The Windfall Elimination Provision (WEP) is something that seems to affect many British expats living/retiring in America. However, most appear not to be expecting it and, as it can only mean a reduction in Social Security (SS) benefits, often comes as an unpleasant and unwelcome surprise.
WEP is a tricky one. The purpose of this blog is to introduce WEP to you, explain it and how it might apply to you, and provide a reference point for you to return to if/when you need to.
I’m going to purposely try and stay quite general. If I get too specific I’m going to lose you because it is pretty dull. I will limit my discussion to what you need to know at retirement, at the time of drawing benefits and/or when doing some planning. Furthermore, if you want specifics now here are a couple of very good resources:
I’ve found that WEP makes people very angry. My gut tells me that this is partly because it hits them out of the blue and partly because they feel it is unjust. But what is it exactly?
What is the Windfall Elimination Provision (WEP)?
WEP is a reduction to someone’s SS retirement benefits because they receive a pension that was funded by employment earnings that were not subject to US Social Security taxes.
If you worked in the UK for any extended period of time and paid National Insurance Contributions (NICs) on your wages (which you almost certainly did), then you probably built up an entitlement to the UK’s State Pension (SP). Even if you know you “opted out” you opted out of SERPS, not the UK SP (because you can’t opt out of the UK SP).
This is a good thing, as it means you are likely to have an extra guaranteed pension income. But as far as WEP is concerned this is a pension that was funded by earnings not subject to US SS taxes and therefore WEP may apply and your SS retirement benefit may be reduced.
Before I drill into this, let’s just pause and briefly look at why WEP exists. You may not care, in which case please skip gaily past this part. However, as angry as it does make people (and I get it) it does actually make some sense and it may be easier to bear if you understand why it exists.
To understand why WEP exists you must first understand a fundamental part of how SS retirement benefits work. They work to replace SOME of your income when you stop working. But, benefits are designed to replace more income for low earners as a percentage of their pre-retirement earnings. So, a high earning retiree may receive much more in dollar terms than a low earning retiree, but as a percentage of their pre-retirement income the lower earner may get much more.
So, SS is designed to replace a higher percentage of income of lower income workers and WEP exists to ensure that workers who made most of their income from employment not subject to SS taxes, and thus have lower purely US earnings as a result, do not get too high a percentage of their total income in the form of SS retirement benefits.
Some jobs are not covered by social security – for example, teachers in certain states opted out of SS in favour of contributing to their own retirement plans – and, therefore the years they spend in these jobs need to be taken into account when calculating their SS retirement benefits to maintain the integrity of this “social” program (i.e. replacing a higher percentage of lower income workers income).
Unfortunately for us, the UK State Pension is also caught in this net.
For more information on this, please see this article.
The specifics (without being too specific)
The way they penalize you is by reducing your SS benefits based on the number of years you have had “Substantial Earnings” attributable to SS taxes. For reference, substantial earnings in 2021 are $26,550, so let’s just assume every year you had substantial earnings.
For a detailed breakdown of how SS retirement benefits are calculated and how WEP is applied, please check out the Motely Fool article I mentioned earlier. I am not going to get granular here simply because I don’t need to for you to understand how it might affect you.
In short, and all of this is in 2021 terms/numbers, if you have been paying into SS for 30 years (i.e. your contribution record is 30 years or more) your SS retirement benefit will not be affected. You will have maxed out your SS retirement entitlement and you will be able to draw your entire UK SP (or any other external pension upon which WEP is assessed), without penalty.
If you have a contribution record of 20 years or less, then your SS retirement benefits will be reduced by up to $498 per month ($5,976 p.a.).
If your contribution record is between 20-30 years by the time your start drawing SS retirement benefits, then there is a sliding scale for how much you will be penalized. For example, a 25-year record will mean your SS retirement benefits are reduced by up to $249 per month ($2,988 p.a.)
Something very important to note is that this could unfairly penalize some people and as a result your SS retirement benefits are guaranteed not to be reduced by more than 50% of the pension that is causing the reduction (i.e. your SS retirement benefits will not be reduced by more then 50% of your UK SP entitlement, assuming your SS retirement benefits are being reduced because of your UK SP and not some other pension).
Therefore, in 2021 terms, I think we can safely say that the worst penalty you will suffer as a result of the WEP is a reduction of $5,967 p.a. OR 50% of your UK SP, whichever is lower. Another way of looking at is it that $5,967 p.a. is the maximum that you can be penalized if the WEP applies to you. And because of the 50% guarantee, you should always be better off claiming your UK SP than not doing.
Beware of the Exchange (FX) Rate
Something to be aware of – I get the impression, from people who have reached out to me who have been affected by this, that the Social Security Administration (SSA) determine and fix your UK SP in dollar terms at the time you first declare it to them (which appears to be on Form SSA-308). Obviously, your UK SP is paid in GBP and always will be, but you declare it in USD terms at the prevailing FX rate at that time.
Here’s the rub – someone with £5,000 p.a. UK SP in 2008 at 2 USD to each GBP is deemed to have a much higher income that someone declaring £5,000 p.a. UK SP in 2018 at 1.3 USD to 1 GBP. We’re talking $10,000 p.a. Vs $6,500.
As a result, because it is locked in at the beginning, continuing the above example, the poor guy (or gal) who started their UK SP in 2008 could be being penalized up to $5,000 p.a. Vs the 2018 retiree suffering only a maximum penalty of $3,250 p.a.
Finally, from what I can ascertain, WEP does not apply to benefits built up in UK company pension schemes.
In summary, WEP makes people very angry, although I suspect that this is mainly because they weren’t expecting it and may have made retirement plans without factoring it in. Worst case scenario, for most of our clients, it really isn’t that big of a deal. Bottom line, because you can only be penalized a maximum of 50% of the UK SP income, you are always best to take both SS retirement benefits and UK SP assuming you are entitled to them. Just be mindful that if you start your UK SP at a time when GBP is strong against the dollar, you could actually end up effectively being penalized more than 50% because GBP has weakened (or USD strengthened, or both) and yet you are still getting paid your UK SP in GBP and getting a whole lot less for it when you bring it into the US.
How to estimate your exposure
You can download a calculator from the SSA and incorporate WEP into the calculation. There is, however, sufficient information usually readily available for you to make an estimation.
You can easily access your SS contribution record and retirement benefit projections by creating a “my Social Security” account – we strongly recommend that you do this regardless.
You can also get a UK SP forecast in about 5 minutes by visiting this site – we strongly recommend that you do this regardless also.
Finally, armed with the above benefit statements/forecasts and an idea of how long you will continue to have Substantial Earnings from employment for SS tax purposes (i.e. how long will you continue to work) you can use the specific information documented in the SSA and Motley Fool links I posted above to predict whether you will be caught by WEP and, if so, what the effect on your PIA is likely to be (the reduction to your PIA will directly affect how much your benefits are reduced).
This isn’t as onerous as it sounds and, of course, our clients needn’t worry about it as we’ll do this on your behalf once you’ve provided us with your SS and UK SP forecasts. The SSA do provide a calculator online (which can be found here), but I think it is probably asking for too much information that people rarely have at their fingertips.
Spouse’s Survivor Benefits
The benefit payable to the spouse of a worker subject to the WEP is also reduced, but only while the worker is alive. If the worker dies, the survivor benefit is calculated using the standard Social Security formula without any reduction for the WEP.
Should I forfeit my UK State Pension?
No, because, as mentioned above, as a result of the guarantee, your SS retirement benefits can only be reduced by a maximum of 50% of your UK SP. Depending on the exchange rate used by the SSA to calculate your UK SP this can in fact result in more or less than 50% being forfeited, but regardless I cannot imagine a scenario where you would be worse off as a result of claiming both. Furthermore, it appears that the WEP could be applied simply on you being eligible for the UK SP and not necessarily even physically claiming or receiving it!
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