Retiring federal employees, beware! Your Social Security benefits might be at risk if you plan to keep working. But here's the kicker: even a lump-sum payout for unused vacation days could temporarily slash your monthly checks.
December has long been a popular month for federal employees to retire, and 2025 was no different. Many CSRS and FERS employees hung up their hats at the end of the year, likely enticed by the prospect of a hefty lump-sum payment for unused annual leave. While this payout can be a nice financial boost, it comes with a catch: it's fully taxable, including Social Security (FICA) and Medicare taxes. These payments, along with your final paycheck, will land in your bank account in January 2026.
And this is the part most people miss: If you're planning to continue working in 2026 – whether as a rehired annuitant, for a private company, or as your own boss – and you're also collecting Social Security retirement benefits, you could face a temporary reduction in those benefits due to the Social Security Administration's (SSA) 'earnings test.' This test applies to earned income, which includes salaries, wages, and self-employment income.
Here's how it works: If you're under your full retirement age (FRA) and receiving Social Security benefits, the SSA may reduce your monthly payments based on your earned income. Your FRA depends on your birth year. For example, if you were born in 1963, your FRA is 67.
Controversial question: Is it fair to penalize retirees who want to stay active and contribute to the workforce?
The earnings test has two tiers. For 2026:
- Under FRA all year: You can earn up to $24,480 annually ($2,040/month) before facing reductions. For every $2 earned above this limit, your Social Security benefit is reduced by $1.
- Reaching FRA in 2026: You can earn up to $65,160 annually ($5,430/month) until the month you reach FRA. For every $3 earned above this limit, your benefit is reduced by $1.
Good news: Once you reach your FRA, the earnings test disappears, and you can earn as much as you want without affecting your Social Security benefits. Even better, the SSA will eventually recalculate your benefits to account for months where they were reduced due to the earnings test, potentially increasing your future payments.
Important: The earnings test only applies to earned income. Investment income, pensions, IRA distributions, and rental income are not factored in.
Pro Tip: If you receive a lump-sum payment for unused leave or a final paycheck after retiring, make sure to file Form SSA-131 (Employer Report of Special Wage Payments) with the SSA. This ensures these payments aren't counted as 2026 earnings and don't trigger benefit reductions.
Understanding the interplay between federal retirement, continued work, and Social Security benefits can be complex. Consulting with a financial advisor specializing in federal employee benefits can help you navigate these rules and maximize your retirement income.
What's your take? Do you think the Social Security earnings test is fair? Share your thoughts in the comments below!
Disclaimer: This information is for general purposes only and should not be considered legal or financial advice. Consult with a qualified professional for personalized guidance.
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