Do your earnings at the point of retirement impact Social Security benefits?
Do the amount of earnings at the time of retirement affect the value of one's SS benefits? Or are SS benefits determined by the total amount you have contributed throughout the years?
Yes and yes! But replacing lower earning years by continuing to work may not have the impact you would expect. This is especially important to understand if you hate your work or your work is physically and/or psychologically wearing you down. Here's how SS calculates your monthly benefit:
- First, they pick the highest 35 earning years. If you haven't worked 35 years, then they'll include zero earnings for enough years to total 35.
- Then, they bring each one of those years forward into today's wages. For example, suppose you earned $20,000 in 1990 and you make $40,000/yr now. Guess what the multiplier is for 1990 wages, about 200% or $40,000. So working another year would not eliminate 1990 from your top 35!
- Then they total all 35 years' earnings and divide by 35 years of months or 420 to get your AIME (average income monthly earnings).
- Finally, they subject your AIME to three calculations. The first $885 of your AIME is multiplied times 90%. $886 through $5,336 wages are multiplied by 32%. Everything above $5,337 is multiplied by 15%. The results are added together to get your PIA (primary insurance amount which is the same as your full retirement age benefit). If your PIA is higher than $2,639, then $2,639 is your maximum PIA in 2017.
Whew! As you can see, the idea is to skew benefits toward lower earning participants, which is appropriate since the program was designed to primarily benefit the elderly poor.
The Social Security Administration uses your highest 35 years of earnings to calculate your benefits. Thus, any lower earning at your early careers may be swapped by some higher earning at the later years. Theoretically, the longer you can work (preferably to the 70), the better or higher SS benefits you could get. Not only it beefs up your payment, but also it benefits your spouse, who could get 100% of what you earn as a survivor spouse. However, there’s no reason to wait any longer than 70 as no extra credit will be given after that. Also, if you file the SS benefits prior to your full retirement age, there can be some deduction due to the Earning Test. Work with a professional to find out when your optimal filing time is. Best!
There are two primary factors to consider when planning for Social Security Retirement Benefits. Here is a quick overview:
- Your Social Security Retirement Benefit will be based on your Average Indexed Monthly Earnings ("AIME"). The Social Security Administration ("SSA") takes your highest 35 years of earnings (indexed for inflation) and divides the sum by 420 (i.e. 35 years x 12). This is the AIME. Then they apply the Personal Insurance Amount (PIA) formula, which determines your monthly retirement payment. The PIA formula can get a bit complex, but it is usually around 30-50% of AIME. The higher a retiree's AIME the lower the percentage. And lower income earners will receive a higher PIA payment. (You can see an example at the ssa.gov website here.)
- The second consideration is how benefits will be taxed. Combined Income, as defined by SSA, is your AGI + tax-free interest received + 1/2 of your PIA payment. If you're married filing jointly and your combined income is above $32,000, half of your PIA payment could be taxable. If combined income is > $44.000 then 85% of your payment could be taxable. If single, half of your payment will be taxable if combined income is north of $25,000. If combined income is > $34,000 it will be 85% taxable. The amount of your SS payment that is taxable is also dependent on a few other factors found of page 7 of Pub. 915.
Your advisor should be able to calculate a current estimate of PIA and/or strategize with you about how to optimize benefits and tax efficiency.
Social Security is calculated based on the average of the highest 35 years of your working career adjusted for inflation. It is very likely that what a person earns closer to retirement is higher than what they were making 35 years ago. In that case, the higher income would replace the lower one.
Because your Social Security benefit is determined over your best 35 years of earnings, your final salary may impact your benefit, but in a relatively limited way. However, your earnings have two other important roles related to Social Security. First, if you are taking your benefit prior to full retirement age (FRA), you have a limit on the amount you can earn from employment without losing part of your benefits. Since most people reach FRA at about 66, if you take your benefit ahead of that and continue to work and earn more than $16,920 (in 2017), you will lose $1 in Social Security benefit for every $2 that you earn. In the year you reach FRA, the formula changes, and you lose $1 for every $3 in excess of $44,880 (in 2017). I know it's complicated, but overlooking the rule is very expensive.
The second way your earnings impact your Social Security benefit concerns the taxability of Social Security. Your Social Security benefit may be income tax free, 50% taxable, or 85% taxable, depending on your income that year. In an odd twist, Social Security even makes you add back income that is otherwise tax exempt, like interest from municipal bonds. Although the taxability of benefits is rarely a consideration in when to take them, it's important to know, so you calculate your taxes properly.
Be Prosperous! Peggy