Social Security Optimization
Making personal savings last
Potential tax-free retirement
How Social Security is calculated
Spousal Benefits vs Survivor Benefits
Independently Entitled Divorced Spouse
WEP & GPO
How Social Security Benefits Are Calculated
PIA and the AIME Calculation
The primary insurance amount, or PIA, is defined as the “benefit a person would receive if he/she elects to begin receiving retirement benefits at his or her normal retirement age”. The PIA is a dollar amount that represents a portion of a worker’s average indexed monthly earnings, or AIME, for the 35 years of highest earnings. In making this calculation, wages earned prior to age 60 are indexed to reflect increases in average wage levels. Simply put, earnings are adjusted to reflect today’s dollars. To be clear, if wage levels have increased threefold since those dollars were earned at age 25, for example, the SSA will triple the age 25 earnings as part of the process for calculating a worker’s PIA. It is important to note that if a worker has less than 35 years of income, 0 is entered for those years where no income was earned.
The indexing of earnings therefore, is a fairly straight forward process that simply converts yesterday’s dollars into today’s dollars (or more specifically, the value of the dollar at the worker’s age 60). By so doing, the SSA can effectively establish a lifetime average wage for those covered workers who are applying for benefits.
NOTES ON EARNINGS:
·Earnings after age 61 (which are not indexed) will be substituted for earnings in earlier years if they result in a higher benefit.
- It is worth noting that a worker may receive increased benefits for work performed after beginning benefits. For those individuals who chose to continue to work while collecting benefits, the SSA will recalculate their benefit and pay any increase due, if their later earnings are higher than any of the previous years. This concept is discussed below in the section entitled Recalculation of Benefit Amount.
- For those employees who are in the higher earnings bracket, continuing to work will generally not play an appreciable role in their overall PIA. However, for someone who has a spotty work history or was out of the workforce for many years, replacing the years of 0 or minimal earnings with actual earnings could make a difference for them in their net PIA amount.
- Workers whose work history includes mainly self-employment and who’ve shown minimal earnings throughout their lifetime for tax purposes should be mindful of the implications those earnings have on their Social Security benefit.
- Workers should periodically review the earnings record maintained for them by the SSA for accuracy. Any discrepancies should be reported so their record can be corrected. A review of earnings records can be done on the SSA website.
Once yearly earnings have been indexed, the highest 35 years are added together and averaged by dividing by 420 months (representing the 35 years) to arrive at the worker’s AIME. Again, it is important to note that zeros will be figured into the calculation as necessary (ie for those workers who have not had 35 years of earnings) which will lower the AIME used to calculate their PIA. Once the AIME is calculated, the AIME formula (explained below) is used to arrive at the worker’s PIA. This process is done automatically by the SSA.
(90% of first $885 of AIME) + (32% of next $4451)
+ (15% of any amount above $5336 of AIME) = PIA
The process for converting the AIME into a PIA is most simply explained utilizing an example. Lets assume the SSA calculates a worker’s AIME at $8500. Their PIA would be calculated as:
90% of $885 = $ 796.50
32% of $4451 = $1424.32
15% of $3164 = $ 474.60
PIA $ 2695.40 (rounded)
The figures $885 and $5336 are referred to by the SSA as ‘bend points’ and they are updated annually.
So this worker whose AIME was $8500 would be eligible for a monthly benefit (absent the cost of living adjustments that are included annually when a COLA is declared) of $2695.40 if they began taking benefits at their Full Retirement Age (FRA). FRA is determined by birth year as follows:
Reduction to FRA for Taking Benefits Early
Workers are eligible to begin taking benefits as early as age 62. However, benefits taken prior to FRA are reduced by the SSA by a set formula of:
5/9 of 1% for each of the first 36 months pre-FRA
plus 5/12 of 1% for each month thereafter
The net result of this reduction formula is that workers who have a FRA of 66 will see the following reduction based on the year they begin receiving benefits:
So, for example, using the example above of the worker with a PIA of $2695.40, if she were to start benefits at 62 rather than waiting until 66, her monthly payment would be reduced by 25% and she would therefore have a monthly benefit rate of $2021.55.
Increase to FRA for Delaying Benefits
If a worker elects to begin taking benefits later than FRA, their benefit will be increased via the application of what is referred to as delayed retirement credits. For each month the worker delays taking benefits beyond their FRA, their PIA is increased by 2/3 of 1% which amounts to an 8% increase annually.
Again, using the example of the worker whose PIA is $2695.40, if she were to delay taking benefits until 67, her monthly benefit amount would be $2911.
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