Question: I have worked in the corporate world all my career. I’ve paid the maximum possible into Social Security most of that time. My wife, on the other hand, has been a teacher in a private school for her career. We both got our Social Security estimates online the other day and I could not believe how close they were. My income was multiples of hers, but she’s getting nearly half of what I’m getting. How does that work?
Answer: The deck is not exactly stacked in your favor.
First, in order to qualify for Social Security benefits, a worker has to have worked at least 40 quarters (not necessarily consecutive) in the “covered” system (i.e., paying Social Security taxes on their wages). This is the tax withholding line item on your payroll stub titled “FICA.”
When it comes time for the Social Security Administration to compute your benefits they first do a calculation to come up with your “average indexed monthly earnings (AIME).” You might think of it as their way of averaging the income you earned during your working years and indexing it for inflation. But this is the federal government, so they use a very complex formula to get the answer. Why do simple when complex is so much more fun?
So now they’ve got your number – the inflation adjusted average of monthly wages you earned over your working life (sorta).
If you compare your AIME and your wife’s AIME, they will look just as disparate as you thought they would. You earned a boatload more money than she did and that fact would be reflected in your respective AIME calculations.
But now it’s time to level the playing field.
Social Security will then slice your AIME into three parts: for 2015, the first part is the first dollar of your monthly earnings up to $826. The $826 per month number is known within Social Security as the first so-called “bend point.”
In 2015, someone earning $826 per month could definitely be considered poor. So Social Security will replace 90% of that bend point, or $743.
The second slice of your AIME would be the portion above $826 and below $4,980. That’s going to take you up to nearly $65,000 of annual income, which covers a lot of folks.
For this second segment (or bend point), Social Security replaces only 32% of the AIME. So, if your AIME was exactly $4,980, you would get 90% of the first segment and 32% of the second segment. By my calculations, that’s $743 plus $1,329, for a total of $2,072.
Once you pass the $4,980 AIME level (in 2015), the amount Social Security replaces drops to just 15%.
So, Social Security takes the sum of these three calculations (the 90%, 32% and 15% segments) to determine how much they will pay you monthly once you reach full retirement age. This figure is also known as your primary insurance amount (PIA).
Can you read between the lines yet?
If your wife had an AIME of just $826 in 2015, she would get 90% of her income replaced by Social Security. Suppose someone else had an AIME of $4,980. Once you put the two levels (bend points, remember) together, you see that Social Security is replacing just 41% of your working income.
If you had an executive level AIME (say $10,000 per month), by my back of the envelope calculations, you would get about 28% of your working income replaced.
Please understand that I am doing my best with some complex calculations. You should have the Social Security Administration give you the exact figures applicable to you. You can do that my going to www.ssa.gov, opening an online account and viewing your benefit statement. It’s really pretty easy to do.
Social Security was never designed to provide full retirement benefits to affluent people. But don’t discount it altogether. It is an important piece of the puzzle, but just one piece.
Although the Social Security deck may not have been stacked to reward high income earners, with some focused planning and effort, you and your advisor can stack a deck of your own designed to complement the foundation Social Security provides.
Byron R. Moore, CFP® is managing director / planning group of Argent Advisors, Inc. Email him at firstname.lastname@example.org. Write to him at 500 East Reynolds Drive, Ruston, LA 71270 or call him at (318) 251-5800. The opinions of any single advisor do not necessarily reflect the opinions of Argent Advisors, Inc.No forecasts can be guaranteed. Argent Advisors, Inc. does not offer tax, insurance or legal advice. The information contained in this column should not be construed as a substitute for personalized investment, tax, insurance or legal advice.