Friday, November 19, 2010

Everything You DIDN'T want to know about Social Security Benefits Calculations - And SOME of the Proposed Changes

In light of the recent scuttle bug created by the most recent elections and the Deficit Commission, I thought I would take our posting here a step further. Now that we have some proposed changes, what do they REALLY mean? You won’t get a straight answer from your congressperson, Senator or even the President. So I’m putting the general information out there, and you can discuss and decide for yourself.

There have been many recommendations over the last couple of years about how to solve the solvency problem with Social Security. The Commission made several recommendations:
  • Increasing the Maximum Taxable limit - curently it is at $106,800
  • Increasing the minimum retirement age to 62
  • Increasing the Full Retirement age to 69
  • Adding an additional 50% Bend Point
So what does this ACTUALLY mean? Well, Social Security calculations are COMPLICATED. I’m going to try my best to point out a few highlights, and show where the Deficit Commission is making SOME recommendations. Keep in mind that I’m just speaking in very general terms, and that Social Security is calculated on an individual bases.
               1. Increasing the Maximum Taxable Amount 

Since 1982, the Social Security base has risen at the same rate as average wages in the economy. However, the percent of covered earnings that is taxable has decreased from 90% in 1982 to 85% in 2004. The percentage of earnings that is taxable is projected to decline to about 83% for 2014 and later. Since the cap was indexed to the average growth in wages, the share of the population below the cap has remained relatively stable at roughly 94%. Of the 8 million Americans with earnings above the base, roughly 80% are men and only 9% had any earnings from self-employment income. New Jersey has the highest share of the population above the maximum (10%) and South Dakota has the lowest share (2%).

The Commission wants to increase the maximum amount. They feel this will help rebuild the depleted trust fund.

Currently there are maximum taxable earnings for Social Security Taxes. That max is $106,800 for 2010. This means that IF you make $106,800 annually (working only one job), with the Social Security Taxes at 6.20%, you would pay a maximum of $6,621.60 in 2010 (106800 X .062 = 6621.60). Ideally, you would think that this is “unfair” to those who make LESS than $106K a year, but (as I will explain later with Bend Points) it is weighted towards those making less money.  The idea was that Social Security wasn’t the sole income for a retiree. Social Security benefits were always meant to be part of or “core” to their retirement income. It was felt that those making OVER the max didn’t “need” Social Security as much as those making less than the max. As you can imagine, this has been at the center of the Social Security debate for decades, but the max has never been abolished.

In addition to setting a max, other criteria was established to assist those in the lower income bracket. There have been SEVERAL changes throughout the years on how to calculate benefits. I won’t get into all of them as most don’t apply today. I will attempt to explain the most current calculation, which is called the New Start Primary Insurance Amount (PIA) calculation that started in 1978.

In a nutshell, benefits are calculated by taking the highest 35 years of a beneficiary's earnings (actually you take the highest 40 years and drop out the lowest 5). Once the highest 35 years have been identified, they are “indexed” or adjusted to bring the earnings from earlier years to a level that more closely reflects earnings levels at the time the beneficiary becomes eligible. Basically it is to reflect the general rise in the standard of living that occurred during the worker’s lifetime. So, here is where we FIRST start to see how tinkering with the retirement age will change some things. To index earnings, you need an “indexing year.” An “indexing year” is two years before a person first becomes eligible for benefits. The highest 35 years of a person's earnings up until two years before they become eligible for benefits are indexed (increased) to match the earnings they would be IF they were actually earned IN the indexing year.

Side Note: The year immediately before AND the year a person becomes eligible for benefits are NOT indexed. The ACTUAL dollar amount for THAT year applies.

               2. Increasing the minimum retirement and full retirement ages

Today, if someone wants to retire, the EARLIEST they can retire and receive Social Security benefits is age 62. So for example, if a person turns 62 in 2011, they become eligible for benefits in 2011 and their “indexing year” is 2009. So their indexing calculations would be based on the AVERAGE of all wages for 2009 - $40,711.61 (based on wage data collected by SSA).

The Commission wants to raise the earliest retirement age from 62 to 64 and the FULL retirement age from 67 to 69. If the earliest retirement age increases to age 64, as proposed by the Deficit Commission, the indexing year will change to two years before a person reaches age 64 which would change their indexing year also changing their indexed earnings.  Additionally, the debate also says that if you raise the minimum age to 64, those that are 62 and can't work due to a disability will be FORCED to file for disability benefits.  Disability benefits are higher than earlier retirement benefits, and would deplete the trust fund sooner.  However, the Commission did state that there would need to be an exception for those that are 62 and can't work, and made it the Social Security Administration's job to figure out how to make that issue work.

Confused? Good! Just how the Feds like it! Let’s continue.

    3. Adding an additional Bend Point

Once the highest 35 years of been identified and indexed, they are then all added together and divided by the number of months IN those 35 years (35yrs X 12mths = 420mths). This gives us the Average Indexed Monthly Earnings (AIME) of their highest 35 years of work.

The AIME is then applied to Bend Points. Bend points are used to give a higher return to wage earners with lower earnings. Basically, if you made less money over your lifetime, you will get a higher return (compared to your lifetime average of wages) than a person who made more money over their lifetime (compared to their lifetime average of wages). Applying the Bend Points, a person will get back from Social Security the (what we will call) Gross SUM of the bend points. To calculate the gross sum, you take 90% of the AIME that falls within the first Bend Point, 32% of the second Bend Point that is over the first Bend Point and the remainder that exceeds the second Bend Point you return 15%. (WHAT???? I know… confusing…).


For 2010, the Bend Points are $761 and $4486.

Example 1.
After you’ve added up a person’s 35 years of indexed earnings and divided it by the 420 (months within 35 years) and you ended up with an AIME of $500. Using the 2010 Bend Points, that AIME is LESS than the first Bend Point of $761. That person would get 90% back of their AIME as their gross. So their gross amount would be $450. And this is the amount used to pay their monthly retirement check.

Example 2.
Let’s say a person’s AIME is $1560. Their Bend Points for 2010 are 90% of the first $761, 32% of the next $4486, and 15% of anything over that. We already see that $1560 is more than the first Bend Point, so they would get 90% of 761 back.

761 X .90 = $684.90

Now, the number BETWEEN 761 and 4486, they would get 32% back. However, her AIME is less than $4486… so we just need to figure out how much over the first Bend Point is needed to apply the 32% to.

$1560(AIME) - $761(first Bend Point) = $799 (amount for the 2nd Bend Point)

$799 x .32 = $255.68

We then take the SUM from the Bend Points ($684.90 + $255.68 = $940.58). So this person’s retirement amount, will be based on $940.58. If they decide to wait until their Full Retirement Age* to start receiving Social Security Benefits, they would receive $940 per month. If they wanted to receive benefits at age 62, this amount would be reduced for age.

The Deficit Commission has recommended adding ANOTHER Bend Point at the 50th percentile. So after 90% would be 50% then 32% and 15%.

I would imagine that if they raised the wage cap... something would need to be adjusted on the Bend Point to balance this whole mess out.  Adding a 50% Bend Point would help to keep low income workers out of poverty, but it would also pay out more in benefits.  I'm not a math guy, so I don't know what amount is need in higher earnings to balance this thing out, but I do believe it is possible.  So then the question becomes, will the upper 5% be okay with paying more in, but continue getting less out?

Have I thoroughly confused you?
Do the recommendations make sense?
If you understand this, do you think they could work?
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