Social Security Retirement Benefits
The Social Security Administration (SSA) issues a Social Security Benefit Statement that you may receive in the mail or view online at https://secure.ssa.gov.
However, the statement does not tell the whole story.
Americans are fairly bad at retirement planning, saving only 11% of what they need in retirement. So how awful would it be to depend on social security only to receive hundreds less a month than you thought you were going to get?
Some retirees are dismayed when they receive as much as $480 less per month than what the statement says. This is not deception on the part of the SSA. Some things just aren't known until you retire.
Understanding the SSA benefit calculations will help you make sure that you have enough money to support yourself throughout your retirement and avoid unexpected surprises.
Minimum Requirements
To receive social security retirement benefits, you must have paid in to the system. Employees earn up to a maximum of 4 credits per year. Workers are entitled to receive social security retirement benefits once they have earned 40 credits.
Beginning in 1978, for each $250 of income in a year, an employee received one credit. The required earnings were indexed for inflation each year so the required earnings to earn one credit in 2020 has risen to $1470. In 2020, once an employee earned 4*$1470=$5880, they received 4 credits, the maximum credits for one year.
Average Indexed Monthly Earnings (AIME)
While 10 years earning $5,880 a year is enough to qualify for a social security retirement benefit, the benefit won’t be much. The SSA averages 35 years worth of earnings and any missing years are counted as $0 years. Therefore, you must have 35 years in the workforce to maximize your benefit.
The SSA keeps track of your lifetime reported earnings from the annual W-2s submitted by your employer(s). There is a cap on what wages are considered and what you pay tax on. This “capped” wage is labeled “Social Security Wages” (box 3) on your W-2. It may be less than your total wages which are labeled “Wages, tips other compensation” (box 1). [See Contribution and Benefit Base for more details.]
If you were self-employed, the IRS supplies the data you reported on tax form Schedule SE to the SSA.
To compensate for inflation, the SSA adjusts prior year earnings upward before averaging your earnings. Each year the SSA calculates the national average wage which they call the Average Wage Index (AWI). The SSA uses the AWI to adjust your prior years’ earnings.
The highest 35 years of these adjusted earnings are averaged to created the Average Indexed Monthly Earnings (AIME) [See these examples].
Primary Insurance Amount (PIA)
The Primary Insurance Amount (PIA) is the benefit a person would receive at their normal retirement age (65–67 based on birth year). At this age, the benefit is neither reduced for early retirement nor increased for delayed retirement.
The PIA is a sum of three percentages of different portions of your AIME.
- 90% of the lowest amount,
- 32% of the middle amount, and
- 15% of the remaining amount.
These different percentages are designed to provide the most help to those with the least incomes.
The three ranges of the AIME are separated by two bend points, which go up each year according to the AWI. The bend points that apply to you are those from the year you turn 62, no matter when you beginning collecting social security.
Example: Tahani is 67 in 2021 and is planning on retiring. Her AIME is $5700. She turned 62 in 2017, so the bend points are from 2017 in this table, $885 and $5336.
.90 * ($885) + .32 * ($5336–$885) + .15 * ($5700–$5336) = $2,275.42
Tahani’s PIA is $2,275.42.
Cost-Of-Living Adjustments (COLA)
Since the PIA is calculated using the bend points at age 62 (earliest retirement age), if the individual then waits to take retirement at normal retirement age, the amount of the PIA is adjusted by the Cost-of-Living Adjustments (COLA).
Example: Tahani retires at age 67 in 2021. The COLA for the four years from 2017 to 2021 are 2%,2.8%,1.6% and 1.3% respectively.
((($2275.40 * 1.02)*1.028)*1.016)*1.013) = $2,455.40
[SSA truncates each calculation to the nearest dime]
The SSA issues checks in even dollar amounts, so Tahani’s social security check would be $2,455.00. The retirement benefit continues to increase each year thereafter by the COLA.
Early Retirement
In the case of early retirement the AIME is reduced each month before normal retirement age.
Example: Eleanor plans on retiring in 2022 when she turns 62. Her normal retirement age is 67, so she is retiring 60 months early.
The reduction is computed by reducing the benefit by 5/9 of 1% for each month for the first 36 months.
36*(5/9)*.01 = .2
The reduction from the remaining 24 months reduce the benefit by 5/12 of 1% for each of these remaining months
24*(5/12)*.01 = .1
.2 + .1 = .3
By retiring early, Eleanor’s social security check would be reduced by 30%.
If at all possible, avoid applying for social security retirement benefits before your normal retirement age to avoid significant reductions in benefits, even if that means working part time until normal retirement age.
Delayed Retirement
For anyone born 1944 or later, each year that retirement is delayed after normal retirement age until age 70 provides an 8% increase.
Example: Janet is scheduled to retire in 2022 at age 69. Since Janet was born in 1953, her normal retirement age is 66. By retiring three years later, Janet’s social security check would be increased by (3*8) = 24%.
Windfall Elimination Provision (WEP)
In the early 80s, 60% of private employers had pensions. According to the U.S. Bureau of Labor Statistics, in 2020, that has declined to 15%. Conversely, prevalence of pensions in the public sector (federal, state, local, education, health care) has grown, with some 86% of public sector employees now having access to pensions.
However, many of those public sector organizations have received waivers to opt-out of the social security system. That means that during the time that people worked for one of these organizations, no social security tax was paid by the employer or withheld from the employee’s wages.
Congress passed legislation in 1983 to prevent what was considered “double dipping”. Employees who did not pay in to the social security system during those years, should not be entitled to receive credit for those years.
The WEP adjusts the first of the three factors of the PIA, downward from 90 percent to between 40 and 85 percent. However, it never reduces the size of the social security benefit by more than half of the public sector pension. Because the SSA does not know the size of the public sector pension until after the pension starts, the SSA cannot include a WEP calculation on the social security benefit statement.
The WEP is only applied if you have less than 30 years of substantial earnings on which you paid social security taxes. Teachers who are covered by such a pension program may have chosen to work private sector summer jobs with social security taxes withheld assuming this would qualify them for social security retirement benefits. However, they may find that their summer earnings were not sufficiently high to qualify as substantial earnings ($25,575 for 2020). Their earnings will still contribute to their AIME, but will not avoid the reduction factor caused by WEP. Fortunately, the reduction in social security retirement benefits through WEP is limited ($480 for 2020, $498 for 2021).
While there have been attempts to repeal the WEP (2013, 2015, 2017, 2019, 2021), these repeals have so far failed because the repeals have not addressed fundamental questions of fairness.
Summary
Understanding social security retirement benefits is challenging. Keep these key understandings in mind to make sure that you have enough money to support yourself throughout your retirement.
- Social security is based on your highest 35 years of inflation adjusted earnings. Because earnings are capped, the maximum social security amount at normal retirement age is $3,011 in 2020, or $3,790 for those who delayed until age 70 to apply for benefits.
- Early retirement can lower your retirement benefit as much as 30%.
- Delayed retirement can raise your benefit as much as 24%.
- Those who were in public sector pensions should try to ensure they have 30 years of substantial earnings on which social security taxes were withdrawn to avoid up to a $480 reduction in social security benefit (2020).
Married couples should also read this article that reviews additional benefits available to married, widowed or divorced couples.
