Over the years, the end of December has been a popular time to retire among federal employees, and the end of December 2025 was no exception as many CSRS employees and FERS employees retired. Perhaps one reason many employees retire at the end of December is that they can get paid in a lump sum payment potentially for the maximum number of unused annual leave hours. The lump-sum payment for unused annual leave hours is fully taxable, subject to federal and state income taxes, and Social Security (FICA) and Medicare Part A (Hospital Insurance Tax) payroll taxes. Those employees who retired December 31, 2025 will have their lump sum payment for unused annual leave hours directly deposited into the same bank account that the employee’s bi-weekly paychecks are directly deposited, sometime in January 2026. A retiring employee will also get direct deposit of his or her final paycheck for pay period 25 of leave year 2025 into his or her bank account sometime in January 2026.
This column discusses how some employees who retired from federal service on December 31, 2025 and who plan to continue working during 2026 (for example, as a rehired annuitant, working for a private company, or being self-employed) and receiving Social Security retirement benefits may temporarily lose some or all of those monthly benefits. The reason for this temporary loss of monthly benefits is due to the Social Security “earnings test.” Included in the discussion is the effect of a retiring federal employee’s lump-sum payment for unused annual leave hours on the Social Security earnings test.
How “Earned Income” Affects Social Security Retirement Benefits
An employee who retires from federal service and continues employment in the public/private sector may be eligible and elects to start receiving monthly Social Security retirement benefits. The retired employee is “fully insured” (earned at least 40 credits of Social Security). Those retired federal employees who have earned a minimum 40 credits of Social Security (and therefore “fully insured” for Social Security benefits) can start receiving their Social Security retirement benefits as early as age 62. If the retiree is younger than his or her full retirement age (FRA), is receiving Social Security retirement benefits while in receipt of “earned income” (salary/wages or net self-employment income), the Social Security Administration (SSA) may temporarily reduce some or all of the monthly Social Security retirement benefit.
FRA depends on a Social Security beneficiary’s year of birth. Once an individual reaches the month of his or her FRA, there is no longer a Social Security earnings test that is imposed. The following table summarizes an individual’s FRA given the individual’s year of birth:
Full Retirement Age (FRA) As Determined by Year of Birth
Each year, the SSA conducts two earnings tests. One earnings test applies to Social Security retirement benefit recipients who are between age 62 and the year they reach their FRA. The second earnings test applies to Social Security retirement benefit recipients who are receiving benefits between January 1 and the last day of the month before the month they reach FRA. The following examples illustrate:
Example 1. Henry was born November 25,1963 and will become age 63 in November 2026. His FRA is 67 years, which he will become in November 2030. If Henry is receiving Social Security retirement benefits during 2026 and has earned income, then Henry is subject to the first earnings test during 2026.
Example 2. Stella was born April 10,1959 and will become 66 years and 10 months on February 10, 2026 . Her FRA is 66 years and 10 months, meaning that Stella will reach FRA in February 2026. If Stella is receiving Social Security retirement benefits during 2026 and has earned income, then Stella is subject to the second earnings test during the month of January 2026..
For the year 2026, the following SSA earnings test rules apply:
• Individuals younger than FRA throughout 2026 (individuals born after December 31,1959) and receiving Social Security monthly retirement benefits can earn $24,480/year or $2,040/month. For every $2 an individual earns above $24,480, the SSA will reduce their monthly Social Security benefits by $1.
• Individuals who will reach the month they become FRA during 2026 (individuals who were born between April 2*,1959 and January 1*, 1960, can earn up to $65,160/year or $5,430/month until the month they reach FRA during 2026. For every $3 an individual earns above $65,160, the SSA will reduce their monthly Social Security benefits by $1.
*Note: For purposes of age, the Social Security Administration considers an individual to be “of age” as of the day before the individual’s birthday. Two examples: (1) An individual born on July 2,1959 is of age as of July 1. This means the individual’s FRA (66 years and 10 months) occurs on May 1, 2026; (2) An individual born on July 1,1959 is of age as of June 30. This means the individual’s FRA (66 years and 10 months) occurs on April 30,2026.
Note the following:
1. Once an individual reaches the month he or she becomes FRA, the individual can have an unlimited amount of earned income without losing any monthly Social Security benefits. That is because the month FRA is reached, the earnings test no longer applies.
2. The earnings test applies only to earned income. Earned income includes salary/wages and net self-employment income. Not included in the earnings test are investment income (interest, dividends, capital gains), pension income (CSRS or FERS annuity income), traditional Thrift Savings Plan (TSP) and traditional IRA income, rental income and “other income” such as gambling or lottery winnings.
3. If an individual younger than his or her FRA throughout 2026 (any individual born after December 31, 1959) and who loses all or part of their Social Security benefits during 2026 as a result of the earnings test, there is some good news. About one year after the individual reaches his or her FRA, the SSA will recalculate and increase the individual’s Social Security monthly benefit. The SSA is doing this in order to consider those months in which the individual received no benefit or a reduced benefit is a result of losing monthly retirement benefits due to excess earned income.
4. Any earned income (subject to the Social Security FICA tax) an individual earned while receiving a monthly Social Security benefit will most likely get an increase in the individual’s lifetime Social Security average indexed monthly earnings (AIME), thus increasing future their monthly retirement benefit. This is because the SSA annually recomputes an individual’s monthly retirement benefit based on an individual’s 35 years of highest Social Security earnings, no matter which years those earnings occurred. The higher earnings associated with post-federal employment may increase a federal retiree’s Social Security monthly retirement benefit as the federal retiree continues to work and has larger Social Security earnings compared to their Social Security earnings during the earlier years of employment.
When Do Salary/Wages Count Towards the Earnings Test?
For purposes of the limit of salary/wages or net self-employment income used in the Social Security earnings test, salary income, wages income and net self-employment are included in the annual earnings limit when the salary/wages or net self-employment income are earned and not when they are paid. If an individual has earned income in one year and there is an agreement between the employer and employee to defer payment until the following year, those earnings will not count as earned income in the year the employee actually receives them. That is, the year the check for the salary earned is actually deposited into his or her bank account.
Special Payments After Retirement
After an employee retires, the individual may receive “special payments” for work performed before the individual started receiving a monthly Social Security retirement benefit. These payments are not included in the earnings test if these payments were work performed before the employee retired.
Special payments for a federal employee who retired in late December 2025 and who planned to start receiving their Social Security retirement monthly benefit early in 2026 include: (1) The employee’s final paycheck for pay period 25 of leave year 2025. At most federal agencies, pay period 25 for leave year 2025 ended on December 27,2025; and (2) The lump-sum payment for unused annual leave hours that a retiring employee has accumulated as of his or her retirement date. The reason that both of these payments will not be counted as part of the “earnings” test” for 2026 is that both payments were earned before January 1, 2026 and paid during January 2026. The following example illustrates:
Example 3. Cynthia became age 64 in October 2025 and retired from federal service on December 31,2025 with 32 years of federal service. She elected to receive her first Social Security retirement check in January 2026. When she retired, Cynthia had 440 hours of unused annual leave which she will receive via a lump-sum payment in early January 2026, together with her last paycheck for pay period 25 and for pay period 26 of leave year 2025 (ending January 10, 2026). Cynthia will receive a 2026 W-2 from her agency in January 2027, showing the amount of her lump-sum payment for unused annual leave hours and her two paychecks for pay period 25 of pay period 26 of leave year 2025. Those two payments will not be counted towards the 2026 earnings limit for Cynthia’s 2026 Social Security “earnings” test. This is because the three payments were earned during 2025.
To ensure that the SSA does not include the lump-sum payment for unused annual leave hours and final pay checks in the “earnings test” for 2026, Cynthia should download Form SSA-131 (Employer Report of Special Wage Payments). She should give the form to her Human Resources/Personnel Office to be filled out and then sent to the SSA for processing. In so doing, Cynthia’s payments will not be included in her 2026 Social Security earnings test should she elect to receive her Social Security monthly benefit during 2026. A sample Form SSA-131 is presented below:
