Social Security: The Windfall Elimination Provision (WEP) Gary Sidor Information Research Specialist April 16, 2014 The House Ways and Means Committee is making available this version of this Congressional Research Service (CRS) report, with the cover date shown, for inclusion in its 2014 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 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 small portion of their careers in Social Security-covered employment. Opponents contend the provision is basically imprecise and can be unfair. 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 2014........................................................................... 1 Table 2. Monthly PIA for a Worker With Average Indexed Monthly Earnings of $1,500 and Retiring in 2014 ..................................................................................................................... 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 2013 ............ 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 (more specifically, 40 or more quarters for which the worker has covered earnings). 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 2014, the PIA is determined in Table 1 as follows: Table 1. Social Security Benefit Formula in 2014 Factor Average Indexed Monthly Earnings 90% of the first $816, plus 32% of AIME over $816 and through $4,917, plus 15% of AIME over $4,917 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. 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 approximately the same proportion of wages for each generation. Congressional Research Service 1 Social Security: The Windfall Elimination Provision (WEP) Consequently, for a worker with a low AIME because he or she split their 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 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 [CSRS]).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 2014. Table 2. Monthly PIA for a Worker With Average Indexed Monthly Earnings of $1,500 and Retiring in 2014 Regular Formula Windfall Elimination Formula 90% of first $816 $734.40 40% of first $816 $326.40 32% of earnings over $816 and through $4,917 $218.88 32% of earnings over $816 and through $4,917 $218.88 15% over $4,917 Total 0.00 $953.28 15% over $4,917 Total 0.00 $545.28 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 monthly benefit for the worker is reduced by $408.00 ($953.28 $545.28) relative to the regular benefit formula. Note that the WEP reduction is limited to the first bracket in the AIME formula (90% vs. 40% 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 $816, the amount of the WEP reduction remains a flat $408 per month. For example, if the worker had an AIME of $4,000 instead of $1,500, the WEP reduction would still be $408 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 $953.28 under the regular benefit formula in 2014, the WEP reduction of $408.00 represents a cut of approximately 43% to the regular formula monthly benefit amount. By comparison, a worker with an AIME of $4,000 would be entitled to a PIA of $1,753.28 under the 2014 regular benefit formula, and the same WEP reduction of $408 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 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 does not apply to workers who have 30 or more years of “substantial” employment covered under Social Security, with an adjusted formula 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% $204.00 $163.20 $122.40 $81.60 $40.80 First factor in formula: 40% Maximum dollar amount of monthly WEP reduction in 2014:a $408.00 $367.20 $326.40 $285.60 $244.80 $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. Also, the reduction is greatest when the AIME is equal to or exceeds the first bend point in the computation formula. When the AIME is less than the first bend point, the effect of the WEP formula is reduced. The WEP also 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 2013, about 1.5 million Social Security beneficiaries were affected by the WEP, as shown in Table 4. About 1.4 million people (92.5%) affected by the WEP were retired workers. About 2.7% of all Social Security beneficiaries (including disabled and spouse beneficiaries) and about 3.8% of all retired worker 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 2014, the “old-law” taxable wage base is equal to $87,000, therefore to earn credit for one year of “substantial” employment under the WEP a worker would have to earn at least $21,750 in Social Security-covered employment. Congressional Research Service 3 Social Security: The Windfall Elimination Provision (WEP) beneficiaries were affected by the WEP in December 2013.7 Of retired workers affected by the WEP, approximately 61% were men.8 Table 4. Number of Beneficiaries in Current Payment Status with Benefits Affected by Windfall Elimination Provision (WEP), by State and Type of Benefit, December 2013 Type of Benefit State Total Total 1,549,544 Alabama Retired Workers 1,433,475 Disabled Workers 17,561 Spouses and Children 98,508 18,077 16,426 322 1,329 Alaska 8,523 8,043 107 373 Arizona 28,603 26,603 304 1,696 Arkansas 10,178 9,496 190 492 California 208,941 194,557 2,100 12,284 Colorado 48,596 45,636 683 2,277 Connecticut 15,784 15,033 150 601 3,595 3,395 39 161 Delaware District of Columbia 7,747 7,403 117 227 Florida 85,783 79,527 884 5,372 Georgia 45,048 42,475 548 2,025 Hawaii 9,463 8,742 76 645 Idaho 6,661 6,145 75 441 Illinois 81,684 77,571 614 3,499 Indiana 15,009 14,023 202 784 Iowa 7,789 7,334 61 394 Kansas 8,595 8,039 118 438 Kentucky 20,168 18,820 323 1,025 Louisiana 33,094 30,200 691 2,203 Maine 14,708 13,895 145 668 Maryland 44,218 41,591 484 2,143 Massachusetts 57,930 55,072 687 2,171 Michigan 19,157 17,678 274 1,205 Minnesota 16,166 15,248 162 756 Mississippi 9,169 8,464 149 556 Missouri 33,033 31,436 385 1,212 Montana 5,525 5,133 53 339 Nebraska 5,038 4,762 45 231 24,289 23,110 240 939 Nevada 7 Social Security data on the total Social Security beneficiary and retired worker populations used in calculations are available from the Monthly Statistical Snapshot, December 2013, at http://www.socialsecurity.gov/policy/docs/ quickfacts/stat_snapshot/2013-12.html. 8 Social Security Administration, Office of Research, Evaluation and Statistics, January 2014, unpublished table W01. Congressional Research Service 4 Social Security: The Windfall Elimination Provision (WEP) Type of Benefit 6,887 Retired Workers 6,471 New Jersey 21,518 19,882 337 1,299 New Mexico 12,357 11,246 170 941 New York 30,194 27,802 423 1,969 North Carolina 27,168 25,466 305 1,397 North Dakota 2,249 2,113 12 124 State New Hampshire Ohio Total Disabled Workers 115 Spouses and Children 301 114,396 107,466 1,287 5,643 Oklahoma 16,883 15,521 283 1,079 Oregon 15,025 13,982 129 914 Pennsylvania 34,129 31,595 525 2,009 Rhode Island 4,995 4,722 68 205 South Carolina 16,685 15,514 216 955 South Dakota 3,663 3,466 34 163 18,684 17,362 221 1,101 Texas 140,144 130,435 1,507 8,202 Utah 12,483 11,374 137 972 Tennessee Vermont 2,445 2,280 21 144 Virginia 45,905 42,547 390 2,968 Washington 28,803 26,329 281 2,193 5,943 5,363 120 460 11,482 10,793 95 594 West Virginia Wisconsin Wyoming Outlying areas and foreign countries 2,248 2,111 24 113 82,687 63,778 633 18,276 Source: Social Security Administration, Office of Research, Evaluation and Statistics, January 2014, 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.9 The purpose of the 1983 provision 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, to the present 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) day the formula does not differentiate between those who worked in low-paid jobs throughout their careers and other workers who appear 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 intends 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 ($816 in 2014), 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 2014 this threshold is $21,750 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. 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 found that the WEP can also lead to 10 Jeffrey R. Brown and Scott Weisbenner, The Distributional Effects of the Social Security Windfall Elimination Provision, Journal of Pension Economics and Finance, Volume 12, Issue 04, October 2013, pp. 415-434. http://business.illinois.edu/weisbenn/RESEARCH/PAPERS/JPEF_Brown_Weisbenner.pdf. Congressional Research Service 6 Social Security: The Windfall Elimination Provision (WEP) 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 an adjustment in the WEP formula applied to the AIME. 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 This comparison implies 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. 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