, some seniors may find the tax ramifications not so appealing. Earning extra money might mean you will owe Uncle Sam for previously untaxed retirement benefits.

Depression-era program outdated
When Social Security was created in 1935, the earnings test was used to help move older workers out of the labor force so that younger ones, many with new or growing families, could fill scarce jobs.

Before the passage of the senior earnings act, workers between 65 and 69 could earn no more than $17,000 or they would lose some Social Security payments. At that pay level, federal retirement benefits were reduced by $1 for every $3 that is earned over the cap. The earnings limit was increased yearly: to $25,000 next year and $30,000 by 2002. When workers reached 70, the earnings cap disappeared.

Capitol Hill consensus was that the Depression-era earnings limit outlived its usefulness and legislators agreed unanimously to eliminate it completely.

The Senior Citizens Freedom to Work Act, H.R. 5, now allows retirees to continue earning any amount and still receive all their Social Security benefits. Workers who are 65 can retire now with full benefits, with the age rising to 67 by 2027. The law is retroactively effective for any money earned this year.

Cost -- and tax -- tradeoffs
So why all the bipartisan legislative agreement on senior workers?

The key reason is that Baby Boomers, a large and politically active group, see their fast-approaching retirement as a continuation of current lifestyles. Many want to keep working and still get all the Social Security they've paid for through payroll taxes. Many people perceive a retirement earnings test as a tax on their labor, says Social Security Commissioner Kenneth Apfel.

Secondly, although scrapping the earnings limit would cut into the federal treasury, proposal advocates say there are factors that counter -- and eventually could reduce -- the initial cost.

In testifying before the Ways and Means subcommittee, Aldona Robbins of the Institute for Policy Innovation pointed to the Texas think tank's study showing that after 2000, the bill's cost would decline for two reasons:

1. The increase in the earnings limit -- to $25,000 in 2001 and $30,000 in 2002 -- enacted by Congress in 1996: Since these caps are going up anyway, there will be only a short-term budgetary hit by eliminating the limit now.
2. The delayed retirement credit increases benefits for people who postpone retirement past the normal age: Instituted in 1972, the credit increases the Social Security benefit for every year a worker postpones retiring until age 70. In 1983, Congress adjusted the law further and now workers born in 1938 who delay retirement will receive a 6.5 percent credit for each year they do not collect benefits. The yearly credit will increase, reaching 8 percent for those born in 1943 or later. For individuals who work a partial year, the yearly percentage is broken into monthly increments. The increase stops at age 70, regardless of when a worker starts collecting benefits. This means more potential retirees are likely to delay collecting benefits longer in order to get bigger checks later.

Finally, these new employees would once again pay into the income tax system. And this is what seniors will have to evaluate if they go back to work.

(Tax)paying to work
Retirees who receive only Social Security or railroad retirement benefits are not taxed on those payments.

Other private retirement benefits also may be tax-free, depending upon how the retirement plan is structured. For example, if a plan included contributions a worker made after paying taxes on contributed money, then that portion of the retirement payout is not taxable. However, any earnings on the pension fund or contributions the employer made or money a worker added to the account before taxes were taken out is taxable.

The amount of retirement money that ultimately is taxed is determined by adding retirement funds plus other income -- whether it's earned at a job or from investments, including any that comes from a spouse -- to see if it reaches a federally set base amount threshold. When the threshold is met, generally 50 percent and possibly 85 percent of a retiree's Social Security benefits are taxable.

The base amount is reached by combining one-half of a retiree's benefits and his or her other income. This year, some benefits may be taxable if the base amount is greater than:

• $25,000 for single, head of household, or a qualifying widow or widower filers.
• $25,000 for married filing separately filers who lived apart from a spouse for all of 1999.
• $32,000 for married filing jointly filers.
• $0 for married filing separately filers who lived with a spouse at any time during 1999.

Once the base amount meets the applicable taxable level, then retirees have additional computations to determine how much -- 50 to 85 percent -- of their retirement money is taxable. Generally, higher total income means more of your retirement benefits are taxed.

Figuring the precise taxable amount depends upon individual filing factors. Worksheets and examples to help retirees are found in Internal Revenue Service Publication 915, Social Security and Equivalent Railroad Retirement Benefits.

Is a post-retirement job worth the extra paperwork and possible taxation of previously tax-free benefits? Most legislators think so. But if you're considering re-entering the workforce, be sure to do the math first.

-- Posted Feb. 25, 2000