MYSTERIES UNRAVELED One of the great mysteries of personal
finance is: How are social security retirement benefits
calculated? The computation itself is something of a mystery.
It's so complex that I'm not sure who could have dreamed it up.
I am sure that most in Congress don't understand it. In this
article we'll take an abbreviated look at what goes into the
computation.
We will be concentrating on the method of computing retirement
benefits in place since 1979. Before then a different, but
equally bizarre, method was used. The changes were instituted in
1979 to help keep benefits more or less inflation-proof. The
computation begins by determining a worker's Average Indexed
Monthly Earnings (AIME). The AIME is based on the worker's
social security wages or earnings from self-employment after
1950, but only up to the social security maximum for each year.
The worker's earnings are then "indexed" by adjusting them for
the average national wage increases. The purpose of the indexing
is to state the wages in terms of the level of wages in the
second year prior to social security eligibility. Generally you
are eligible for social security at age 62, so we index to the
year in which you turn 60.
Now that you have "adjusted" the earnings, you must next
determine the average. Begin this process by determining the
number of years after 1950 (or turning 21 if later) and before
when you turn 62. Got that number? Great, now subtract five.
(Why five? Beats me.) Social security calls this figure the
"number of computation base years." Now, go back to your indexed
annual earnings and select the highest earning years until you
have enough to equal the "number of computation base years." For
example, you began work at 22 and worked to 62. Your benefits
will be computed based on the highest 35 (40 - 5) years of
indexed earnings. Finally, total all the indexed years and
divide by the number of months in those years. Congratulations,
you have just computed the AIME. Have a drink.....or six.
If you thought you're done, guess again. The amount of the
social security benefit is equal to the Primary Insurance Amount
(PIA). Fortunately, you don't have to do these computations
yourself. The Social Security Administration is happy to do it
for you. Just get a Form SSA-7004-PC from your local Social
Security Office, fill it out and send it in. In a few weeks the
good folks at Social Security will send you an estimate of your
benefit.
They will also send you a print out of your "earnings record."
Your earnings record is the amount Social Security thinks you
made each year. It pays to check this periodically, say every
three years. Mistakes are possible and those mistakes can cost
you in social security benefits later on.
About the author:
Mr. Morris, a fee based Investment Advisor Representative with
Raymond James Financial Services, Inc., helps
401k participants get the
most out of their corporate plans.
