By Kevin Pomarnke, CTFA, MBA, Wealth Advisor
WHY ESTIMATE YOUR SOCIAL SECURITY BENEFITS?
When you’re planning for retirement, figuring out how much you’ll receive from Social Security is an important part of determining your complete financial picture. Depending on your situation, you also may be interested in estimating divorced spouse benefits, survivor benefits, and disability benefits as well. Getting an accurate number is important, so take care to avoid overlooking or overstating the value of your Social Security benefits. While predicting the future of Social Security is difficult because of questions about its solvency mean it may change in the future. It’s more likely that the younger and more financially well off you are, the more changes will affect you. But keep in mind that even if you plan to retire in the next few years, Social Security was never meant to be a retiree’s sole source of income. As President Dwight D. Eisenhower famously said: “The system is not intended as a substitute for private savings, pension plans, and insurance protection. It is, rather, intended as the foundation upon which these other forms of protection can be soundly built.” Determining your Social Security benefits now helps to create an effective long-term retirement strategy and to understand benefits that might protect your family if you or your spouse dies or becomes disabled.
HOW TO OBTAIN YOUR BENEFITS ESTIMATE
Using your actual earnings record, you can estimate your retirement benefit online with the Retirement Estimator calculator on the Social Security Administration (SSA) website at ssa.gov. You also can create different scenarios based on current regulations that show how different earnings amounts and retirement ages will affect it. The site also includes other benefit calculators to help you estimate disability and survivor benefits. Make sure to sign up to view your Social Security statement, which includes a detailed record of your earnings, as well as estimates of retirement, survivor, and disability benefits. If you’re not registered for an online account and are not yet receiving benefits, you’ll receive a statement in the mail every year, starting at age 60.
HOW YOUR BENEFIT AMOUNT IS DETERMINED
Your average lifetime earnings, otherwise known as your Primary Insurance Amount (PIA), determine your Social Security benefits. As you can guess, calculating your PIA is complicated because some factors in the formula change annually. It’s easiest to get that benefit estimate directly from the SSA, however, knowing how your PIA is calculated is useful in retirement planning. Currently, the two most frequently used PIA calculation methods are:
The simplified old-start benefit method
Evolved from the original 1939 Act formula, this method is used if, prior to 1979, you turned 62 years old, became disabled, or death occurred prior to 1979. It averages actual (not indexed) earnings and uses a table to calculate PIA.
The wage indexing method
In use since 1979, this method indexes earnings to adjust them to reflect changes in wage levels throughout years of employment, ensuring that your benefits reflect increases in the standard of living. Through this method, your PIA is reached by indexing lifetime earnings up to and including the year you turn 59. Then, your PIA is calculated by averaging your highest earnings for a specific number of years (usually 35) and a benefit formula is applied.
CALCULATING YOUR PRIMARY INSURANCE AMOUNT (PIA) USING THE WAGE INDEXING METHOD
While the wage indexing method works to calculate retirement, survivor’s, and disability benefits, calculating disability benefits is slightly different. So the following applies only to calculating PIA for retirement and death.
Follow these steps to calculate your PIA:
Count the number of years between 1951 (or the year you turned 22, if later) and the year you turned 61. If you were born in 1929 or later, it will be 40.
Example: Julie retired from her job in 1992 when she was 62. She turned 22 in 1952, so the number of years between 1952 and 1991 (the year she turned 61), equals forty.
Use the number of elapsed years (40, in this case) to figure out the number of benefit computation years by subtracting five. The result will be used to calculate your average indexed monthly earnings (AIME). If you were born in 1929 or later, this number is 35.
Use your earnings record to calculate your indexed earnings by using the appropriate table to determine what the indexing average wage was or will be the year you turn 60. Then, look to see what the indexing average wage was in the year you are indexing. These figures become part of an indexing ratio applied to each year of earnings starting with 1951 and ending with the year you turn 59. (Earnings before 1951 are generally disregarded. Earnings in the year you turn 60, your indexing year, and earnings in all later years are considered in calculating your PIA, but they are not indexed.) The indexing ratio can be expressed as the actual earnings in the year being indexed multiplied by the indexing average wage in the year you turned 60, divided by the indexing average wage in the year being indexed. The result will equal your indexed earnings for the year being indexed.
Example: Julie started working in 1951 and retired in 1992. For each year starting with 1951 and ending with 1989 (the year she turned 59), calculate her indexed earnings. Her indexing year is 1990 (the year she turned 60). For example, Julie’s earnings in 1965 were $2,000. In 1965, the indexing average wage was $4,658.72. In 1990, the indexing average wage was $21,027.98. Calculate her 1965 indexed earnings: $2,000 multiplied by $21,027.98 divided by $4,658.72 = $9,027.36
Example(s): In 1965, the maximum earnings limit was $4,800. Had Julie’s actual earnings exceeded that amount, she would replace her actual earnings figure in the ratio with $4,800 to calculate her indexed earnings for 1965.
Once you index earnings for each year you worked before age 60, you can use those figures to calculate your Average Indexed Monthly Earnings (AIME).
TIP: Actual earnings are those credited to an individual’s Social Security record. However, each year’s actual earnings are subject to a maximum earnings limit. If your earnings for the year you are indexing exceed the maximum limit, substitute the maximum earnings limit amount in place of your actual earnings amount.
Calculate your AIME by selecting your highest earnings for the benefit computation years (including any earnings not subject to indexing). Add these up and divide by the total number of months elapsed during these years. Example: Julie had 39 years of indexed earnings and two years of earnings (1990 and 1991) not indexed but included in the calculation. Select her 35 highest-earning years. The earnings for these years total $950,000. Divide this figure by 420 months (35 x 12). Her AIME is $2261.90.
Calculate the PIA for the year you reach age 62 by applying percentages to certain dollar amounts of the AIME. The percentages are fixed, but the dollar amounts (called bend points) are adjusted each year for inflation.
Example: Julie turned 62 in 1992. Her PIA is calculated using 1992 bend points – 90 percent of the first $387 of her AIME, and adding 32 percent of the AIME in excess of $387 through $2,333, and adding 15 percent of the AIME in excess of $2,333. So, Julie’s PIA is $348.30 (90 percent of $387) plus $599.65 (32 percent of $1,873.90) or $947.95, rounded to the next lower multiple of 10 cents: $947.90.
Bend points make calculating your future PIA difficult because the bend points for each year are only published on or before November 1 of the preceding year. For 2020, the bend points are $960 and $5,785.
Adjust your PIA to reflect changes in the Cost-Of-Living Allowance (COLA) annually. Example: If Julie’s PIA was $947.90 when she retired in October 1992, then her PIA was adjusted for COLA in December 1992, and her January 1993 benefit check reflected the change.
Using your PIA to figure out your benefit amount
Once the PIA is determined, all of your benefits (and those of your dependent family members) will be based on this figure. Your PIA is the maximum benefit you could receive upon achieving eligibility.
Your maximum benefit may be payable if:
- You retire at full retirement age
- You are a widow or widower who is at least full retirement age
- You are a disabled worker
In some circumstances, your actual benefits will be a percentage of your maximum benefit. For example, if you elect to receive early retirement benefits, your maximum benefit will be less than the maximum each month. If you or your family members are eligible for reduced benefits, the reduction will be expressed as a percentage of your PIA.
Example: Mr. Jones retired at age 65 (full retirement age) after working for many years. His PIA was determined as $1,176. He receives the maximum retirement benefit (100 percent of his PIA), so his monthly benefit check is $1,176. His wife retired at age 65. Since her own PIA was less, she decided to base her retirement income on her husband’s PIA. She is entitled to 50 percent of his PIA, so she receives a monthly benefit check of $588.
FACTORS THAT CAN AFFECT YOUR BENEFIT
If you elect to receive retirement benefits early, your benefit is proportionately reduced. You can elect to receive retirement benefits as early as age 62, but for each month of early retirement, your total benefit will be reduced by 5/9 of 1 percent, up to 36 months, and by 5/12 of 1 percent thereafter. For example, if you elect to receive retirement benefits at age 62 and your full retirement age is 66, then you would receive approximately 25 percent less each month than you would if you retired at age 66.
By contrast, you receive more if you delay receiving retirement benefits past full retirement age. Late retirement may increase your average earnings (which may, in turn, increase your benefit) and you also receive a special delayed retirement credit. This credit is figured as a percentage of your Social Security benefit and is in addition to your regular benefit, but doesn’t affect your PIA.
The delayed retirement credit varies depending on when you were born and how many months or years after full retirement age you retire (up to the maximum age of 70). For example, if you were born in 1944 (your full retirement age is 66), you will earn an extra 8 percent of your benefit for every year you delay retirement up to age 70. This means that if you delay receiving your retirement benefit until age 70, your benefit payment will be 32 percent larger than if you began receiving retirement benefits at age 66.
INCOME WHILE RETIRED
You must report any income you earn after you retire to the Social Security Administration. It may temporarily reduce your retirement benefit if you haven’t reached full retirement age, however, some of your annual earnings are exempt and won’t affect your benefit.
Occasionally, you may be entitled to receive benefits based not only on your earnings record, but on someone else’s as well. This often happens when a married couple retires.
Example: Mr. Jones isn’t planning to retire or receive Social Security retirement benefits until he is 68. His PIA is $1,176. At age 63, his wife wants to retire now, but she can’t begin receiving a spouse’s retirement benefit until her husband starts to receive his retirement benefits. However, since she is already over 62, she can receive retirement benefits based on her own PIA. Hers, adjusted for early retirement, will be $400. When her husband retires, she can receive her own retirement benefit and a spouse’s benefit of $188, the difference between her own worker’s benefit ($400) and the spouse’s benefit she would have received based on 50 percent of her husband’s PIA ($588).
A FAMILY MAXIMUM BENEFIT APPLIES
Your family may receive benefits based on your earnings record. There is, however, a limit to the amount of monthly benefit that can be based on an individual’s Social Security record. The limit varies but generally ranges from 150 to 180 percent of your PIA. Family members’ benefits may be reduced if they exceed the family maximum. The formula used to compute the family maximum is similar to that used to compute the PIA.
As you can see, estimating your retirement benefits can be a complex endeavor with many variables, but our team is ready to help. Planning now for retirement is the safest way to ensure you will have the resources to achieve your dream retirement.