Each year, after decades of contributions to the program, millions of Americans claim social security benefits for the first time. Most go on to receive hundreds of thousands of dollars in the form of a monthly "paycheck" from the government. For some it's the only source of income in retirement. And for middle and even higher income earners, it forms a substantial (20-50%) part of their retirement incomes. Yet, precious few ever take the time to truly understand how those monthly dollar amounts are even computed. So this month, let's do just that...
To begin, know that the Social Security Administration (SSA) uses the same formula for every single American. First, they determine your "Averaged Indexed Monthly Earnings" or AIME. To calculate this number, the SSA looks at every year you earned any money whatsoever. They then apply an indexing factor to your annual total to account for inflation. For instance, $10,000 earned in 1985 is worth a whole lot more in 2019. The highest 35 years of earnings are then added up and divided by 35 to determine your annual average earnings. That number is then divided by 12 to determine your AIME.
From there, your Primary Insurance Amount, or PIA, is calculated. To determine your PIA, the Social Security Administration applies a bit of a wonky formula. They take 90% of the first $895 of your AIME, then add 32% of the amount greater than $895 but less than $5397, and finally add (if applicable) 15% of the amount over $5397. Voila, your monthly social security payment! Note: This number can further be altered by claiming early, late, cost of living adjustments, or working while also receiving a social security benefit.
While this newsletter doesn't allow a more in-depth look at your social security benefit, we should note a few important points, especially as we are in tax season. First, is that social security benefits are weighted to help lower income people more. Note above how the more money you earn, the lower the percentage your social security "payback" is. Relatedly, if you are taking the S-election on your small business tax return, instead of claiming the lowest amount of income possible, as most people do, I always encourage claiming up to $64,764/yr in salary. Why that number? Easy, it's $5397 x 12 (months). Claiming this amount maximizes the top two more generous tiers of social security while leaving off that last 10% tier, where you don't get much "bang for your buck." So, by thinking just a little more deeply about how social security is calculated, you can strategize how to maximize your own benefit.
Have I gotten you totally psyched to calculate your social security payment? You can always visit the social security administration's website here to check on your benefit and see the government's end calculation. And if you'd like a worksheet to check their work or calculate hypotheticals yourself, visit this link.