Did you know that retiring at the end of December could cost you some of your Social Security benefits? It’s a surprising twist that many federal employees overlook. But here’s where it gets controversial: while retiring in December allows you to cash in on a lump-sum payment for unused annual leave, it might also trigger a temporary reduction in your Social Security benefits if you plan to keep working in the new year. Let’s break it down in a way that’s easy to understand, even if you’re new to this.
Every year, December sees a wave of federal retirements, and 2025 was no different. Many CSRS and FERS employees chose this time to retire, partly because they can receive a lump-sum payout for their unused annual leave hours. Sounds great, right? Well, there’s a catch. That lump-sum payment is fully taxable—think federal and state income taxes, Social Security (FICA), and Medicare Part A taxes. For those who retired on December 31, 2025, this payment, along with their final paycheck, will hit their bank accounts in January 2026. But this is the part most people miss: if you’re planning to work in 2026—whether as a rehired annuitant, for a private company, or as a self-employed individual—while collecting Social Security, you could temporarily lose some or all of those benefits due to the Social Security ‘earnings test.’
How Does the ‘Earnings Test’ Work?
The Social Security Administration (SSA) has rules about how much you can earn while receiving retirement benefits before you reach your Full Retirement Age (FRA). Your FRA depends on your birth year, and once you hit it, the earnings test no longer applies. For example, if you were born in 1963, your FRA is 67, and the earnings test stops affecting you once you reach that age.
Here’s the breakdown for 2026:
- If you’re under FRA all year (born after 1959): You can earn up to $24,480 annually ($2,040/month). For every $2 you earn above this, your Social Security benefits are reduced by $1.
- If you’ll reach FRA in 2026 (born between April 1959 and January 1960): You can earn up to $65,160 annually ($5,430/month) until the month you reach FRA. For every $3 you earn above this, your benefits are reduced by $1.
But here’s a silver lining: If you lose benefits due to the earnings test, the SSA will recalculate and increase your benefits about a year after you reach FRA to account for those reduced months. Plus, earning more now could boost your future benefits, as the SSA recalculates your average earnings over your highest-earning 35 years.
What Counts as ‘Earned Income’?
The earnings test only applies to earned income—think salaries, wages, and net self-employment income. It doesn’t include investment income, pensions, TSP or IRA distributions, rental income, or gambling winnings. And this is the part most people miss: income is counted when it’s earned, not when it’s paid. So, if you earned income in 2025 but get paid in 2026, it won’t count against your 2026 earnings limit.
Special Payments After Retirement
Let’s say you retired in December 2025 and received your final paycheck and lump-sum leave payment in January 2026. These payments won’t count toward your 2026 earnings test because they were earned in 2025. To ensure the SSA doesn’t mistakenly include them, you can file Form SSA-131 with your employer, who will submit it to the SSA.
Controversial question: Should the earnings test be adjusted to better reflect the realities of today’s workforce, where many retirees continue working? Let us know your thoughts in the comments!
About the Author:
Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER® and other financial designations, offering tax planning, federal benefits, retirement, and insurance consulting services in Silver Spring, MD. Disclaimer: This information is for general purposes and should not replace professional advice. Always consult a qualified expert for personalized guidance.
