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Social Security: The Windfall Elimination Provision (WEP)

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Social Security: The Windfall Elimination Provision (WEP) Alison M. Shelton Analyst in Income Security January 18, 201130, 2012 The House Ways and Means Committee is making available this version of this Congressional Research Service Service (CRS) report, with the cover date shown above, for inclusion in its 20112012 Green Book website. CRS works exclusively for the United States Congress, providing policy and legal analysis to Committees and Members of both the House and Senate, regardless of party affiliation. Congressional Research Service 98-35 CRS Report for Congress Prepared for Members and Committees of Congress Social Security: The Windfall Elimination Provision (WEP) Summary The windfall elimination provision (WEP) reduces the Social Security benefits of workers who also have pension benefits from employment not covered by Social Security. Its purpose is to remove an advantage or “windfall” these workers would otherwise receive as a result of the interaction between the Social Security benefit formula and the workers’ relatively short careers in Social Security-covered employment. Opponents contend that the provision is basically imprecise and can be unfair. This report will be updated annually or upon legislative activity. Congressional Research Service Social Security: The Windfall Elimination Provision (WEP) Contents Background ...................................................................................................................................... 1 Who is Affected by the WEP? ......................................................................................................... 3 Legislative History and Rationale.................................................................................................... 5 Arguments for the Windfall Elimination Provision ................................................................... 6 Arguments Against the Windfall Elimination Provision ........................................................... 6 The WEP’s Impact on Low-Income Workers ............................................................................ 6 Tables Table 1. Social Security Benefit Formula in 2011 2012........................................................................... 1 Table 2. Monthly PIA for a Worker With Average Indexed Monthly Earnings of $1,500 and Retiring in 20112012 ..................................................................................................................... 2 Table 3. WEP Reduction Falls with Years of Substantial Coverage ................................................ 3 Table 4. Number of Beneficiaries in Current Payment Status with Benefits Affected by Windfall Elimination Provision (WEP), by State and Type of Benefit, December 20102011 ............ 4 Congressional Research Service Social Security: The Windfall Elimination Provision (WEP) Background The Social Security benefit formula is designed so that workers with low average lifetime earnings in Social Security-covered employment receive a benefit that is a larger proportion of their earnings than do workers with high average lifetime earnings. The benefit formula does not distinguish, however, between workers who have low average earnings because they worked for many years at low wages in Social Security-covered employment and workers who have low average earnings because they worked briefly in Social Security-covered employment. The generous benefit that would be provided to workers with short careers in Social Security-covered employment—in particular, workers who have split their careers between Social Security-covered and non-covered employment is sometimes referred to as a “windfall” that would exist in the absence of the windfall elimination provision (WEP). The WEP reduces the Social Security benefits of workers who also have pension benefits from employment not covered by Social Security. A worker is eligible for Social Security after he or she works in Social Security-covered employment for 10 or more years (40 or more quarters). The worker’s earning history is indexed to wage growth to bring earlier years of his or her earnings up to a comparable, current basis. Average indexed earnings are found by totaling the highest 35 years of indexed wages and then dividing by 35. Next, a monthly average, known as Average Indexed Monthly Earnings (AIME), is found by dividing the annual average by 12. The Social Security benefit formula is designed to provide a progressive benefit. The benefit formula applies three progressive factors—90%, 32%, and 15%—to three different levels, or brackets, of AIME.1 The result is known as the “primary insurance amount” (PIA) and is rounded down to the nearest 10 cents. For persons who reach age the age of 62, die, or become disabled in 20112012, the PIA is determined in Table 1 as follows: Table 1. Social Security Benefit Formula in 20112012 Factor Average Indexed Monthly Earnings 90% of the first $749767, plus 32% of AIME over $749767 and through $4,517624 plus 15% of AIME over $4,517624 The averaging provision in the benefit formula tends to cause workers with short careers in Social Security-covered employment to have low AIMEs, similar to persons who worked for low wages in covered employment throughout their careers. This is because years of zero covered earnings are entered as zeros into the formula that averages the worker’s wage history over 35 years. For example, a person with 10 years in Social Security-covered employment would have an AIME that reflects 25 years of zero earnings. Consequently, for a worker with a low AIME because she split her career between covered and non-covered employment, the benefit formula replaces more of covered earnings at the 90% rate than if this worker had spent his or her full 35-year career in covered employment at the same 1 Both the annual earnings amounts over the worker’s lifetime and the bracket amounts are indexed to national wage growth so that the Social Security benefit replaces the same proportion of wages for each generation. Congressional Research Service 1 Social Security: The Windfall Elimination Provision (WEP) than if this worker had spent his or her full 35-year career in covered employment at the same wage level. The higher replacement rate2 for workers who have split their careers between Social Security-covered and non-covered jobs is sometimes referred to as a “windfall.”3 A different Social Security benefit formula, referred to as the “windfall elimination provision,” applies to many workers who are entitled to Social Security as well as to a pension from work not covered by Social Security (e.g., individuals who work for certain state and local governments, or under the Federal Civil Service Retirement System). 4 Under these rules, the 90% factor in the first bracket of the formula is replaced by a factor of 40%. The effect is to lower the proportion of earnings in the first bracket that are converted to benefits. Table 2 illustrates how the regular and WEP provisions work in 20112012. Table 2. Monthly PIA for a Worker With Average Indexed Monthly Earnings of $1,500 and Retiring in 20112012 Regular Formula Windfall Elimination Formula 90% of first $749 $674.10767 $690.30 40% of first $749 $299.60767 $306.80 32% of earnings over $749767 and through $4,517 $240.30624 $234.56 32% of earnings over $749767 and through $4,517 $240.30624 $234.56 15% over $4,517624 Total 0.00 $914.40924.86 15% over $4,517624 Total 0.00 $539.90541.36 Under the WEP formula, the benefit for the worker is reduced by $374383.50 ($914.40 - $539.90924.86 - $541.36) per month relative to the regular benefit formula. Note that the WEP reduction is limited to the first bracket in the AIME formula (90% vs. 40% formula rates), while the 32% and 15% factors for the second and third brackets are the same as in the regular benefit formula. As a result, for AIME amounts that exceed the first threshold of $749767, the amount of the WEP reduction remains a flat $374383.50 per month. For example, if the worker had an AIME of $23,000 instead of $1,500, the WEP reduction would againstill be $374383.50 per month. A “guarantee” in the WEP provision ensures that a worker’s WEP reduction cannot exceed more than one half of the government pension based on the worker’s non-covered work. This “guarantee” is designed to help protect workers with low non-covered pensions and also ensures that the WEP can never completely eliminate a worker’s Social Security benefit. The WEP also exempts workers who have 30 or more years of “substantial” employment covered under Social Security, with lesser reductions for workers with 21 through 29 years of substantial covered employment, as shown in Table 3.5 2 A worker’s replacement rate is the ratio of his or her Social Security benefit to pre-retirement income. The WEP is sometimes confused with the Government Pension Offset (GPO), which reduces Social Security spousal benefits of a worker who also has a government pension based on work that was not covered by Social Security. For more information on the GPO, please refer to CRS Report RL32453, Social Security: The Government Pension Offset (GPO), by Alison M. Shelton. 4 Social Security Act §215(a)(7). Federal service where Social Security taxes are withheld (Federal Employees’ Retirement System or CSRS Offset) is not affected by the WEP. 5 For determining years of coverage after 1978 for individuals with pensions from non-covered employment, “substantial coverage” is defined as 25% of the “old law” (i.e., if the 1977 Social Security Amendments had not been (continued...)enacted) Social Security maximum taxable wage base for each year in question. In 2012, the “old-law” taxable wage base is equal to $81,900, therefore to earn credit for one year of “substantial” employment under the WEP a worker would have to earn at least $20,475 in Social Security-covered employment. 3 Congressional Research Service 2 Social Security: The Windfall Elimination Provision (WEP) Table 3. WEP Reduction Falls with Years of Substantial Coverage Years of Social Security Coverage First factor in formula Maximum dollar amount of monthly WEP reduction in 2010a2012a 20 21 22 23 24 25 26 27 28 29 30 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% $380.5 $342.5 $304.4 $266.4 $228.3 $190.3 $152.2 $114.2 $76.1 $38.1383.5 $345.2 $306.8 $268.5 $230.1 $191.8 $153.4 $115.1 $76.7 $38.4 $0 Source: Social Security Administration, How the Windfall Elimination Provision Can Affect Your Social Security Benefit, Washington, DC, http://www.socialsecurity.gov/retire2/wep-chart.htm. a. WEP reduction may be lower than the amount shown because the reduction is limited to one-half of the worker’s pension from non-covered employment. The WEP does not apply to (1) an individual who on January 1, 1984, was an employee of a government or nonprofit organization and to whom Social Security coverage was mandatorily extended by the 1983 amendments to the Social Security Act (e.g., the President, Members of Congress in office on December 31, 1983); (2) benefits for survivors; (3) workers who reached the age of 62, became disabled, or were first eligible for a pension from non-covered employment, before 1986; (4) benefits from foreign Social Security systems that are based on a “totalization” agreement with the United States; and (5) people whose only non-covered employment that resulted in a pension was in military service before 1957 or is based on railroad employment. Who is Affected by the WEP? According to the Social Security Administration (SSA), as of December 20102011, about 1.34 million Social Security beneficiaries were affected by the WEP, as shown in Table 4. About 1.23 million persons affected by the WEP were retired workers (about 3.4% of retired workers). Of retired workers affected by the WEP, approximately 63% were men. 6 (...continued) enacted) Social Security maximum taxable wage base for each year in question. In 2011, the “old-law” taxable wage base is equal to $79,200, therefore to earn credit for one year of “substantial” employment under the WEP a worker would have to earn at least $19,800 in Social Security-covered employment. 6people (91.9% ) affected by the WEP were retired workers. About 2.5% of all Social Security beneficiaries (including disabled and spouse beneficiaries), and about 3.5% of all retired worker beneficiaries, were affected by the WEP in December 2011.6 Of retired workers affected by the WEP, approximately 62.7% were men.7 6 Social Security data on the Social Security beneficiary and retired worker populations are available from the Monthly Statistical Snapshot, December 2011, at http://www.ssa.gov/policy/docs/quickfacts/stat_snapshot/index.html. 7 Social Security Administration, Office of Research, Evaluation and Statistics, January 201027, 2012, unpublished table W01. Congressional Research Service 3 Social Security: The Windfall Elimination Provision (WEP) Table 4. Number of Beneficiaries in Current Payment Status with Benefits Affected by Windfall Elimination Provision (WEP), by State and Type of Benefit, December 20102011 Type of Benefit State Total Total Retired Workersworkers Disabled Workersworkers Spouses and Children 1,282,786 1,174,743 17,136 90,907 16,228 14,549 331 1,348 Alaska 6,735 6,344 90 301 Arizona 23,694 21,873 299 1,522 Arkansas 9,342 8,577 213 552 California 167,438 154,652 2,009 10,777 Colorado 38,430 35,814 510 2,106 Connecticut 12,513 11,815 180 518 Delaware 2,943 2,739 44 160 District of Columbia 7,104 6,721 132 251 Florida 73,098 67,214 851 5,033 Georgia 36,913 34,485 480 1,948 Hawaii 8,018 7,342 80 596 Idaho 5,625 5,153 75 397 Illinois 65,927 62,098 579 3,250 Indiana 12,850 11,829 235 786 Iowa 6,942 6,446 80 416 Kansas 7,466 6,949 103 414 Kentucky 16,600 15,279 328 993 Louisiana 25,322 22,764 565 1,993 Maine 11,739 10,984 156 599 Maryland 38,518 35,924 504 2,090 Massachusetts 45,128 42,572 658 1,898 Michigan 16,076 14,683 269 1,124 Minnesota 14,536 13,579 159 798 Mississippi 8,134 7,392 161 581 Missouri 27,099 25,478 394 1,227 Montana 4,731 4,343 67 321 Nebraska 4,556 4,254 43 259 18,408 17,378 228 802 5,810 5,395 122 293 New Jersey 18,639 17,095 344 1,200 New Mexico 10,817 9,661 187 969 New York 26,596 24,300 454 1,842children 1,370,688 1,259,310 17,958 93,420 16,905 15,219 346 1,340 Alaska 7,361 6,915 106 340 Arizona 25,357 23,483 295 1,579 Arkansas 9,685 8,943 213 529 California 181,048 167,675 2,125 11,248 Colorado 41,714 38,952 593 2,169 Connecticut 13,507 12,796 175 536 Delaware 3,110 2,912 48 150 District of Columbia 7,360 6,968 131 261 Florida 77,311 71,317 877 5,117 Georgia 39,401 36,901 525 1,975 Hawaii 8,494 7,787 77 630 Idaho 5,948 5,472 76 400 Illinois 70,984 67,044 601 3,339 Indiana 13,534 12,544 226 764 Iowa 7,251 6,766 78 407 Kansas 7,898 7,334 128 436 Kentucky 17,725 16,376 345 1,004 Louisiana 27,755 25,053 628 2,074 Maine 12,697 11,899 176 622 Maryland 40,393 37,768 511 2,114 Massachusetts 49,106 46,490 692 1,924 Michigan 17,121 15,682 290 1,149 Minnesota 15,137 14,190 151 796 Mississippi 8,423 7,715 164 544 Missouri 29,024 27,359 423 1,242 Montana 5,008 4,619 66 323 Nebraska 4,728 4,441 37 250 20,324 19,244 232 848 6,143 5,734 109 300 New Jersey 19,651 18,041 362 1,248 New Mexico 11,378 10,215 178 985 Alabama Nevada New Hampshire Congressional Research Service 4 Social Security: The Windfall Elimination Provision (WEP) Type of Benefit State Total Retired Workersworkers Disabled Workers Spouses and Children North Carolina 23,222 21,517 331 1,374 North Dakota 2,140 1,974 18 148 Ohio 92,301 85,858 1,069 5,374 Oklahoma 15,114 13,695 309 1,110 Oregon 12,672 11,729 164 779 Pennsylvania 29,641 27,124 531 1,986 Rhode Island 4,086 3,807 79 200 South Carolina 14,457 13,272 222 963 South Dakota 3,275 3,060 37 178 16,183 14,806 239 1,138 Texas 110,408 101,641 1,435 7,332 Utah 10,897 9,806 136 955 Vermont 2,148 1,988 22 138 Virginia. 40,334 37,030 436 2,868 Washington 24,358 22,030 301 2,027 5,328 4,719 132 477 Wisconsin 10,077 9,371 121 585 Wyoming 2,023 1,874 29 120 70,147 53,761 595 15,791 State Tennessee workers Spouses and children New York 27,898 25,548 477 1,873 North Carolina 24,721 22,972 336 1,413 North Dakota 2,202 2,036 24 142 Ohio 99,306 92,739 1,153 5,414 Oklahoma 15,742 14,324 314 1,104 Oregon 13,472 12,514 158 800 Pennsylvania 31,228 28,708 545 1,975 Rhode Island 4,373 4,085 85 203 South Carolina 15,226 14,033 227 966 South Dakota 3,420 3,208 34 178 17,014 15,624 248 1,142 Texas 120,032 110,935 1,530 7,567 Utah 11,503 10,361 154 988 2,255 2,087 20 148 Virginia 42,245 38,909 449 2,887 Washington 25,938 23,529 318 2,091 5,548 4,952 126 470 Wisconsin 10,534 9,821 116 597 Wyoming 2,081 1,935 28 118 74,469 57,136 632 16,701 Tennessee Vermont West Virginia Outlying areas and foreign countries Source: Social Security Administration, Office of Research, Evaluation and Statistics, January 2010, unpublished table27, 2012, unpublished Table B. Legislative History and Rationale The windfall elimination provision was enacted in 1983 as part of major amendments designed to shore up the financing of the Social Security program. The 40% WEP formula factor was the result of a compromise between a House bill that would have substituted a 61% factor for the regular 90% factor and a Senate proposal that would have substituted a 32% factor for the 90% formula.78 The purpose of the 1983 law was to remove an unintended advantage that the regular Social Security benefit formula provided to persons who also had pensions from non-Social Securitycovered employment. The regular formula was intended to help workers who spent their lifetimes in low paying jobs, by providing them with a benefit that replaces a higher proportion of their earnings than the benefit that is provided to workers with high earnings. However, the formula could not differentiate between those who worked in low-paid jobs throughout their careers and other workers who appeared to have been low paid because they worked many years in jobs not 78 Conference Report to Accompany H.R. 1900, 98th Cong., March 24, 1983 (Washington: GPO, 1983), p. 120. Congressional Research Service 5 Social Security: The Windfall Elimination Provision (WEP) could not differentiate between those who worked in low-paid jobs throughout their careers and other workers who appeared to have been low paid because they worked many years in jobs not covered by Social Security. Under the old law, workers who were employed for only a portion of their careers in jobs covered by Social Security—even highly paid ones—also received the advantage of the “weighted” formula. The windfall elimination formula is intended to remove this advantage for these workers. Arguments for the Windfall Elimination Provision Proponents of the measure say that it is a reasonable means to prevent payment of overgenerous and unintended benefits to certain workers who otherwise would profit from happenstance (i.e., the mechanics of the Social Security benefit formula). Furthermore, they maintain that the provision rarely causes hardship because by and large the people affected are reasonably well off because by definition they also receive government pensions from non-covered work. The guarantee provision ensures that the reduction in Social Security benefits cannot exceed half of the pension from non-covered work, which protects persons with small pensions from noncovered work. In addition, the impact of the WEP is reduced for workers who spend 21 to 29 years in Social Security-covered work and is eliminated for persons who spend 30 years or more in Social Security-covered work. Arguments Against the Windfall Elimination Provision Some opponents believe the provision is unfair because it substantially reduces a benefit that workers may have included in their retirement plans. Others criticize how the provision works. They say the arbitrary 40% factor in the windfall elimination formula is an imprecise way to determine the actual windfall when applied to individual cases. The WEP’s Impact on Low-Income Workers The impact of the WEP on low-income workers has been the subject of debate. Jeffrey Brown and Scott Weisbenner (hereinafter referred to as “Brown and Weisbenner”) point out two reasons why the WEP can be regressive. 89 First, because the WEP adjustment is confined to the first bracket of the benefit formula ($749 in 2011767 in 2012), it causes a proportionally larger reduction in benefits for workers with lower AIMEs and benefit amounts.910 Second, a high earner is more likely than a low earner to cross the “substantial work” threshold for accumulating years of covered earnings (in 20112012 this threshold is $19,80020,475 of Social Security-covered earnings); therefore, high earners are more likely to benefit from the provision that phases out of the WEP for persons with between 21 and 30 years of covered employment. Brown and Weisbenner found that the WEP does reduce benefits disproportionately for lowerearning households than for higher-earning households. For some high-income households, applying the WEP to covered earnings even provides a higher replacement rate than if the WEP 8 9 Jeffrey R. Brown and Scott Weisbenner, The Distributional Effects of the Social Security Windfall Elimination Provision, NBER and the Social Security Administration, September 5, 2008, pp 8-13, http://www.nber.org/programs/ ag/rrc/books&papers.html. 910 For example, a worker with an AIME of $4,000 would be entitled to a PIA of $1,714.40 before a WEP reduction of $374.50 per month, which would represent a reduction of 22% in this worker’s benefit. By contrast, the worker shown in Table 2 with an AIME of $1,500 would be entitled to a benefit of $914.40 before the WEP reduction of $374.50, representing a cut of 41% to this worker’s benefit (CRS calculations). Congressional Research Service 6 Social Security: The Windfall Elimination Provision (WEP) Brown and Weisbenner found that the WEP does reduce benefits disproportionately for lowerearning households than for higher-earning households. For some high-income households, applying the WEP to covered earnings even provides a higher replacement rate than if the WEP were applied proportionately to all earnings, covered and non-covered. Brown and Weisbenner also found that the WEP can also lead to large changes in Social Security replacement rates based on small changes in covered earnings, particularly when a small increase in covered earnings carries a person over the threshold for an additional year of substantial covered earnings, leading to a modification in the WEP formula. SSA estimated that in 2000, 3.5% of recipients affected by the WEP had incomes below the poverty line. For comparison purposes, at that time 8.5% of all Social Security beneficiaries aged 65 and older had incomes below the poverty line and 11.3% of the general population had incomes below the poverty line. 1011 A potential conclusion is that persons who are subject to the WEP, who by definition also have pensions from non-covered employment, face a somewhat reduced risk of poverty compared with other Social Security beneficiaries. 10 11 These are the most recent estimates available. Poverty rates were calculated by David Weaver of the Social Security Administration’s Office of Retirement Policy using the March 2001 Current Population Survey (CPS). Poverty status is taken directly from the CPS and is thus subject to errors in the reporting of income. The sample size for the WEP poverty rate is relatively small (230 cases) and only includes persons for whom SSA administrative records could be matched. Congressional Research Service 7