The other day I received an email from Social Security. They wrote with an annual reminder to review my current Social Security statement. I am still way too young to receive benefits (I can already imagine my reaction when I read what I just wrote 30 years from now), however, Social Security is already planning for that day. They have been tracking me since I received my Social Security Number (SSN) at birth.
The Social Security Administration site is actually a very handy website for anyone of working age. Once you create an account you can view the following information:
- Your taxable Social Security and Medicare earnings for each year in which you had W-2 income
- Your estimated Social Security benefit if you start receiving benefits at ages 62, 67, and 70
FI Road Tip: When you view your taxable Social Security earnings for each year remember that there is a cap on how much W-2 or self-employment income is taxed. So if you are fortunate enough to earn more than the cap in a single year the amount you see on the Social Security website will reflect the cap for that particular year, not the total amount you earned. Medicare tax does not have any cap so the two values may differ on the site for the same year.
Social Security Benefits Primer
A quick primer on social security benefits…
You can choose to start collecting your social security benefits as early as 62 and as late as 70. Based on your birth year, social security considers your “full retirement age” to be between 66 and 67. Below is the table for determining your full retirement age. If you were born before 1943 and you found this blog post then 1) you are awesome and 2) this table doesn’t apply to you but, then again, you are already collecting Social Security anyway.
| Year of Birth | Full Retirement Age |
|---|---|
| 1943-1954 | 66 |
| 1955 | 66 and 2 months |
| 1956 | 66 and 4 months |
| 1957 | 66 and 6 months |
| 1958 | 66 and 8 months |
| 1959 | 66 and 10 months |
| 1960 and later | 67 |
The government would love for all of us to wait to take benefits at a later age. Therefore, they have built an incentive to encourage that behavior. They pulled together their actuaries and came up with a model where you get less than 100% of your monthly benefit if you elect to start collecting prior to your full retirement age and greater than 100% of your monthly benefit if you start collecting after your full retirement age. Here is what that table looks like for someone born in 1960 or later (if you were born before 1960, click here to view the table based on the year you were born)
| Benefits Start Age | Benefit Percentage |
|---|---|
| 62 | 70% |
| 63 | 75% |
| 64 | 80% |
| 65 | 86.7% |
| 66 | 93.3% |
| 67 (full retirement age) | 100% |
| 68 | 108% |
| 69 | 116% |
| 70 | 124% |
FI Road Tip: There are even smaller benefit percentage increments by month that you can view on the Social Security site. For example, you get a slightly larger benefit by starting collecting at 65 years and 6 months (90%) versus 65 years and 7 months (90.6%).
You cannot choose to go past 70 and received an even higher benefit percentage. The maximum benefit percentage for someone born in 1960 or later is 124%.
Since the benefit percentage varies greatly between 62 and 70 it is helpful to have an idea of what your estimated monthly benefit would be at certain ages to help you better plan for retirement.
Viewing Your Estimated Benefits On The Social Security Site
Being able to log in and get a quick snapshot of your estimated benefits is fantastic. The Social Security website presents you with a view of your estimated benefits at early retirement age (62), full retirement age, and age 70.
FI Road Tip: If both you and your husband/wife/partner are eligible for Social Security you will each have your own statement. Therefore, you should set up separate accounts on the Social Security site to view your individual estimated benefits.
You should see something like this on the site if you have earned enough credits to qualify for benefits. I am not going to dive into credits in this post. Read more about earning credits in the How You Earn Credits publication.
While this quick snapshot is great, it isn’t perfect for those of us still many years from hitting 62. This is because the last line in the image states, “Your estimates are based on the assumption that you will earn $… a year from now until retirement.” where the dollar amount represents your taxable Social Security earnings from the most recent year where you had taxable earnings.
It is understandable why the site takes this approach. They do not want to assume you are going to make more every year in the future, nor do they want to assume what the cap on taxable earnings will be in the future. Therefore they play it conservative and make assumptions that your taxable earnings will not increase and the cap on taxable earning will not decrease.
As I’ll discuss below, Social Security calculates your benefits using your 35 highest years of Average Wage Indexed (AWI) earnings. If you have already worked for 30-35 years, the assumption they use is probably close enough even if you haven’t hit 62 unless you expect your earnings to increase dramatically as you approach retirement. However, if you have only worked 20 years and are entering your peak earning years in your 40s and 50s, the estimate may be quite different from reality. This is where being able to calculate your own estimated Social Security benefits comes in handy.
Estimating Your Future Social Security Monthly Benefit
Almost everything you need to calculate your estimated social security monthly benefit is on the Social Security website. It’s just a matter of adding in some of your own assumptions about your future earnings, future maximum taxed earnings, and inflation.
The best part about creating your own estimates is that you can see what happens if you earn more or less in the future or want to see what would happen if you stop working at a certain age.
FI Road Tip: In this post, my examples assume that you will start taking retirement benefits no sooner than the year that you retire. However, it is possible to start taking retirement benefits while continuing to work and have those earnings impact your AIME as well as your monthly benefit amount in future years. Note that there are tax implications that need to be considered. To learn more about that scenario and tradeoffs I recommend Michael Kitces’ post, How Continuing To Work, Even In Retirement, Can Increase Social Security Benefits
Calculating Your Average Indexed Monthly Earnings (AIME)
First, you need to calculate your average indexed monthly earnings, or AIME. There are two inputs for calculating your AIME:
- Actual and/or forecasted taxable earnings for all years until retirement
- Average Wage Index based on your year of birth
Earnings Table
For your actual and/or forecasted earnings, start by pulling your Earnings Record from the Social Security site into your spreadsheet. This is the list of all taxable earnings up to the previous tax year. You may even see earnings from summer jobs and internships from many years past.
Next, plug in forecasted taxable earnings for all years until retirement. Things to consider are:
- What age do you want to retire?
- What are your earnings expectations in future years? Do you expect to get annual raises that track inflation or will your earnings fluctuate differently?
- If you have a job where you reach or think you will reach, the maximum Social Security taxable amount in a year, what will the maximum taxable amount be in future years? Remember that even if you make $500,000 in a single year your earnings record will only reflect the maximum taxable amount for that year
Example: Let’s work through an example as we go through this. For this example, we’ll look at Amanda, who was born in 1980 and has earnings going back to 2000. Amanda would like to estimate her future monthly benefit for three scenarios: retiring at 50, retiring at 55, and retiring at 62.
Amanda enters her actual earnings from her Social Security Earnings Record for the years 2000-2018 and then forecasts her future taxable earnings for each scenario.
Since she plans on entering a new career in two years she estimates her new salary and then uses an annual 2% increase for each year thereafter. Her salary does not reach the maximum Social Security taxable earning amount so she enters her forecasted total taxable earnings for each future year.
Average Wage Index (AWI)
Prior to calculating your AIME, Social Security adjusts your earnings for inflation using the Average Wage Index (AWI). According to the Social Security’s National Average Wage Index page, this “ensures that a worker’s future benefits reflect the general rise in the standard of living that occurred during his or her working lifetime.” Over 30-40 years of earnings the AWI plays a key role in determining your AIME.
Actual Average Wage Index values are only available for people who are older than 62 or turn 62 in the current year. However, on the Social Security Indexing Factors for Earnings page you can estimate your own AWI based on the year you will turn 62 and become eligible for benefits.
In our example, Amanda goes to the Indexing Factors for Earnings page and enters the year she turns 62, 2042. Using the data returned, she enters the AWI for each year into her spreadsheet.
Adjusted Earnings
Now that you have your actual/forecasted earnings and the AWI based on when you will be eligible for Social Security it is time to calculate your adjusted earnings.
To calculate adjusted earnings for each year, multiply your earnings by the AWI. Easy as that!
Continuing our example, Amanda calculates her adjusted earnings for each of her three scenarios by multiplying her earnings and the AWI for each year.
Highest 35 Years of Adjusted Earnings
As mentioned above, Social Security uses the highest 35 years of your adjusted earnings when calculating your AIME. You follow the same approach and identify the highest 35 years based on the adjusted earnings you calculated in the previous step.
- If you have 35 or fewer years of taxable earnings then you simply add up all of your adjusted earnings
- If you have more than 35 years of taxable earnings then you identify the 35 years with the highest adjusted earnings.
FI Road Tip: Note that in a real-world scenario you highest 35 years of adjusted earnings may not always be the last 35 years that you work. Career changes, job changes, breaks in employment, and the effect of the AWI over long timespans means that you need to review all years to identify the top 35.
In our example, Amanda identifies the highest 35 years of adjusted earnings for each of her three scenarios and highlights them in her spreadsheet.
Interestingly, note that due to the AWI factor that even though her highest salary years occurred in the years just before retirement they do not fall into her highest 35 years of adjusted earnings and therefore do not increase, or even factor into, her Social Security benefits calculation.
Calculate Your Average Indexed Monthly Earnings
Finally, it is time to calculate your AIME. Since AIME is a monthly amount calculated over 35 years of adjusted earnings you take the sum of your highest 35 years of adjusted earnings from the previous step and divide by 420 (35 years * 12 months in a year = 420). This result is your Average Indexed Monthly Earnings (AIME).
Amanda calculates her AIME for each of her three scenarios:
| Retire at 50 | Retire at 55 | Retire at 62 | |
|---|---|---|---|
| Sum of Adjusted Earnings | $4,163,425 | $4,685,238 | $4,808,397 |
| Average Indexed Monthly Earnings (AIME) | $9,913 | $11,155 | $11,449 |
Calculating Your Primary Insurance Amount (PIA)
Once you have calculated your AIME for the scenario(s) you are modeling, you are ready to move on to calculating your Primary Insurance Amount (PIA). Your PIA is the monthly benefit you would receive if you start taking benefits at your normal retirement age, such as 67 for those born in 1960 or later.
Three separate numbers make up your PIA and they are calculated using your AIME and two “bend points”. Bend points are set by the Social Security Administration each year and are adjusted annually for inflation. The general calculation of PIA is as follows:
PIA = (90% of AIME below bend point 1) + (32% of AIME between bend point 1 and bend point 2) + (15% of AIME above bend point 2)
As you can see, as your AIME gets higher, less of it is applied to your monthly benefit to the point where only 15 cents of each dollar of your AIME that is above bend point 2 comes back to you once you start drawing social security.
FI Road Tip: This is one of the key reasons that high earning individuals, in particular, should estimate future Social Security benefits using multiple earnings and retirement age scenarios. You may find that working additional years once you have saved enough for retirement only adds a few dollars to your monthly benefit. Of course, if you simply enjoy what you do for a living then, by all means, keep going!
While the Social Security site provides a handy way to estimate AWI values out into the future they do not provide the same utility for bend points. However, there is a handy calculator at https://socialsecurityintelligence.com/bendpointcalculator/. You simply need to enter your year of birth, the current year’s bend points (they have a link that takes you to the page on the Social Security site where those are listed), and an assumed annual percentage increase. The percentage increase defaults to 2% and lets you choose from 2%, 3%, and 4%. Personally, being conservative I like to stick to the lowest number.
Now that you have your AIME for each scenario and the future bend points you can calculate your PIA.
Using her AIME values for her three scenarios shown in the table above, Amanda calculates her PIA (monthly benefit at full retirement age) for each scenario.
She enters her year of birth, current bend points, and uses 2% for an annual increase on the bend point calculator site. This returns bend point 1 equal to $1,460 and bend point 2 equal to $8,804.
| Retire at 50 | Retire at 55 | Retire at 62 | |
|---|---|---|---|
| PIA up to bend point 1 | $1,314.00 | $1,314.00 | $1,314.00 |
| PIA between bend points 1 and 2 | $2,350.08 | $2,350.08 | $2,350.08 |
| PIA above bend point 2 | $166.34 | $352.70 | $396.68 |
| PIA (Total Monthly Benefit) | $3,830.42 | $4,016.78 | $4,060.76 |
Amanda finds that by working to 55 instead of 50 those five extra years net her an extra $186 in monthly benefits ($2,236 annually). Amazingly, she can also see that seven additional years between 55 and 62 only increases her PIA by $44 a month ($527 annually)! Those extra years may be valuable for reasons such as increasing net worth prior to retirement and maintaining medical benefits prior to Medicare eligibility, but they are certainly not worth it from a Social Security perspective.
Adjusting PIA for Early and Late Retirement
As I described at the beginning of the article, you can choose to start collecting benefits as early as age 62 and as late as age 70. For those of us born in 1960 or later, our “full retirement age” is 67. If you retire at age 67 years and 0 months you get 100% of the PIA, or monthly benefit, that we calculated in the previous steps. Refer back to the table in the Social Security Benefits Primer section to view how benefit percentages change if you choose to start receiving benefits before or after your full retirement age.
A couple additional items to note about your monthly benefit:
- Once you start receiving benefits the percentage of your benefit is locked and does not change. So if you start at age 62 your monthly benefit is 70% of your full benefit forever
- However, if you continue working after you start receiving benefits those additional years of income are considered every year and your monthly benefit could increase in future years if your AIME is impacted by those additional years of work (see my note above with a link to Michael Kitces’ article about tax implications related to working while receiving Social Security benefits)
- As mentioned above, your monthly benefit percentage is adjusted based on how old you are in years AND months. For example, if you start receiving benefits when you are 63 and 0 months your percentage is 75%. If you start benefits when you are 63 and 5 months your percentage is 77.1%
Once you calculate your monthly benefit you can then run through scenarios where you model receiving benefits at different ages. For example, receiving benefits starting at age 62 vs. starting at age 67. In that scenario, assuming a constant cost-of-living adjustment (COLA) each year, you are better off waiting until 67 if you live beyond the age of 81. However, if you die before 81, you would receive more in benefits starting at age 62. Of course, each person needs to consider what works best for them based on health, family, financial, and other personal situations.
Try It Yourself
I hope this post has inspired and enabled you to estimate your own future Social Security monthly benefit. I know for me it was eye-opening to see just how little additional benefit came from working additional years after hitting the second bend point in the PIA equation. While full retirement age may seem far off for many, Social Security is another Personal Finance area where planning early pays valuable dividends toward a strong financial future.
Did you discover anything surprising when you calculated your estimated Social Security monthly benefit or run into any questions as you worked through it? Let me know in the comments.
Featured Image Photo by Sam Truong Dan on Unsplash
