Turning on Social Security Early? Keep Your Final Paystub to Avoid Penalties
Deciding to take Social Security benefits early can be a practical choice for many retirees, but it comes with potential challenges. One major consideration is the earned income penalty, which could reduce your benefits if you’re still earning income over a certain threshold. But there is a flaw in the Social Security system that sometimes incorrectly assesses the earned income penalty. When someone retires, oftentimes their income for the year is already above the $23,400 earned income threshold but very few retirees realize that if their social security benefit is not turned on until after they receive their final paycheck, the earned income penalty will not apply even though social security may attempt to assess the penalty anyways.
The good news? With proper planning and documentation, such as holding onto your final paystub, you can avoid unnecessary penalties and protect your benefits.
If you are planning to retire prior to your social security full retirement age, and you are also planning on turning on your social security benefits as soon as you retire, you have to be aware of a flaw in the social security system that may automatically prompt social security to attempt to assess an earned income penalty error against your social security benefit in the year that you retire.
Social Security Earned Income Penalty
If you elect to begin receiving Social Security benefits prior to your full retirement age, Social Security assesses a penalty against the Social Security benefits that you receive if your earned income exceeds a specific threshold. That limit in 2025 is $23,400. If you have earned income over $23,400, and you file for social security benefits prior to your FRA, social security will assess a penalty equal to $1 for every $2 over the $23,400 threshold.
For example, Scott retires at age 63; his full retirement age for Social Security is 67, but he elects to file for Social Security benefits as soon as he retires. Scott continues to work part-time and makes $35,000. Since Scott’s income is $11,600 over the $23,400 threshold, social security will assess a $5,800 penalty against Scott’s social security benefit in the following year.
Social security does not assess the penalty by requesting a check from Scott, instead, if Scott was receiving $2,000 per month in Social Security, then the following year they would withhold 3 months of social security payments from Scott, totaling $6,000 to cover the penalty, and then Scott’s monthly benefit would resume after the penalty months have been assessed.
Note: Social security does not withhold partial months for the penalty; if $100 is still owed in the penalty and the monthly SS benefit is $2,400, social security will withhold the full $2,400 monthly benefit to assess the final $100 penalty amount owed.
Flaw In Assessment of Social Security Income Penalty
There is a common flaw in the assessment of the Social Security earned income penalty in the year that an individual retires because it’s a common occurrence that prior to an individual actually retiring, they may have already earned more than the $23,400 income threshold with their employer prior to turning on their social security benefits. Will they be doomed and have to pay the SS penalty, or is there a way to appeal the earned income penalty in these cases?
Thankfully, it’s the latter of the two. In the year that you retire, if you stop working and then turn on your social security benefits AFTER you have stopped working, the income earned prior to the month that you turned on your social security benefits is ignored for purposes of the social security earned income penalty.
For example, Jen, age 64, works for ABC Company from January – May, and then fully retires May 30, 2025. Between January – May, Jen had a W-2 income of $40,000, well above the $23,400 SS earned income threshold. However, since Jen did not turn on her social security benefits until June, after she had received her final paycheck from ABC Company, the $40,000 in W-2 that she earned prior to turning on her SS does not count toward the $23,400 income penalty threshold.
However, here is the flaw. Social Security has no idea when Jen stopped working during the year. All social security knows is that Jen turned on her social security prior to her full retirement age, and according to her tax return filed in that year, her earned income was over the $23,400 threshold. Due to this flaw, we coach clients by saying, “expect social security to attempt to assess the earned income penalty, but keep your final pay stub which shows the date of your final payroll and the total W-2 amount, which should be the amount of earned income that was reported on your tax return”. It may also be helpful to obtain a letter from your employer verifying your final date of employment and the total W-2 income earned at the time of separation from service.
Individuals Who Retire but Then Work Part-time
There are situations where individuals retire from their primary career, turn on Social Security after receiving their final paycheck, but then later in that calendar year they work part-time or start a business that produces income. There is a special assessment of the Social Security earned income penalty for these individuals. The income earned prior to turning on their social security benefit is still ignored, but assuming that their income exceeds the $23,400 threshold before they retire, social security allows these individuals to continue to collect their social security benefit without penalty as long as:
Their monthly income received does not exceed $1,950 ($23,400 divided by 12 months) …..AND
The individual did not perform substantial services in self-employment. The definition of substantial services means devoting more than 45 hours a MONTH to the business or between 15 – 45 hours to a business in a highly skilled occupation.
Exceeding either of the thresholds listed above will trigger the penalty.
Full Retirement Age – No Income Limits
Once you have reached FRA (full retirement age) for Social Security, the earned income penalty no longer applies. You can then earn as much as you want in earned income, and the Social Security earned income penalty will not apply.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Frequently Asked Questions (FAQs):
What is the Social Security earned income penalty?
If you begin receiving Social Security benefits before reaching your full retirement age (FRA) and continue to earn income from work, the Social Security Administration may reduce your benefit. In 2025, the income limit is $23,400. For every $2 you earn above that amount, $1 of your Social Security benefits is withheld.
How does Social Security apply the penalty?
Social Security doesn’t send you a bill. Instead, it withholds full months of future benefit payments until the penalty amount is repaid. For example, if your penalty is $5,800 and your monthly benefit is $2,000, Social Security would withhold three full months of benefits ($6,000 total).
What happens if I retire mid-year and already earned more than the limit?
If you stop working and turn on your Social Security benefits after retirement, your earnings from earlier in the same year do not count toward the $23,400 limit. However, because Social Security’s system doesn’t automatically know when you stopped working, it may incorrectly assess a penalty.
How can I appeal an incorrect earned income penalty?
Keep your final pay stub showing your last paycheck date and total W-2 income, and ask your former employer for a letter verifying your final date of employment. You can use these documents to appeal the penalty and demonstrate that your income occurred before you began receiving benefits.
Can I work part-time after turning on Social Security before full retirement age?
Yes, but limits still apply. As long as you earn less than $1,950 per month (the monthly equivalent of $23,400 per year) and do not perform “substantial services” in self-employment (more than 45 hours per month, or 15–45 hours in a highly skilled field), your benefits will not be reduced.
What happens once I reach full retirement age (FRA)?
Once you reach FRA, the earned income penalty no longer applies. You can earn as much income as you want without any reduction in your Social Security benefits.
Why is the earned income penalty considered a flaw?
The flaw arises because Social Security’s system uses annual income data from tax filings without knowing when during the year the income was earned. This often causes the system to mistakenly flag retirees who stopped working mid-year as exceeding the income limit, even when they are not subject to the penalty.
Social Security Income Penalties Are Refunded To You When You Reach Fully Retirement Age
If you turn on social security prior to your fully retirement age andmake too much money in a given tax year, Social Security will assess an earned income penalty against your social security benefit but not many taxpayers realize that your get those penalties refunded to you once you reach Full Retirement Age
If you decide to turn on your Social Security payments before your full retirement age, the IRS has something called the Social Security Earnings Test where they assess a penalty if you make over a specified amount during that tax year. For 2025, that amount is $23,400 and the penalty is $1 for every $2 you earn over that threshold, but not many taxpayers realize that Social Security actually refunds you the penalty amounts once you reach full retirement age. In this article, I will walk you through:
• Social Security Full Retirement Age Based on Date of Birth
• Social Security Earnings Test
• How they assess the Social Security earnings penalty
• How does Social Security refund you the penalties paid when you reach full retirement age
• Other social security filing considerations
Social Security Full Retirement Age
As I mentioned in the intro, if you turn on Social Security PRIOR to your Full Retirement Age (“FRA”) and you continue to work, you are subject to the SS earnings test and possible penalties. Your SS full retirement age varies based on your date of birth:
The final column in the chart above shows the permanent reduction in your social security benefit if you turn on your SS benefit at age 62. If you plan to turn on your social security prior to your full retirement age and you plan to continue to work, you have to be careful with this decision. Not only are you permanently reducing your SS benefit, but you are also subject to the Social Security earnings test.
Once you reach Full Retirement Age, the SS earnings test goes away, you can make as much money as you want, and social security does not assess a penalty.
Social Security Earnings Test
Here’s how the social security earnings test works. If you turn on your SS benefit prior to full retirement age and you make more than $23,400 in 2025, SS will assess a penalty of $1 for every $2 you earn over that limit (50% penalty). The IRS increases the income threshold a little each year. Let’s look at the example below:
• You are age 63
• Your monthly social security benefit is $1,000 ($12,000 annually)
• You made $26,320 in earned income in 2025
In the example above, you earned $4,000 in income above the limit ($26,320 - $23,400 = $2,920). Social Security will assess a penalty of $1,460 ($2,920 × 50%).
How Do You Pay The Social Security Earned Income Penalty?
Let’s keep building on the previous example, you failed the earnings test, and you owe the $1,460 penalty, how do you pay it? The good news is you don’t have to write a check for it; instead, social security will withhold your social security payments the following year until you have satisfied the penalty. In the example above, your monthly SS benefit was $1,000 and you had a $1,460 penalty. Social security will withhold two of your monthly SS payments the following year and then your monthly social security payment will resume as normal.
Note: Social security does not withhold partial months, only full months to assess the penalty which means they may technically assess a larger penalty than what is actual due based on the 50% over the limit calculation.
The math for this example came out easy, 2 months exactly, but what if your monthly benefit is $1,000 and the penalty is $2,400, which would be 2.4 months of benefit payments? Social security rounds UP all fractional months, so they would withhold 3 full months of your social security payments even though that means they are withholding $3,000 to pay back a $2,400 penalty. The additional $600 that they withheld will be refunded back to you when they process the refund of the earned income penalty at your full retirement age. *reword to match example? (YES DELETE THIS SECTION)
Social Security Does Refund You The Penalties At Full Retirement Age
If social security withheld some of your monthly payments due to a failed earnings test prior to reaching your FRA, the good news is, once you reach full retirement age, social security refunds those penalties back to you. Unfortunately, they do not just send you a check for the dollar amount of all of those missed payments. Instead, upon reaching full retirement age, they recalculate your monthly social security payment taking into account those missed payments.
The easiest way to explain the refund calculation is via an example:
• Your SS full retirement age is 67
• You turned on your SS payment at age 62
• Your monthly SS benefit payments are $2,000
• Every year you made $8,000 over the SS earnings test limit
• This resulted in a $4,000 earned income penalty each year
• SS withheld 2 months of your benefit payments each year to assess the penalty
• 2 months × 5 years of SS payments = 10 months of missed payments
Between age 62 and reaching age 67, social security withheld a total of 10 months of your social security payments. Upon reaching FRA 67, instead of continuing your monthly benefit at $2,000, they credit you back those 10 months of payments, by recalculating your social security benefit assuming you originally turned on your SS benefit at age 62 & 10 months instead of age 62 & 0 months. This reduces the amount of the permanent penalty that you incurred for turning on your social security benefit prior to full retirement age, and you will receive a slightly higher social security benefit for the rest of your life to repay you for those earned income penalties that were assessed prior to full retirement age. It may take you a number of years to recoup those penalty payments, but how long you live will ultimately determine whether this refund calculation benefits you or the social security system.
Other Considerations Before Turning on Your SS Benefit Early
After reading this article, it may seem like a no-brainer to turn on your SS benefit early: if you earn too much in a given year and get assessed a penalty, so what — you just get the money back later. But it’s important to understand that there are other factors that you need to take into consideration before turning on your social security benefits early which include:
• The impact on the survivor benefits for your spouse
• The breakeven age of turning on the benefits early versus waiting
• How social security benefits are taxed
• Taking advantage of the automatic increase in the amount of the benefit each year
• The 50% spousal benefit
• Your life expectancy
Here is our article on Social Security Filing Strategies covering these other considerations.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Frequently Asked Questions (FAQs):
What is the Social Security Earnings Test?
The Social Security Earnings Test applies if you claim benefits before your full retirement age and continue to work. In 2025, you can earn up to $23,400 without penalty; beyond that, Social Security withholds $1 in benefits for every $2 you earn over the limit.
Does the earnings test apply after reaching full retirement age?
No. Once you reach your full retirement age (FRA), the earnings test no longer applies. You can earn an unlimited amount without any reduction in your Social Security benefits.
How is the Social Security earnings penalty paid?
You don’t pay the penalty out of pocket. Instead, Social Security withholds full monthly benefit payments until the total amount of the penalty is recovered. Because the program only withholds full months, it may temporarily take more than the exact penalty amount.
Does Social Security refund withheld benefits at full retirement age?
Yes. Once you reach your FRA, Social Security recalculates your benefit to credit back the months that were withheld due to the earnings test. Rather than sending a lump-sum refund, your monthly benefit is permanently increased to reflect those previously lost months.
How does the refund adjustment work?
When you reach full retirement age, Social Security recalculates your benefit as if you had started payments later—reducing the early-claiming penalty. For example, if you began benefits at age 62 and had ten months of payments withheld, your benefits would be adjusted as though you started at age 62 and 10 months, increasing your future monthly payments.
What factors should you consider before claiming Social Security early?
Before turning on benefits early, consider the long-term impact on survivor benefits, the break-even age compared to waiting, potential taxation of your benefits, annual cost-of-living adjustments, spousal benefit eligibility, and your life expectancy.
