Social Security: The Windfall Elimination Provision (WEP) Christine Scott Specialist in Social Policy February 15, 2013 Congressional Research Service 7-5700 www.crs.gov 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 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 2013 ........................................................................... 1 Table 2. Monthly PIA for a Worker With Average Indexed Monthly Earnings of $1,500 and Retiring in 2013 ..................................................................................................................... 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 2012 ............ 4 Contacts Author Contact Information............................................................................................................. 7 Acknowledgments ........................................................................................................................... 7 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 2013, the PIA is determined in Table 1 as follows: Table 1. Social Security Benefit Formula in 2013 Factor Average Indexed Monthly Earnings 90% of the first $791, plus 32% of AIME over $791 and through $4,768, plus 15% of AIME over $4,768 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 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 2013. Table 2. Monthly PIA for a Worker With Average Indexed Monthly Earnings of $1,500 and Retiring in 2013 Regular Formula Windfall Elimination Formula 90% of first $791 $711.90 40% of first $791 $316.40 32% of earnings over $791 and through $4,768 $226.88 32% of earnings over $791 and through $4,768 $226.88 15% over $4,768 Total 0.00 $938.78 15% over $4,768 Total 0.00 $543.28 Source: Calculations were made by the Congressional Research Service (CRS). Note: To simplify the example, rounding conventions that would normally apply are not used here. Under the WEP formula, the benefit for the worker is reduced by $395.50 ($938.78 - $543.28) 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 formula threshold of $791, the amount of the WEP reduction remains a flat $395.50 per month. For example, if the worker had an AIME of $4,000 instead of $1,500, the WEP reduction would still be $395.50 per month. The WEP therefore causes a proportionally larger reduction in benefits for workers with lower AIMEs and monthly benefit amounts. 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 Christine Scott. 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 the worker shown in Table 2, with an AIME of $1,500 and a monthly benefit of $938.78 under the regular benefit formula in 2013, the WEP reduction of $395.50 represents a 42% cut to the regular formula monthly benefit amount. By comparison, a worker with an AIME of $4,000 would be entitled to a PIA of $1,738.78 under the 2013 regular benefit formula, and the same WEP reduction of $395.50 per month would represent a 23% reduction in this worker’s monthly benefit amount (CRS calculations). 3 Congressional Research Service 2 Social Security: The Windfall Elimination Provision (WEP) 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 3.6 Table 3. WEP Reduction Falls with Years of Substantial Coverage Years of Social Security Coverage 20 21 22 23 24 25 26 27 28 29 30 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% $197.75 $158.20 $118.65 $79.10 $39.55 First factor in formula: 40% Maximum dollar amount of monthly WEP reduction in 2013:a $395.50 $355.95 $316.40 $276.85 $237.30 $0.00 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 2012, about 1.5 million Social Security beneficiaries were affected by the WEP, as shown in Table 4. About 1.4 million people (92.2% ) affected by the WEP were retired workers. About 2.4% of all Social Security beneficiaries (including disabled and spouse beneficiaries), and about 4.0% of all retired worker beneficiaries, were affected by the WEP in December 2012.7 Of retired workers affected by the WEP, approximately 61.9% were men.8 6 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 enacted) Social Security maximum taxable wage base for each year in question. In 2013, the “old-law” taxable wage base is equal to $84,300, therefore to earn credit for one year of “substantial” employment under the WEP a worker would have to earn at least $21,075 in Social Security-covered employment. 7 Social Security data on the Social Security beneficiary and retired worker populations are available from the Monthly (continued...) 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 2012 Type of Benefit State Total Alabama Total 1,466,386 Retired Workers 1,351,752 Disabled Workers 18,158 Spouses and Children 96,476 17,558 15,885 351 1,322 Alaska 8,011 7,552 105 354 Arizona 27,104 25,150 299 1,655 Arkansas 9,947 9,213 206 528 California 196,310 182,284 2,114 11,912 Colorado 45,386 42,482 660 2,244 Connecticut 14,758 14,041 157 560 3,328 3,129 47 152 Delaware District of Columbia 7,578 7,199 135 244 Florida 81,811 75,619 890 5,302 Georgia 42,455 39,885 544 2,026 Hawaii 8,986 8,277 76 633 Idaho 6,294 5,802 80 412 Illinois 77,033 72,956 633 3,444 Indiana 14,329 13,338 205 786 Iowa 7,604 7,111 79 414 Kansas 8,266 7,681 133 452 19,023 17,653 348 1,022 Kentucky Louisiana 30,319 27,517 667 2,135 Maine 13,787 12,978 165 644 Maryland 42,500 39,846 518 2,136 Massachusetts 53,649 50,892 705 2,052 Michigan 18,302 16,810 301 1,191 Minnesota 15,786 14,830 164 792 Mississippi 8,819 8,109 156 554 Missouri 31,285 29,619 434 1,232 Montana 5,260 4,859 69 332 Nebraska 4,901 4,617 41 243 22,296 21,177 228 891 6,507 6,073 128 306 Nevada New Hampshire New Jersey 20,650 19,008 376 1,266 New Mexico 11,853 10,721 167 965 (...continued) Statistical Snapshot, December 2012, at http://www.socialsecurity.gov/policy/docs/quickfacts/stat_snapshot/index.html 8 Social Security Administration, Office of Research, Evaluation and Statistics, January 2013, unpublished table W01. Congressional Research Service 4 Social Security: The Windfall Elimination Provision (WEP) Type of Benefit New York 29,068 Retired Workers 26,730 North Carolina 26,052 24,315 327 1,410 North Dakota 2,253 2,099 17 137 107,264 100,431 1,233 5,600 Oklahoma 16,319 14,919 303 1,097 Oregon 14,349 13,364 141 844 Pennsylvania 32,825 30,250 540 2,035 Rhode Island 4,691 4,413 67 211 16,006 14,834 223 949 State Ohio South Carolina Total South Dakota Disabled Workers 446 Spouses and Children 1,892 3,541 3,334 36 171 17,967 16,571 250 1,146 Texas 130,515 121,020 1,566 7,929 Utah 12,060 10,918 145 997 2,367 2,197 22 148 Virginia 44,354 40,976 430 2,948 Washington 27,336 24,893 316 2,127 Tennessee Vermont West Virginia 5,750 5,155 130 465 Wisconsin 11,027 10,328 120 579 Wyoming 2,175 2,028 29 118 78,772 60,664 636 17,472 Outlying areas and foreign countries Source: Social Security Administration, Office of Research, Evaluation and Statistics, January 2013, 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.9 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 covered by Social Security. Under the old law, workers who were employed for only a portion of 9 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) 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.10 First, because the WEP adjustment is confined to the first bracket of the benefit formula ($791 in 2013), it causes a proportionally larger reduction in benefits for workers with lower AIMEs and benefit amounts. Second, a high earner is more likely than a low earner to cross the “substantial work” threshold for accumulating years of covered earnings (in 2013 this threshold is $21,075 in 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 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. 10 Jeffrey R. Brown and Scott Weisbenner, The Distributional Effects of the Social Security Windfall Elimination Provision, NBER, Working Paper no. 18342, August 2012, http://www.nber.org/papers/w18342. Congressional Research Service 6 Social Security: The Windfall Elimination Provision (WEP) 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.11 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. Author Contact Information Christine Scott Specialist in Social Policy cscott@crs.loc.gov, 7-7366 Acknowledgments This report was originally written by Alison M. Shelton, a former Analyst at the Congressional Research Service. All questions should be directed to the current author. 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