Many older Americans who are underemployed due to the current state of the economy may consider applying for social security benefits to supplement their income.  Continuing to work while also receiving benefits may cause those benefits to be reduced more then they think.  If you are not on disability and currently under the full retirement age of 66, you will be impacted.

An earnings test is the easiest way to determine how you might be impacted.  Generally the earnings test is based on income earned during the year as a whole, not month by month.  The Senior Citizen’ Freedom to Work Act mandates the retirement earnings test is eliminated in the calendar year in which you reach your full retirement age.  You do not have to worry about an earnings test after you reach 66, however, the earnings test still applies for the time period before you reach full retirement age.

Currently, social security benefits are impacted by earnings at a rate of $1 for each $2 earned over the exempt amount, which is currently $14,160 annually.  The year that you reach your retirement age, your earnings are impacted at a rate or $1 for each $3 earned, and the exempt amount increases to $37,680 (currently for 2010).  The month you reach full retirement age, earnings are no longer affected.

Example of the earnings test:

A man age 62 makes $3000 per month at his job.  Based on past earnings history, he expects his social security benefits to be about $1400 per month or $16,800 annually.

Since his annual salary is over the exemption amount of $14,160, he is subject to the earnings test.  His annual salary is $36,000 so he would reduce that by the exemption amount of $14,160 leaving $21,840 above the exemption.  His social security is decreased by $1 for every $2 over the exemption, so you basically divide the figure by half.  Thus, his social security benefit would be reduced by $10,920 ($21,840 divided by 2).  Therefore he will only be receiving social security benefits of $5880 per year ($16,800 - $10,920).  Much less than the original amount of $16,800 he originally expected.

As you plan your retirement, remember to factor the earnings test in the picture if it applies to you.  It might affect if you choose to receive partial social security benefits or not.  In the long run it might not be the best decision.