Social Security benefits received before a person attains full retirement age (FRA) are subject to an actuarial reduction for early retirement and also may be reduced by the Social Security Retirement Earnings Test (RET) if the beneficiary has earnings that exceed an annual threshold. Under the RET, a beneficiary who is below FRA and will not attain FRA during the calendar year is subject to a $1 reduction in benefits for each $2 of earnings above an annual exempt amount, which is $14,640 in 2012. During the calendar year in which a beneficiary attains FRA, he or she is subject to a $1 reduction in benefits for each $3 of earnings above a higher annual exempt amount, which is $38,880 in 2012. This report explains how the RET is applied under current law and provides detailed benefit examples to show how the RET affects both the worker beneficiary and any family members (auxiliary beneficiaries) who receive benefits based on the worker beneficiary's record. The report points out features of the RET that are not widely known or understood, such as the recomputation of benefits when a beneficiary attains FRA to adjust (increase) benefits to take into account months for which no benefit or a partial benefit was paid as a result of the RET. Finally, the report discusses policy issues related to the RET, including recent research on the effect of the RET on work effort and the decision to claim Social Security benefits. Key points discussed in the report include the following: Benefits may be reduced in part or in full for one or more months as a result of the RET. Benefit reductions under the RET apply both to the worker beneficiary and to any family members (auxiliary beneficiaries) who receive benefits based on the worker beneficiary's record. This would include, for example, a dependent child and a spouse who may have already attained FRA. When a worker beneficiary and family members are subject to a benefit reduction under the RET, the reduction is pro-rated and applied to each person's benefit in proportion to each person's original entitlement amount. (The total amount of the reduction remains the same, but the reduction is pro-rated across more people.) An auxiliary beneficiary may be subject to a reduction in benefits under the RET both on the basis of the worker beneficiary's earnings above the exempt amount and on the basis of his or her own earnings above the exempt amount. Benefits "lost" as a result of the RET may be recouped by the beneficiary. When a beneficiary attains FRA and is no longer subject to the RET, his or her benefits are adjusted upward to take into account months for which no benefit or a partial benefit was paid as a result of the RET. The Social Security Administration (SSA) estimates that elimination of the RET for individuals aged 62 or older would have no major effect on Social Security's projected long-range financial outlook. In the short run, however, SSA estimates that eliminating the RET would have a negative effect on the Social Security trust fund in the amount of $81 billion from 2012 to 2018. The RET raises several policy issues, including the effect of the RET on labor supply (how many hours to work and when to retire) and its effect on when workers claim Social Security benefits. In general, Social Security benefits are meant to replace, in part, earnings lost to an individual or family because of retirement, disability, or death. The rationale for the RET was outlined in the 1935 report of the Committee on Economic Security, which recommended that no benefits be paid before a person had "retired from gainful employment." The original Social Security Act barred payment of benefits for any month in which a beneficiary received wages from "regular employment." This provision never went into effect, however, because the Social Security Board and many other analysts thought it would be nearly impossible to determine what was "regular" employment in different industries and occupations. Instead, the board recommended a specific monetary amount to simplify administration. In 1939, Congress incorporated these recommendations in amendments to the Social Security Act. Starting with the first benefits paid in 1940, benefits were withheld for months in which covered earnings were $15 or more. The RET has evolved from a monthly test to an annual one (with the exception of the "grace year" as discussed below) and from a provision that initially affected all worker beneficiaries to one that affects beneficiaries who are below the FRA. The most recent legislative change to the RET was in 2000 when Congress eliminated the RET for beneficiaries beginning with the month they attain FRA. This change was made under the Senior Citizens Freedom to Work Act ( P.L. 106-182 ). Before the change in 2000, the RET applied to beneficiaries until they attained the age of 70. Social Security benefits are based on the average of a worker's highest 35 years of earnings. A worker's primary insurance amount (PIA) is computed by applying the Social Security benefit formula to the worker's career-average, wage-indexed earnings. The benefit formula replaces a higher percentage of the pre-retirement earnings of workers with low career-average earnings than for workers with high career-average earnings. A worker's initial monthly benefit is equal to the worker's PIA if he or she begins receiving benefits at FRA. A worker's initial monthly benefit will be less than his or her PIA if the worker begins receiving benefits before FRA, and it will be greater than his or her PIA if the worker begins receiving benefits after FRA. For a more detailed explanation of the Social Security benefit computation and the actuarial adjustment to benefits claimed before or after FRA, see Appendix A . Social Security also provides auxiliary benefits to eligible family members of a retired, disabled or deceased worker. Benefits payable to family members are equal to a specified percentage of the worker's PIA. For example, a spouse's benefit is equal to 50% of the worker's PIA, and a widow(er)'s benefit is equal to 100% of the deceased worker's PIA. The total amount of benefits payable to a family based on a retired or deceased worker's record is capped by the maximum family benefit amount, which varies from 150% to 188% of the retired or deceased worker's PIA. For more information on auxiliary benefits and the maximum family benefit amount, see Appendix B . The RET applies to beneficiaries who are below the Social Security FRA and have earnings that exceed a specified dollar amount (an annual exempt amount). The RET does not apply to worker beneficiaries who are at or above FRA (the RET no longer applies beginning with the month the beneficiary attains FRA) or to those who are disabled. In addition, the RET does not apply to beneficiaries living outside the United States whose work is not covered by the U.S Social Security system; in this case, the "foreign work test" is applied. Self-employed persons are subject to the RET if they have performed "substantial services," which are determined by the nature of the service performed rather than by profit or loss. For beneficiaries who are below FRA and will not attain FRA during the calendar year, Social Security benefits are reduced by $1 for each $2 earned above the exempt amount. For beneficiaries who will attain FRA during the calendar year, Social Security benefits are reduced by $1 for each $3 earned above the exempt amount. Earnings above the exempt amount are charged against monthly benefits beginning with the first chargeable month of the year, at the applicable rate of $1 for each $2 or $3 of earnings above the exempt amount, and continue to be charged each month until all earnings above the exempt amount have been charged against the worker's benefits and any benefits payable to family members on his or her work record. A partial benefit is paid when the charge to a given month is less than the monthly benefit. The RET applies only to wage and salary income (i.e., earnings from work). It does not apply to income from pensions, rents, dividends, interest, and other types of "unearned" income. The RET annual exempt amounts in 2012 are $14,640 for beneficiaries who are below FRA and will not attain FRA in 2012, and $38,880 for beneficiaries who will attain FRA in 2012. The RET exempt amounts generally increase each year at the same rate as average wages in the economy. Appendix C shows the annual exempt amounts under the RET from calendar years 2000 to 2012. A "grace year" applies during the first year of benefit entitlement (or, for dependent beneficiaries, in the last year of benefit entitlement). During the grace year, the RET is applied effectively on a monthly basis. A beneficiary may receive full benefits for any month during which his or her earnings do not exceed one-twelfth of the annual exempt amount, regardless of the total amount of earnings for the year. As an example, consider a worker aged 62 who (1) has $60,000 in earnings from January through June 2012, (2) claims Social Security retirement benefits on July 1, 2012, and (3) has no additional earnings for the remainder of the year (July through December 2012). Because this person does not have earnings above the 2012 monthly exempt amount of $1,220 in any month from July through December 2012, full benefits are paid for each month of the second half of the year. This is the case even though this person's total earnings for 2012 are $60,000, an amount higher than the 2012 annual exempt amount of $14,640. There are two ways in which a person who receives Social Security auxiliary benefits (benefits paid to spouses, survivors, and other dependents) could be affected by the RET. First, benefits paid to spouses and dependents are affected by the RET when the benefits are based on the record of a worker beneficiary who is subject to the RET (i.e., the worker beneficiary is below FRA and has earnings above the exempt amount). This includes benefits paid to spouses who are below FRA as well as to those who are above FRA.