The Impact of Social Security Exclusion on Part-Time Employees at the University of California

by Howard Ryan

Many part-time employees at the University of California, and also at many community colleges, are being denied the most basic form of retirement security afforded to other American workers: social security. UC denies social security (SS) coverage to any employee with an appointment of less than 50% of full time. The SS-excluded employees are denied participation in the University's defined-benefit pension program as well. In lieu of social security, and in accordance with federal law, UC requires these employees to participate in a defined contribution plan (DCP), and a 7.5% contribution is deducted from their paychecks; UC makes no contribution to the DCP.

Based on the University's DCP year-end report of June 30, 2004, there were nearly 26,000 UC employees that year who were being excluded from social security in the manner described here. Among this group are some 1,300 of the University's 3,000 lecturers. We have not identified the remaining affected employees; however, UC-AFT has submitted an information request and awaits this information from the University.

This paper explores how UC's social security exclusion affects the retirement income of five fictional test-case lecturers. We also address the impact on disability and survivor benefits, and the special impact on women. Detailed figures and calculations for the test cases are in a separate Excel file; I will provide the file upon e-mail request. I've relied on Social Security Administration material and other online sources to guide my benefits calculations. My references and explanation of methods are also available via e-mail request.

In order to calculate the effect of SS exclusion on retirement income, I needed to take into account the employees' DCP savings and earnings. I assume a 5% interest rate on the DCP, a typical rate of return in recent years for the DCP's Savings Fund. The Savings Fund is the default investment option applied by the University when employees do not select an investment option.

I also needed to project how the employees would handle their DCP savings upon retirement, and how long the employees would live after retiring. Here is how I addressed these. In all five cases:

1. The employees retire on their 66th birthday.

2. If female, the employee expects to live 19 years after retiring -- i.e., to age 85. If male, the employee expects to live 16 years after retiring, to age 82. The employees may actually live longer or shorter than they expect, but their expectation guides how they handle the withdrawal of their DCP savings.

These longevity expectations are based on life expectancy figures from the Centers for Disease Control. In 2003, U.S. life expectancy at age 65 (i.e., upon one's 65th birthday) was 19.8 years for a female and 16.8 years for a male. I rounded these figures to 20 and 17, and then subtracted one year since my test cases retire at 66 rather than 65.

We don't know how many retirees plan their finances by using CDC life expectancy figures. But life expectancy calculations are a standard tool in the retirement planning field.

3. Upon retiring, the employees cash out their DCP savings and invest them in U.S. Treasuries and CD accounts, where they continue to earn 5%.

4. The retirees withdraw their savings through a monthly schedule: 228 equal monthly withdrawals for females, and 192 withdrawals for males, until the funds are depleted. That is, the retirees set a withdrawal schedule according to their life expectancy.

5. For simplicity's sake, I assume that the retiring employees have no other DCP or 401(k) holdings beyond those identified in my study.

When I began this study, I worried about two potential impacts of SS exclusion: first, that the employee would earn fewer SS monthly benefits because s/he would not accrue SS-covered earnings while working at UC; and second, that the employee's earned SS benefits from non-UC employment would be penalized through social security's Windfall Elimination Provision (WEP). The WEP applies a penalty to your SS benefits if you have employment where you are not covered by SS but where the employer provides you with another pension plan. A DCP that is based on at least 7.5% of earnings qualifies as a pension under SS law.

My discovery, however, is that the WEP penalty is largely avoidable for affected UC part timers. By cashing out their DCP savings as a single lump sum upon retirement, such employees avoid the WEP except for a one-time penalty of $328 (the WEP maximum penalty in 2006). In fact, 401(k) holders almost always cash out their holdings as a single lump sum when they retire, according to Alicia Munnell and Annika Sundèn (Coming Up Short: The Challenge of 401(k) Plans, p. 2). Such a cash-out leads to an increased income tax bill for that particular year (the taxation on DCP withdrawals is supposed to be less overall if spread over a number of years). But the benefit of avoiding a monthly WEP penalty over a period of years will normally far outweigh the higher tax bill. To confirm my theory about the lump sum cash-out, I called SS administration and spoke with a representative who agreed that such an approach legitimately avoids the WEP penalty after the one-time charge.

Another way to avoid the WEP penalty is by having many years of "substantial earnings" that are covered by social security. For 21 years of substantial earnings, the employee gets a small reduction on the WEP penalty. The penalty reduction is then increased for each successive year and is completely eliminated at 30 years. The annual earnings needed to qualify as "substantial" range between 44 to 47% of U.S. national average wages.

Case 1
Mary was born December 31, 1952. She began working in 1971, with gradually growing wages (she earned $500 in 1971, $50,000 in 2005). All her employment prior to UC was in the private sector (hence, covered by social security). She began working as a part-time UC lecturer in 2001. UC excludes her from SS, and in lieu enrolls her in a DCP with a 7.5% payroll deduction. Her 33%-time UC employment comprises one-third of her income. The remainder is earned from a private sector job. Our case assumes that Mary will keep this arrangement until she retires upon turning 66 in 2019.

Mary's DCP with 5% interest will be worth $37,200 at the time she retires. Upon retiring, she cashes out her DCP as a single lump sum and invests it in U.S. Treasuries and CDs, where it continues earning 5%.

She plans to take out her savings in 228 equal monthly withdrawals until the funds are depleted at age 85.

Impact
Does Mary gain or lose as a result of her exclusion from social security at UC?

Monthly Income Comparison thru Age 85 (228 months)
No Exclusion Exclusion + DCP Savings
SS Benefit $1512 $1281
Income from DCP Savings 0 $253
Total Income $1512 $1534
Net Gain/Loss Due to Exclusion +$22

Monthly Income Comparison after Age 85
No Exclusion Exclusion
SS Benefit $1512 $1281
Net Gain/Loss Due to Exclusion -$231

SS exclusion gives Mary a slight gain of $22 in monthly income through age 85. But after age 85, with DCP savings depleted, she has a monthly loss of $231. Were she never excluded, her SS benefit would be $1512; with exclusion, it's $1281.

Note that Mary may well live beyond the average life expectancy for a 65-year-old female, and there is a 31% chance that she will live to age 90 or older (Munnell and Sundèn, p. 145-46). One major risk of SS exclusion is that employees will live beyond their DCP-supplemented years.

Case 2
John was born December 31, 1952. He began working in 1971, and his yearly earnings are exactly the same as Mary's. John worked in the private sector (i.e. covered by social security) prior to his UC employment. UC hired him in 1990 as a 33%-time lecturer. UC excludes him from SS, and in lieu enrolls him in a DCP with a 7.5% payroll deduction. Also in 1990, John began part-time teaching jobs in the community colleges. His UC employment comprises one-third of his income, with the remainder earned in the community colleges. His retirement coverage at the community colleges is the same as at UC -- i.e., no SS, and mandatory DCP with 7.5% payroll deduction. Our case assumes that John will keep his current employment arrangement -- one-third at UC, two-thirds at the community colleges -- until he retires upon turning 66 in 2019.

John's DCP with 5% interest will be worth $185,670 at the time he retires. Upon retiring, he cashes out his DCP as a single lump sum and invests it in U.S. Treasuries and CDs, where it continues earning 5%.

He plans to take out his savings in 192 equal monthly withdrawals until the funds are depleted at age 82.

Impact
Does John gain or lose as a result of his exclusion from social security at UC and the community colleges?

Monthly Income Comparison thru Age 82 (192 months)
No Exclusion Exclusion + DCP Savings *
SS Benefit $1512 $718
Income from DCP Savings 0 $1407
Total Income $1512 $2124
Net Gain/Loss Due to Exclusion +$612
* John's first SS payment under exclusion is reduced by $328 (i.e., $390 rather than $718) due to one-time WEP penalty.

Monthly Income Comparison after Age 82
No Exclusion Exclusion
SS Benefit $1512 $718
Net Gain/Loss Due to Exclusion -$794

Through age 82, SS exclusion gives John a strong gain of $612 in monthly income. But after age 82, with DCP savings depleted, John will see a huge monthly loss of $794. Were he never excluded, his SS benefit would be $1512; with exclusion, it's $718.

Case 3
Mark was born December 31, 1952. He began working in 1971, and his yearly earnings are exactly the same as Mary's and John's. All his employment prior to UC was in the private sector. He began working as a part-time UC lecturer in 2001. UC excludes him from SS, and in lieu enrolls him in a DCP with a 7.5% payroll deduction. His 33%-time UC employment comprised one-third of his income, with the remainder earned in the private sector. He held this arrangement for five years, but then left UC in 2006 to work full-time in the private sector. Our case assumes that Mark will keep his 2006 arrangement until he retires upon turning 66 in 2019.

By the time Mark leaves UC, he has accumulated DCP savings of $5945. He cashes out these savings to help cover his daughter's college tuition expenses, while paying a 10% penalty to the IRS for early cash-out. Such early cash-outs, we should note, are quite common among DCP and 401(k) holders. When workers with 401(k)s change jobs, 55% take the distribution as cash rather than rolling it over into an IRA, according to Munnell and Sundèn, who note that early cash-outs are especially common when the amounts are small (p. 40).

Impact
Does Mark gain or lose as a result of his exclusion from social security at UC?

Since Mark took an early cash-out of his DCP, we'll consider the DCP results first, and then we'll look at his retirement income. The table below compares these two conditions:
a) Mark never contributes to a DCP, but simply takes home the 7.5% of wages that would be contributed to a DCP.
b) Mark contributes to a DCP that earns 5% interest, and then does an early cash-out.

Comparison of DCP versus No DCP, Years 2001 thru 2005
No DCP
(7.5% of wages not deducted from pay) DCP
7.5% of wages + 5% interest
Gross earnings $5272 $5945
10% penalty for early cash-out -- $595
Net earnings $5272 $5350
Net gain/loss from DCP -- +$78

John reaps a small gain of $78 from his DCP participation, even with the 10% early cash-out penalty. But suppose Mark had put the same 7.5% of wages into a savings account or CD, with a modest interest of 3%. This would have earned him $320, or $242 more than the DCP with 5% interest and early cash-out.

Of course, Mark was not forced to take the early cash-out and bear its penalty; he could have opted instead for a rollover. But the reality is that many people find it difficult to save money for retirement. This is what makes defined-benefit programs -- such as social security and employer-sponsored pension plans -- important to our retirement security.

Since Mark has cashed out the DCP, it bears no impact on his future retirement. The long-term effect of Mark's SS exclusion is simply to reduce his SS benefits upon retirement. Had UC not excluded him, his monthly SS benefit would be $1512; instead, it will be $1459 -- a $53 monthly loss.

Rollover Option
As an alternative, let's suppose that Mark did roll over his DCP rather than cashing it out after leaving UC. His DCP upon retirement would be worth $11,955. Here is how he would fare:

Monthly Income Comparison thru Age 82 (192 months)
No Exclusion Exclusion + DCP Savings *
SS Benefit $1512 $1459
DCP-Related Income 0 $90
Total Income $1512 $1549
Net Gain/Loss Due to Exclusion +$37
Notes:
* Mark's first SS payment under exclusion is reduced by $328 (i.e., he receives $1131 rather than $1459) due to one-time WEP penalty.

Monthly Income Comparison after Age 82
No Exclusion Exclusion
SS Benefit $1512 $1459
Net Gain/Loss Due to Exclusion -$53

If Mark takes the recommended approach and rolls over his DCP, he'll see a gain of $37 in monthly retirement income as a result of his SS exclusion through age 82. However, he will lose $53 monthly after age 82. Plus, he'll suffer a one-time WEP penalty of $328 on his first SS check.

Case 4
Carol was born December 31, 1952. She entered the workforce in 1971. Carol worked in various part-time and temporary positions. She became a wife and busy mother of three, while working on her bachelor's and then her master's degree in environmental studies. In 2001, after completing her master's, Carol accepted a 45%-time position as a UC lecturer, as well as a 50%-time position at an environmental non-profit. UC excludes her from SS, and in lieu enrolls her in a DCP with a 7.5% payroll deduction. Her work at the environmental firm is SS-covered. She held this dual arrangement for five years, until being laid off by UC. The environmental firm then increased her hours to 75% time. Our case assumes that Carol will keep this position until she retires upon turning 66 in 2019.

Carol's DCP with 5% interest will be worth $21,327 at the time she retires. Upon retiring, she cashes out her DCP as a single lump sum and invests it in U.S. Treasuries and CDs, where it continues earning 5%.

She plans to take out her savings in 228 equal monthly withdrawals until the funds are depleted at age 85.

Impact
Does Carol gain or lose as a result of her exclusion from social security at UC?

Monthly Income Comparison thru Age 85 (228 months)
No Exclusion Exclusion + DCP Savings *
SS Benefit $885 $786
Income from DCP Savings 0 $145
Total Income $885 $931
Net Gain/Loss Due to Exclusion +$46
* Carol's first SS payment under exclusion is reduced by $328 (i.e., she receives $458 rather than $786) due to one-time WEP penalty.

Monthly Income Comparison after Age 85
No Exclusion Exclusion
SS Benefit $885 $786
Net Gain/Loss Due to Exclusion -$99

While Cases 1, 2, and 3 all had the same total earnings, and their incomes were moderate, I wanted to look at one case with a lower earnings history. So I drew up Carol, who spent many years as a mother-housewife and only in casual employment until completing her master's degree and taking more gainful employment in 2001.

Through age 85, Carol will see a small gain of $46 in monthly retirement income as a result of her SS exclusion at UC. But the one-time WEP penalty of $328 on her first SS check will be a big hit, since her full SS monthly benefit is only $885. After age 85, when the DCP savings are depleted, Carol loses $99 on her monthly SS check, taking home only $786. Carol will be poor in retirement with or without UC's SS exclusion, but the exclusion will hurt her badly in her post-DCP years.

Case 5
While the typical impact of UC's SS exclusion would be to reduce SS benefits in exchange for DCP savings, it may also lead to a complete loss of SS benefits. In order to qualify for SS retirement benefits, you must have earned at least 40 "work credits." A credit is earned each time you earn a designated minimum of SS-covered wages in a quarter. You can also earn four credits by earning a designated minimum in a year. These minimums are reasonably low: in 2006, the quarterly minimum is $970, and the yearly minimum is four times that amount at $3880. With either 40 quarters or 10 years of qualified earnings, you're in. Nevertheless, UC's exclusion policy can leave some employees out. In the following case, the employee had 9 years of qualified earnings, but failed to reach the 10th year due to SS exclusion at UC and at a community college.

Yung was born in Guangzhou, China on December 31, 1952. He completed his master's degree in mathematics, and then worked in research and teaching for several years in Guangzhou. In 1989, Jung took advantage of an opportunity to work abroad -- as a full-time staff research associate in the mathematics department at UC Irvine. Yung held this position for nine years, during which time he married an American woman who sponsored him successfully for permanent U.S. residency. In 1998, when Yung's employing lab lost its funding, he took a 40%-time position as a UCI mathematics lecturer. He also found a 45%-time teaching position at a local community college. His UC and community college teaching positions are both excluded from SS, with a DCP in lieu through a 7.5% payroll deduction. Our case assumes that Yung will keep this arrangement until he retires upon turning 66 in 2019.

Yung's DCP with 5% interest will be worth $103,323 at the time he retires. Upon retiring, he cashes out his DCP as a single lump sum and invests it in U.S. Treasuries and CDs, where it continues earning 5%.

He plans to take out his savings in 192 equal monthly withdrawals until the funds are depleted at age 82.

Impact
Does Yung gain or lose as a result of his exclusion from social security at UC and the community college?

Monthly Income Comparison thru Age 82 (192 months)
No Exclusion Exclusion + DCP Savings
SS Benefit $1263 0.00
Income from DCP Savings -- $783
Total Income $1337 $783
Net Gain/Loss Due to Exclusion -- -$480

Monthly Income Comparison after Age 82
No Exclusion Exclusion
SS Benefit $1263 0.00
Net Gain/Loss Due to Exclusion -$1263

SS exclusion will hurt Yung heavily in retirement. Since he falls short of 40 SS credits, he has no SS retirement benefit at all -- whereas full SS coverage would have given him a $1263 monthly benefit. His DCP moneys will provide him a small income of $783 a month through age 82 -- or a $480 monthly loss as a result of his SS exclusion.

Much worse, however, is that Yung's resources will be fully depleted if he lives beyond age 82: he'll have no income at all.

Discussion of Test Cases
The five cases may be summarized as follows:

Lifetime earnings Years teaching at UC SS status of second job
Case 1 moderate 20 covered by SS
Case 2 moderate 30 not covered by SS
Case 3 moderate 5 covered by SS
Case 4 low 5 covered by SS
Case 5 moderate but not enough SS-covered earnings to quality for SS 32 not covered by SS

Cases 3 and 4 -- who teach at UC for only five years -- reflect a more typical UC lecturer profile. While some lecturers remain in their positions for many years and through to retirement, most have relatively short UC careers. Still, I consider the long-term lecturer cases to be worthwhile to our study, if only because they lay bare some of the patterns and potentials of SS exclusion.

The case that puts SS exclusion perhaps in its most favorable light is case 2, where John's high DCP earnings give SS exclusion a gain of $612 a month for the first 16 years of retirement. If John dies by age 82, then SS exclusion has clearly benefited his retirement finances. Only if John lives longer than 82 do we see a big downside of DCP reliance, where -- with DCP savings depleted -- John's monthly income is $794 less than it would have been with full SS coverage.

In the other cases, the employees gain or lose during the years of DCP savings withdrawals, depending on their individual histories. But all are hurt by SS exclusion when the DCP moneys are depleted.

Two factors weigh large when considering the impact of SS exclusion upon one's retirement: one is simply the unpredictability and unknowns of a DCP-based retirement strategy versus the predictability of guaranteed SS monthly checks. While a DCP might well earn more than 5%, it could just as well earn less. And there always remains the possibility of disaster due to stock market crash or due to poor investment decisions by the employee or by his/her fund management company. The other factor is the danger of outliving one's DCP savings. However we draw up our cases, the risk factors associated with SS exclusion are very hard to avoid.

And we must emphasize that most workers who invest in DCPs and 401(k)s do so by personal choice; they are rarely forced by the employer to take on the risks of investing. The SS-excluded UC employee, on the other hand, is forced by the University, as a condition of employment, to participate in a risky retirement venture. And while most workers who invest in DCPs have their full SS benefits as a baseline income, the SS-excluded employee does not. UC's executive leaders would never impose upon themselves the retirement risks that they are systematically imposing upon the University's part-time employees.

Impact on Social Security Disability Insurance
UC's SS exclusion not only impacts on retirement income but also threatens one's Social Security Disability Insurance (SSDI) coverage. SSDI provides benefits for eligible workers who have long-term disability prior to age 65. The benefit amount is equal to the SS retirement benefit accrued by the applicant at the time of disability, or at the time the disability claim is approved. Therefore, in a great many cases, UC's SS exclusion will reduce the SSDI benefits available for a disabled employee.

But the impact may be worse. In order to be eligible for SSDI, you must have earned a certain number of work credits; the credits are based on minimum quarterly earnings as discussed in Case 5. Generally, you need to have earned 40 credits overall, and at least 20 credits within the 10 years preceding your disability. Younger workers need fewer credits while older workers need more. After age 42, the requirement for recently earned credits increases. For example, a 52-year-old worker needs 40 credits overall, but needs 30 credits earned within the 10 years preceding disability. So, UC's SS exclusion could well make some part timers ineligible for SSDI -- either because they hadn't accrued enough credits, or because they hadn't accrued enough recent credits.

Most Americans do not have coverage for long-term disability other than that offered by SSDI. California workers also have access to State Disability Insurance, but SDI is only for short-term disability -- benefits do not extend beyond 52 weeks. UC does a disservice to its part-time employees by weakening their access to this important safety net program.

UC employees may purchase long-term disability coverage through the University's Supplemental Disability Insurance Plan. However, to be eligible for this plan, the employee must be "a member of a Defined Benefit Retirement Plan to which the University contributes (such as UCRP, PERS, etc.)" (plan book, p. 7). Since the part timers whom UC excludes from SS are also excluded from the University's defined-benefit pension plan, they are similarly ineligible to enroll in the Supplemental Disability Insurance Plan.

Impact on Survivor Benefits
The SS benefit losses discussed above bear upon an employee's survivor benefits as well. Social security offers a range of benefits to the employee's family in case of his/her death including:

• The surviving spouse can receive a portion of the deceased's retirement benefits and, at full retirement age, can receive 100% of the deceased's benefit amount.
• A surviving child under age 18 can receive up to 50% of the deceased's retirement benefit amount.
• A deceased's SS disability benefits are fully payable to the spouse if s/he is caring for her child who is under age 16.
• A surviving child under age 18 may receive up to 50% of the deceased's disability benefit amount.

Insofar as SS exclusion reduces an employee's retirement and disability benefits, or makes them completely ineligible, the family of such employees are likewise affected.

Impact on Women
UC's SS exclusion policy has a particular impact on women. With a longer life expectancy than men, but with fewer resources (lower lifetime earnings and lower pension incomes, on average), women's reliance on social security during the retirement years is typically greater than men's. The Social Security Administration observes that:

• Women represent 58 percent of all Social Security beneficiaries age 62 and older and approximately 70 percent of beneficiaries age 85 and older.
• For unmarried women – including widows – age 65 and older, Social Security comprises 52 percent of their total income. In contrast, Social Security benefits comprise only 38 percent of unmarried elderly men's retirement income and only 35 percent of elderly couples' income
(http://www.socialsecurity.gov/women)

Conclusion
The impact of UC's SS exclusion policy will clearly vary depending on the circumstances and work histories of each employee. But it does appear that large numbers face losses -- in retirement income, retirement security, disability protections -- for themselves and their families.

The bottom line is that no one should be forced to live in poverty when they retire. That was why our country established Old Age, Survivors, and Disability Insurance through the 1935 Social Security Act. Built into the social security system is the concept that employers must share the responsibility for ensuring the retirement security of their employees. Today, employers pay a 6.2% SS tax, matching the employee's 6.2% tax. Unfortunately, the law has allowed state and local government employers to opt out of this responsibility. Typically, the government agencies that opt out of social security do provide employees with a defined benefit pension plan. Such, for example, is the status for most California schoolteachers.

But the UC part timers are a special case: they have neither SS coverage nor coverage by the UC pension plan. The University chooses to exclude part timers from these plans because it saves the University money. Instead of paying the 6.2% SS employer tax, UC forces the part timer to pay a 7.5% DCP contribution, with no cost to the University. It is a cost saver to be sure, but it is one that does harm to thousands of employees and their families and undermines the good aim of social security to eliminate old-age poverty.