If you receive a pension from a job for which you did not have to pay Social Security taxes (e.g. work as an employee of a local government), any Social Security benefits you would otherwise be eligible to receive could be reduced by two special rules:

• The Windfall Elimination Provision (WEP), or
• The Government Pension Offset (GPO).

Note that neither of these rules applies in the case of a worker who receives a pension from work that was subject to Social Security taxes.

Windfall Elimination Provision (WEP)

The Windfall Elimination Provision reduces any Social Security benefit you would receive for other work that you did — that is, work that was covered by Social Security taxes.

Example: Elena works for 21 years as a police officer — a job in which she does not pay Social Security taxes. She then works for another 19 years for a private security firm. Because of her work for the local government, Elena qualifies for a pension. And because of her work for the security firm, she also qualifies for Social Security. The Windfall Elimination Provision will reduce the amount of Social Security benefits that Elena receives.

The Windfall Elimination Provision works by changing the formula used to calculate the amount of benefits you would receive if you claimed at your “full retirement age.” From there, any percentage adjustments are applied as normal for claiming earlier or later than full retirement age.

For people not affected by the WEP, Social Security is calculated to replace a certain percentage of their “average indexed monthly earnings” — that is, the average monthly earnings from their 35 highest-earning years, after adjusting those earnings for inflation. For somebody becoming eligible for Social Security in 2012, if claimed at full retirement age, Social Security would replace:

• 90% of average indexed monthly earnings (AIME) up to $767, plus
• 32% of AIME from $767 to $4,624, plus
• 15% of AIME beyond $4,624.

The Windfall Elimination Provision changes that 90% number (from the first line of the calculation) to a lower number, depending on the number of years in which you had “substantial earnings” covered by Social Security taxes. (The threshold for “substantial earnings” changes by year. For 2012, it is $20,475.)

• If you have 20 or fewer years with substantial earnings, the figure used will be 40% instead of 90%.
• For each year of substantial earnings beyond 20, the figure increases by 5%.
• Once you reach 30 years of substantial earnings, the Windfall Elimination Provision will not apply.

Important exception: The Windfall Elimination Provision will never reduce a worker’s primary insurance amount (that is, the benefit he/she would receive if claimed at full retirement age) by more than 50% of the worker’s monthly pension amount. (If you are paid a pension in the form of a lump sum, the pension will be recalculated as if it were paid monthly.)

Government Pension Offset (GPO)

The Government Pension Offset reduces any Social Security spousal or survivor benefits you would receive based on your spouse’s work record. The reduction in monthly benefits is calculated as 2/3 of the monthly pension amount you receive. (Again, in the case of a pension taken as a lump sum, the reduction will be calculated as if the pension had been paid out on a monthly basis.)

Example: Bob worked for many years in an administrative role for his local fire department. Upon his retirement at age 67, Bob gets a monthly pension of $2,100 per month. At full retirement age, Bob’s wife Janice begins claiming her Social Security benefit of $2,000 per month.

Ordinarily, this would mean that Bob could get a spousal Social Security benefit of $1,000 per month (50% of Janice’s $2,000) as long as he claims it at full retirement age or later. However, because of the Government Pension Offset, Bob’s monthly spousal benefit will be reduced by $1,400 (2/3 of his $2,100 monthly pension), thereby eliminating it completely.

Upon Janice’s death, Bob will be able to claim a Social Security survivor benefit on Janice’s record. Ordinarily, since Janice claimed her benefit at her full retirement age and because Bob is claiming the survivor benefit after full retirement age, he’d be able to receive a survivor benefit equal to the $2,000 per month benefit she was receiving. But the GPO will reduce the benefit by $1,400 (2/3 of his $2,100 monthly pension), thereby leaving him with a monthly survivor benefit of $600.

A reader writes in, asking:

“After reading about the new online Social Security statements, my husband and I created accounts to check our estimated benefits. The website told me that at this time I do not have enough credits to qualify for retirement benefits. This is not a surprise because I spent many years out of the workforce while raising our children.

I’ve gone back to work, and I understand that if I keep working for another 2-3 years I’ll qualify for benefits. But I’m curious what would happen if I didn’t go back to work. I see the total amount of taxes paid by me and by my employers. Where would that money go? If I don’t qualify for benefits, what happens with all the money in my Social Security account?”

The short version is that you don’t have a Social Security account — at least, not in the sense that you have an account at a bank or brokerage firm. When you pay Social Security taxes, the money does not go into an account somewhere with your name on it. Instead, the money is primarily used to pay for the benefits of people who are currently retired and collecting Social Security.

In other words, when the Social Security website shows you the amount of Social Security taxes that you’ve paid over the course of your career, it does not mean that that money is sitting around waiting for you. That money has (mostly) already been spent on other people’s benefits.

With Social Security, there’s no promise that you’ll get your money back or that you’ll earn a certain rate of return on your money. The promise is simply that (if the rules don’t change and the money is available to pay the promised benefits*), once you become eligible, you will receive benefits for the rest of your life (or until you become ineligible) in keeping with the applicable benefits formula(s).

Different Returns for Different People

It’s simply the nature of the system that different people will earn very different rates of return on the money they pay into Social Security.

Example 1: Susan has a very lucrative career as a physicist, earning the maximum amount subject to Social Security taxes every year from age 25-60. At age 61, she dies suddenly, with no spouse or dependents and having never been disabled.

Result: Susan paid a heck of a lot of money into the system and never got back a dime.

Example 2: Sharon spends her entire career working as a kindergarden teacher at a financially-struggling private school. She enjoys her work, but earns very modest pay throughout her career. At age 60, she marries Luis, a lawyer with a very high earnings history. One year later, Luis dies. Sharon lives to be 103, collecting survivor benefits based on Luis’ earnings history for more than 40 years.

Result: Sharon made out like a bandit, collecting a relatively high Social Security benefit for many years, despite having paid relatively little into the system herself.

The takeaway: The amount of money you end up getting back from Social Security is not directly proportional to the amount of money you put into it. The “total taxes paid” figure on the Social Security website may be interesting, but it doesn’t mean much when it comes to predicting the amount of money you’ll receive.

*Admittedly, this is something of a contradiction in terms. If the rules don’t change, the money won’t be there to pay 100% of the benefits promised by the current system. According to the most recent Social Security Trustees Report, starting in 2033 only 75% of projected benefits are expected to be able to be paid unless some sort of legislative action is taken.