It is important to understand that Social Security is not a system that you pay into and then later get that amount out. You are simply paying a Social Security tax and you and/or your heirs will eventually receive a benefit depending upon the guidelines of the system. This Letter reviews these fundamental guidelines.
If you have not done so already, it is a good idea to go to the my Social Security website at socialsecurity.gov and create an account. Once you are setup, you can view your earnings record, estimated benefit, and most recent statement.
Qualifying for Coverage
In order to qualify for your own Social Security (SS) retirement benefit, you must have 40 quarters (10 years) of employment earnings where Federal Insurance Contributions Act (FICA) taxes were deducted. You complete 1 quarter of coverage when you earn at least $1,300 within a 3-month period. You complete 4 quarters (a full year) of coverage when you earn at least $5,200 within a year. You qualify for quarters by earning at least the minimum amount within that time period, not by working for the entire period. You could earn 1 quarter of coverage by only working 3 hours within a 3-month period if you earned at least $1,300. You could earn 4 quarters of coverage by working 1 day within a year if you earned at least $5,200. (Note: $1,300 is the amount of earnings necessary to earn a quarter in 2017. The amount is adjusted each year based on changes in the national average wage index.)
It is worth repeating that, for Social Security purposes, your covered earnings are your employment wages or self-employment income subject to Social Security FICA taxation. Social Security only applies the FICA tax up to a certain amount of your annual earnings ($127,200 for 2017). Your earnings above this threshold are not taxed for FICA.
How Your Retirement Benefit is Calculated
Social Security determines your benefit amount by first calculating your earnings base, which they call your Average Indexed Monthly Earnings (AIME). Your AIME is calculated by taking your past years of covered earnings, up through age 60, and indexing them to adjust for the average increase in wages each year. Earnings after age 60 are not included. They then take the largest 35 years and divide by 12 to get your AIME. If you do not have 35 years, they use $0 for the missing years which decreases your AIME.
Your earnings base (AIME) is then used to calculate the benefit amount you are due to receive at your regular retirement age. This full benefit amount is called your Primary Insurance Amount (PIA). The PIA is based on a formula that uses progressive “bend points” that are adjusted each year. For 2017, the PIA is derived from taking 90% of the first $885 of AIME, 32% of the AIME between $885 and $5,536, and 15% of the AIME over $5,336. The bend points in the year you turn 62 are used to determine your final PIA. The following table compares an example PIA calculation for two 62-year-olds, Sam and Mary, with very different AIME amounts:
As you can see here, the PIA calculation is highly progressive. Even though Mary’s AIME was 100% higher than Sam’s, her monthly benefit is only 48% higher.
When You Can Take Your Benefit
Social Security calls your regular retirement age your Full Retirement Age (FRA). Your FRA will be between somewhere in the range of 65 to 67, depending upon the year you were born. The table on the right shows you at what age you will reach your FRA.
Impact of Taking Your Benefit Early or Late
To receive your entire benefit (PIA), you have to wait until your regular retirement age (FRA). However, you can apply to begin taking a reduced benefit at age 62. Taking your benefit at age 62 instead of at your FRA will reduce your monthly payment by either (1) 25% if you were born before 1961 or (2) 30% if you were born during or after 1961. Every month you wait after age 62 to begin taking your benefit will decrease this reduction a little, thus giving you a larger monthly benefit. In 2014, 35% of men and 40% of women filed early at age 62.
You can also put off taking your benefit at regular retirement age (FRA) until as late as age 70. You will earn Delayed Retirement Credits (DRC) for every month you wait. The DRC is .67% per month or 8% per year. An individual with a FRA of 67 could increase their monthly payment by 24% by waiting until age 70 to begin collecting. In 2014, only 2% of men and 3% of women waited until age 70.
Cost of Living Adjustments (COLA)
Retirement benefits are adjusted each year, if necessary, to reflect increases in the cost-of-living as measured by the Consumer Price Index (CPI), a price index calculated by the Bureau of Labor Statistics (BLS) that is commonly used in financial markets. At the beginning of each year, benefits are raised by a measurement of the average rate of inflation since the year of the last adjustment. Over the last 10 years, the COLA adjustment has been as low as 0% (2010, 2011, and 2016) and as high as 5.8% (2009).
Working While Collecting Benefits
If you collect benefits early and choose to keep on working, you may have part or all of your monthly benefit withheld. Social Security applies an earnings test each year until you reach your FRA. For 2017, $1 of benefits will be withheld for every $2 in earnings that exceed $16,920. Benefits withheld are not refunded, the individual’s benefit is adjusted higher at FRA to compensate for the amount withheld.
Taxation of Benefits
Retirement benefits are not taxed when Combined Income is under $25,000 (Single) or $32,000 (Married, Filing Jointly). Up to 50% of a benefit may be taxed when combined income is between $25,000 to $34,000 (Single) or $32,000 to $44,000 (Married, Filing Jointly). Up to 85% of a benefit may be taxed when combined income is above $34,000 (Single) or $44,000 (Married, Filing Jointly). Combined Income is calculated by taking your Adjusted Gross Income + 1/2 of your Nontaxable Interest + 1/2 of your Social Security Benefit. It is worth noting that these thresholds are not indexed for inflation so, as time goes by, more Americans will have their benefits taxed for the first time or taxed at a higher rate.
I hope you found this overview helpful. If you have feedback or a question, please comment below and I will respond. In a future Letter, we will take a detailed look at Social Security spousal and widow(er) benefits.
Joshua S. Hall, ChFC
The True Vine Letter is a publication of True Vine Investments, the investment advisory business of Joshua S. Hall, ChFC, and a Registered Investment Advisor in the U.S.A. The information presented is for educational purposes only and should not be regarded as specific financial or investment advice nor a recommendation to buy or sell securities or other investments. It does not have regard to the investment objectives, financial situation, and the particular needs of any person who may read this Letter. True Vine Investments will not be held responsible for the independent financial or investment actions taken by readers. All data presented by the author is regarded as factual, however, its accuracy is not guaranteed. Investors are encouraged to conduct their own comprehensive evaluation of financial strategies or specific investments and consult a professional before making any decisions.
The True Vine Letter often provides analysis on specific companies. True Vine Investments does not receive compensation for this analysis. Various companies are reviewed to highlight aspects of the decision making process used by the Advisor in selecting securities for various portfolio strategies. These reviews are for educational purposes only and not a recommendation to buy or sell securities or other investments. In no way should they be construed as investment advice. The companies reviewed are often junior miners which are often illiquid, highly volatile, and extremely risky. They should only be held as part of a broader portfolio managed by a professional or other experienced and sophisticated investor. The clients of True Vine Investments always come first. The Advisor reserves the right to buy or sell any security at any time, often for reasons not related to analysis provided in the Letter, to properly manage their portfolios.
Positive comments made regarding this article should not be construed by readers to be an endorsement of Joshua Hall’s abilities to act as an investment advisor.