Most California employees work for employers who do not withhold Social Security taxes from their salaries, which means that your governmental pension may reduce your Social Security benefits. This potential reduction in your Social Security is called the Windfall Elimination Provision.

The Windfall Elimination Provision affects how the amount of your retirement or disability benefit is calculated if you receive a pension from work where Social Security taxes were not taken out of your pay. This modified formula is used to calculate your benefit amount, resulting in a lower Social Security ¬benefit than you otherwise would receive if you had no governmental pension.

The Windfall Elimination Provision primarily affects you if you earned a pension in any job where you did not pay Social Security taxes and you also worked in other jobs long enough to qualify for a Social Security retirement or disability benefit.

For example, Windfall Elimination Provision affects Social Security ¬benefits if any part of your government employment is after 1956. However, federal service where Social Security taxes are withheld (Federal Employees’ Retirement System) will not reduce your Social Security benefit amounts. The Windfall Elimination Provision may apply if:

• You reached 62 after 1985; or
• You became disabled after 1985; and
• You first became eligible for a monthly pension based on work where you did not pay Social Security taxes after 1985, even if you are still working.

Social Security benefits are intended to replace only a percentage of a worker’s pre-retirement earnings. The way Social Security benefit amounts are figured, lower-paid workers get a higher return than highly paid workers. For example, lower-paid workers could get a Social Security benefit that equals about 55 percent of their pre-retirement earnings. The average replacement rate for highly paid workers is about 25 percent.

Before 1983, people who worked mainly in a job not covered by Social Security had their Social Security benefits calculated as if they were long-term, low-wage workers. They had the advantage of receiving a Social Security benefit representing a higher percentage of their earnings, plus a pension from a job where they did not pay Social Security taxes. Congress passed the Windfall Elimination Provision to remove that advantage.

Social Security benefits are based on the worker’s average monthly earnings adjusted for inflation. They separate your average earnings into three amounts and multiply the amounts using three factors. For example, for a worker who turns 62 in 2011, the first $749 of average monthly earnings is multiplied by 90 percent; the next $3,768 by 32 percent; and the remainder by 15 percent. The sum of the three amounts equals the total monthly payment amount.

The 90 percent factor is reduced in the modified formula and phased in for workers who reached age 62 or became disabled between 1986 and 1989. For those who reach 62 or became disabled in 1990 or later, the 90 percent factor is reduced to 40 percent.

There are exceptions to this rule. For example, the 90 percent factor is not reduced if you have 30 or more years of “substantial” earnings in a job where you paid Social Security taxes.

The Windfall Elimination Provision does not apply if:

• You are a federal worker first hired after December 31, 1983;
• You were employed on December 31, 1983 by a nonprofit organization that did not withhold Social Security taxes from your pay at first, but then began withholding Social Security taxes from your pay;
• Your only pension is based on railroad employment;
• The only work you did where you did not pay Social Security taxes was before 1957; or
• You have 30 or more years of substantial earnings under Social Security.

I hear from many public employees, “I paid in to Social Security; “it’s not fair that they don’t give me my full credit!” It may not be fair but the rules are the rules. If you plan for it, the effects may be greatly minimized.

If you have questions regarding the Windfall Elimination Provision and how it may affect you individually, call me at (800) 627-6722. Information, statistics and other data obtained from www.socialsecurity.gov-2011.

Curt Howard is a CSFA endorsed Investment Advisor Representative with Transamerica Financial Advisors, Inc. (TFA). Securities and Investment Advisory Services offered through Transamerica Financial Advisors, Inc. (TFA). Member FINRA, SIPC and A Registered Investment Advisor. Non-securities products and services are not offered through TFA. CSFA is not affiliated with TFA. 2339 Gold Meadow Way, #200, Gold River, CA 95670 (800) 627-6722.

LD40987-08/12.