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Social Security penalty?

Question: I'm a professor at Duke University. However, I used to work at a state university, and in the 7 years I worked there, I did not contribute to Social Security except Medicare (we had the option to "opt out")- instead putting money into a TIAA-CREF 401(k). Now, I've worked at Duke (a private school) for 4 years and plan to continue, but I've heard about the "windfall elimination provision" and am wondering how badly the 7 years I worked elsewhere will decrease my eventual Social Security benefits. If I work in my current job for, say, 18 or 25 or 30 years, am I still going to get "penalized" for the 7 years that I didn't contribute, and if so, by how much? Thanks- love your show, by the way! Mohamed, Durham, NC

Answer: Well, like so much in personal finance, it all depends. (I should probably have that phrase programmed into my computer.)

Some background: It used to be that the Social Security formula worked in the favor of people who didn't contribute for a time into the system. The formula assumed that they were long-term, low-wage workers. In practice, that meant they got a Social Security benefit that represented a higher percentage of their earnings and a pension from a job where they did not pay Social Security taxes. Congress passed the "Windfall Elimination Provision" to remove that formula-calculation advantage. Instead, the formula is now adjusted for circumstances like yours.

So, if you worked in your current job for 18 years (as in your question) you will take a haircut on your Social Security payout. But there are few exceptions. The most important is if you have substantial earnings for 30 years (again, as in your question) you won't. Social Security has a nice explanation of the formula, its impact on your potential benefit payout, and the exceptions at this section of the Social Security website.

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