Understanding Social Security: A Case Study

Introduction

Social Security is very important in providing financial support during retirement, especially for those who have paid into the system throughout their working years. But how exactly is Social Security calculated, and what can you expect in monthly payments? Let’s take a look at a detailed example.

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Step 1: Understand the Basics of Social Security

Social Security benefits are primarily based on your earnings history. Specifically, the Social Security Administration (SSA) looks at your 35 highest-earning years to calculate your benefits. If you worked fewer than 35 years, they will average in zeros for the missing years, which will lower your benefits.

The benefit you’ll receive each month is referred to as your Primary Insurance Amount (PIA), which is based on your Average Indexed Monthly Earnings (AIME). The AIME is a calculation of your average monthly earnings, adjusted for inflation.

Once you have your AIME, the SSA applies a formula to determine your PIA. This is done through bend points, which adjust the percentage of your earnings that will be replaced by Social Security.

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Step 2: Calculate the AIME

Let’s consider a case study. Meet John, who is about to retire at age 67, the full retirement age (FRA). John has earned different amounts each year throughout his working life. We’ll simplify this example by assuming John’s income was consistent in his highest-earning years. Over his career, John earned an average of $60,000 per year in today’s dollars.

To calculate his AIME:

1. Step 1: John’s total earnings over his 35 highest-earning years are $60,000 per year × 35 = $2,100,000.
2. Step 2: Divide his total earnings by 420 (the number of months in 35 years): AIME=2,100,000420=5,000AIME = \frac{2,100,000}{420} = 5,000AIME=4202,100,000​=5,000 So, John’s Average Indexed Monthly Earnings (AIME) is $5,000.

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Step 3: Apply the Bend Points to Calculate the PIA

In 2024, the bend points for calculating Social Security benefits are as follows:

• 90% of the first $1,115 of AIME
• 32% of AIME between $1,115 and $6,721
• 15% of AIME above $6,721

Using these bend points, we can calculate John’s Primary Insurance Amount (PIA):

1. 90% of the first $1,115 of AIME: 1,115×0.90=1,003.501,115 \times 0.90 = 1,003.501,115×0.90=1,003.50
2. 32% of the AIME between $1,115 and $5,000: (5,000−1,115)×0.32=3,885×0.32=1,243.20(5,000 - 1,115) \times 0.32 = 3,885 \times 0.32 = 1,243.20(5,000−1,115)×0.32=3,885×0.32=1,243.20
3. John’s AIME does not exceed $6,721, so there’s no need to calculate the 15% bend point.

Adding these together:

PIA=1,003.50+1,243.20=2,246.70

John’s Primary Insurance Amount (PIA) is $2,246.70. This is the amount John will receive each month if he retires at his full retirement age of 67.

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Step 4: Adjust for Early or Delayed Retirement

John’s PIA is based on him retiring at age 67. However, if John chooses to retire earlier, say at age 62, his benefits will be reduced. Conversely, if he delays his retirement past 67, his benefits will increase.

• If John retires at age 62, he will receive approximately 30% less each month. This reduction would mean John receives $1,572.69 per month ($2,246.70 - 30%).
• If John delays retirement to age 70, he will receive approximately 24% more. In this case, John’s monthly benefits would be $2,785.91 per month ($2,246.70 + 24%).

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Step 5: Cost-of-Living Adjustments (COLA)

It’s important to remember that Social Security benefits are also subject to Cost-of-Living Adjustments (COLA), which are meant to keep up with inflation. For example, if the COLA for a particular year is 2%, John’s benefits would increase accordingly. While we used 2024 numbers, these figures can change annually based on adjustments.

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Final Monthly Benefit for John

If John retires at age 67, his expected Social Security benefit will be $2,246.70 per month. If he retires early or delays retirement, the amount can vary significantly. For retirees, it’s essential to consider factors like the timing of retirement and personal savings in addition to Social Security.

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Conclusion

Understanding how Social Security is calculated can help you make informed decisions about your retirement. By breaking down the numbers, as in John’s case, you can estimate your monthly payments and decide on the best time to claim your benefits.

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Thank You for Reading

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