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What does this Social Security thing do?

My son’s latest mission is to collect car parts. This might be because he has an almost-eleven-year-old’s confidence that if he collects enough parts, he can build an actual car; or just because one of his close friends recently found and abandoned bumper. “Pull over, Mom!” he pleaded, when he spotted an ownerless hubcap off the shoulder of highway I-294 (or the “Tri-state” if you live in Greater Chicago). For about 20 seconds, I weighed my desire to promote curiosity and environmentalism against the reality of Chicago’s driving culture. Sanity and a will to stay alive and unscathed won out. We stayed moving in the car and in lieu of stopping on the shoulder in rush hour, I phoned our local repair shop (hands-free, of course). My son was mollified when he emerged an hour later from the shop with a foot-long, pipe-like metal piece with a movable knob on one end.

The automotive shop owner explained that this particular automotive part allows the steering wheel to steer the actual wheels, but I’ll be darned if I could tell you how. Parts of Social Security are like that. You may be aware that they exist and that they are important for making the system go, but you are not quite sure, you understand how.

Average Indexed Monthly Earnings (or “AIME”) is one of those key parts. Essentially, AIME is the first step in translating your life’s earnings history into your retirement or disability benefit. If you have worked a while, you have probably seen a big change in your earnings. Part of this is due to the fact that you’ve gained experience and moved into higher paying jobs, but part is also due to inflation. The Fair Labor Standards Act of 1938 set the first hourly minimum wage at $0.25. By 1988, the minimum wage was $3.35, and in 2018 it was $7.25. If Social Security just averaged your wages over history without accounting for the effect of inflation, the result for most of us would be a small payment with low purchasing power in today’s dollars. Instead, the Administration uses as a benchmark the year that is two years prior to the year you file, and it translates all prior years’ earnings to their benchmark year’s equivalent.

If I file for benefits in 2019, my benchmark year is 2017 and my earnings prior to 2017 are indexed to recompute them in 2017-dollar terms. You can see a detailed example of how this works here.. If you want to try it out on your own earnings, you can use the calculator here. Remember to use the year that is two years prior to your planned filing date as the indexing year. Once the indexing process has been completed, the Social Security calculation then averages the monthly wage for your 35 highest earning years to obtain your AIME. Note that if you are filing for retirement benefits and could have worked 35 years or more but did not, the missing years will be entered as zeros. This is why it can enhance your benefit to keep working until you have 35 years. Or to keep working longer if you want to override some low-earning years. If you file for disability prior to your retirement, your AIME is based on a lower number of earning years since, by definition, you could not have worked the full time.

A second key part is the Primary Insurance Amount (or “PIA”). Social Security is not designed to be a 100% wage replacement for all workers. It is supposed to be a safety net for everyone, but particularly for low-income workers, who would have found it harder to save for retirement in other ways. To affect this policy, the SSA uses a formula to convert a person’s AIME to her/his PIA. The formula works by applying different percentages to different portions of a person’s AIME, separated by what are called “bend points.” The lowest portion of a wage counts for the most, as follows:

  • The first $926 of the AIME is multiplied by 90%,

  • The portion of the AIME between $927 and $5,583 is multiplied by 32%,

  • The portion of the AIME over $5,583 is multiplied by 15%,

  • The percentages are added and rounded down to the next lowest multiple of $10 and that result is the PIA.

For almost everyone, the PIA is equivalent to the retirement benefit that person will get at the age that Social Security has determined to be her/his full retirement age (FRA). FRA varies with the date of birth. Those born earlier have a younger FRA. For many of those already retired, FRA was age 65. For most people still working today, FRA is between age 66 and 67. You can start drawing your Social Security retirement benefit as early as 62, but the amount you receive will be your PIA reduced by 5/9 of 1% for each month before your FRA for up to 36 months and another 5/12 of one percent for each month for over 36 months. If you retire at 62, your monthly benefit would be around 30% lower than if you waited till your FRA. Conversely, if you delay your filing beyond your FRA, your benefit will be 8% higher for each year you delay up to your age 70. Note that there is no possibility to file early or delay a filing for disability benefits.

PIA is not only a basic driver for a person’s own benefits but also for the benefits that any family member might receive on that person’s record. For example, if I file for disability or retire, my spouse, my minor children and my adult children with disabilities are each eligible for an auxiliary benefit of up to 50% of my PIA. If I die, my minor children or adult children with disabilities would be eligible for a benefit that is up to 75% of my PIA. Note that these auxiliary benefits are based on my PIA, and NOT the actual benefit that I am receiving, which may be smaller if I filed early or larger if I delayed filing. Separately, my spouse’s benefit may be reduced due to her/his filing age. My spouse’s widow(er)’s benefit will be whatever my actual benefit was at the time I died if s/he is at full retirement age and will be reduced if s/he is younger.

All this sounds like it could result in a large windfall for a large family, but there is a reason I added “up to” before the various percentages. A third key part of Social Security’s workings is the Family Maximum. There is a limit to how much in benefits may be paid out on one person’s earnings record. The limit ranges from 150% to 180%. So, you can see that if I retire and file and my spouse and two children are both eligible, the limit will kick in. If I get 100% of my PIA, then my spouse and two children cannot get 50% each, because the total would be 250% and thus above the family maximum. Instead, I will get 100% of my PIA and their benefits will be reduced proportionately. Note that whether I file early or late, 100% of my PIA is what will count for my share of the family maximum. There are many more levels of complexity to Social Security’s calculations. A spouse or adult child with a disability may be eligible for benefits based on her/his AIME and PIA, as well as an auxiliary benefit based on another person’s. In such a case, the family maximum calculation is more complicated with more moving parts.

A couple of days later, I took my car into the shop. The shop owner had another bent piece of metal for my son. He did his best to explain again, this time with abundant hand gestures, how this particular part fit into the overall car, and what it did in the process of driving. It’s all a smidge clearer now, but it will probably take a few dozen more explanations before it really makes sense to me. If you are trying to make sense of how Social Security works, I hope this blog helps to understand a little better how the AIME, PIA and family maximum steer the benefits calculation—but you may need to read a few more.

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