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A Rough, General-Purpose Retirement Plan

For a few years now I’ve been talking about a basic “cookie cutter” sort of Social Security plan (i.e., an approach that works reasonably well in most cases) and about factors that would suggest that a person or couple should make adjustments to such a plan.

I’ve been thinking recently that it might be fun/useful to extend that same type of thinking to a broader range of retirement planning areas. So here’s my attempt to do just that.

And just to be super clear about something that is hopefully obvious given the brevity of this article: there are many, many cases in which the suggestions below would not be the best approach for an actual person, due to their personal circumstances. I have mentioned some of the circumstances that would suggest alternative approaches, but in each of the topics below there are plenty of potential factors that I have not mentioned.

Social Security

If you’re single, delay claiming benefits until somewhere in the 68-70 range. If you’re married, the spouse with the higher earnings record files at 70, and the spouse with the lower earnings record files as early as possible (62 and 1 month in most cases).

Some of the circumstances that would suggest an adjustment to such a strategy include:

  • You are single and are in very poor health (in which case you should file earlier),
  • You are married and both spouses are in good health (lower earner should file somewhat later) or very bad health (higher earner should file somewhat earlier),
  • The lower earning spouse is working beyond age 62 (in which case they should usually wait to file until they quit work or have reached full retirement age),
  • You have minor children or adult disabled children (may be a reason for the higher earner to file earlier), or
  • You or your spouse will be receiving a government pension (could affect the decision in either direction).

Tax Planning (Retirement Account Distributions)

Try to “smooth out” your taxable income over the course of your retirement.

For example, if you retire at age 60 but don’t plan to take Social Security until 70, you have a 10-year window during which your income will be markedly lower than it has been in the past (because you’re retired) and lower than it will be in the future (because neither Social Security nor RMDs have started yet). So it’s likely wise to spend from tax-deferred accounts and likely do some Roth conversions during that 10-year window — with the goal being to shift income from future years (which would otherwise be higher-income years) into the current lower-income years (i.e., smoothing out your taxable income over time).

To be clear, that’s somewhat of a simplification. In reality you want to try to smooth your marginal tax rate — rather than taxable income — over time. That is, if your marginal tax rate now is lower than it will be later, try to shift income from future years into this year. (And it’s key to remember that your marginal tax rate is often quite different from your tax bracket, especially during retirement.)

Spending Rate

Firstly, set aside (in something safe, such as a short-term bond fund) enough money to fund any Social Security delay that will be happening. For example, if you are forgoing $150,000 of Social Security benefits by waiting from 62 until 70, set aside $150,000 in something safe in order to fund the extra spending necessary until age 70. Then, from the remainder of the portfolio, use the IRS RMD table (i.e., “Uniform Lifetime table“) to calculate a spending amount each year. And for years prior to 70, use the same overall age-based approach — with a lower rate of spending the younger you are.

We discussed this overall strategy last year, and you can find a paper here from Steve Vernon that discusses it in more depth. Broadly speaking though, basing spending on RMD percentages has two main advantages:

  • It adjusts spending over time based on portfolio performance, rather than spending a fixed inflation-adjusted amount each year of retirement, and
  • It adjusts spending based on your remaining life expectancy (i.e., it accounts for the fact that you can afford to spend a larger percentage of your portfolio per year when you are age 90 than when you’re age 60).

Circumstances that could suggest an adjustment to such a strategy:

  • You have an unusually long or short life expectancy,
  • Real interest rates are very high or very low,
  • Market valuations are very high or very low, or
  • Your portfolio makes up a relatively small part of your overall financial picture. (For instance if you have a government pension that covers all of your major needs, you can spend from your portfolio at a faster rate, if you so desire — because, unlike many retirees, you would not be in an especially bad situation if you depleted, or nearly depleted, your portfolio.)

Asset Allocation

There’s a huge range of asset allocations that could be reasonable for a retirement portfolio (i.e., the portfolio that does not include the fixed sum that is set aside for the purpose of delaying Social Security).

  • Want a 70% stock, 30% bond portfolio? Go for it.
  • Prefer a 30% stock, 70% bond portfolio? That’s cool too.
  • Want to exclude international stocks completely? Sure.
  • Prefer to have a heftier 30-50% international stock allocation? Knock yourself out.
  • Want to use only Treasury bonds for your fixed-income holdings? That’s reasonable.
  • Prefer to use a “total bond” fund instead? Super.

One key point — something that surprises many people — is that a higher stock allocation (or any allocation decision that shifts things toward more risk and more expected return) tends to result in only a relatively modest increase in the amount you can safely spend per year early in retirement. The higher expected returns are, to a significant extent, offset by the increased unpredictability. (For related reading, here’s Wade Pfau’s 2018 update to the Trinity Study — though of course that has to be considered with all the usual caveats about using historical returns to try to plan for the future.)

The more dramatic impacts of higher-risk, higher-expected return allocations are that they tend to mean more volatility (duh) and a greater chance of either a) leaving a large sum to your heirs or b) increasing spending later in retirement.

Insurance

If you are retired, you probably don’t need life insurance, as it’s likely that you have no dependents anymore. One noteworthy case in which you likely would want life insurance as a retiree would be if you still have minor children or if you have an adult disabled child. Another case in which a retiree might want life insurance is if they’re married and a major portion of their total income comes from a pension with a small survivor benefit amount.

If you are retired you almost certainly don’t need disability insurance. Disability insurance exists to replace income that you’d be unable to earn if you’re unable to work. But if you aren’t working anyway (i.e., you’re retired), you don’t need it.

Health insurance is a must-have. If retiring prior to Medicare eligibility, make sure you have a very specific, well-researched plan for health insurance. The Affordable Care Act makes it possible to get insurance, but make sure you have a good idea of the cost, and make sure you have researched plans to know what they cover — though of course it’s subject to change every year.

Long-term care insurance is a genuine predicament, regardless of what decision you make. If you don’t buy it, you could potentially be on the hook for huge costs. If you do buy it, you might be faced with premiums that rise rapidly and unpredictably. (Other related products to consider are “hybrid” long-term care annuities or long-term care life insurance, but those both have their problems as well.)

Having proper liability insurance (including an umbrella policy, in many cases) continues to be important. In fact, it’s likely more important than at any prior point, given that during retirement you are more dependent on maintaining your assets than you are at earlier stages.

As far as longevity risk (i.e., the risk of outliving your money, because you live well beyond your life expectancy), lifetime annuities (whether immediate or deferred) can provide protection. The downside is that they reduce your liquidity/flexibility, reduce the amount you’re likely to leave to your heirs, and usually come with significant inflation risk. Delaying Social Security provides the same type of protection at a much better cost — and with an inflation adjustment. So purchasing such an annuity generally only makes sense if you are already age 70 and still want additional longevity protection (or if you are already planning to delay Social Security to 70 and still want additional longevity protection).

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Investing Blog Roundup: Remembering Jack Bogle

As you have likely heard by now, Jack Bogle died this week.

There have been an abundance of great articles about him in the last two days — not just about what he achieved professionally (as monumental as those achievements were), but about what he was like as a person. That’s no coincidence. Many of us have personal stories to share.

He founded a massive company, and he revolutionized an industry, but he was as approachable as anybody I’ve met. He’d ask you what you were working on. He’d tell you about what he’d been reading lately. He’d sit next to you at lunch and discuss Social Security — sharing his opinions (he had opinions!), but also listening intently to yours.

If you’re feeling moved to do something in his memory, I have two suggestions:

  1. A donation to the National Constitution Center (Bogle served as chairman of the Center’s board for several years and often bragged about the work that they do), and/or
  2. A donation to the John C. Bogle Center for Financial Literacy.

And this is probably as good a time as any to suggest that you consider signing up to be an organ donor, if you have not yet done so. It’s easy, costs nothing, and could save somebody’s life — much as Jack’s life was saved in 1996 by somebody’s generous decision to be an organ donor.

Recommended Reading

Thanks for reading!

Open Social Security Update: Child Benefits, Retroactive Applications

A few days ago I rolled out an update for the Open Social Security calculator that includes a few new pieces of functionality:

  • Child benefits (now for married couples as well as single people),
  • Child-in-care spousal benefits, and
  • Retroactive applications.

This update took about three months of work, mostly because the “combined family maximum” rules and child-in-care spousal benefit rules are pretty complicated. (And the calculator has to be prepared to deal with any combination of uncommon complicating factors.)

If you are using the child benefit-related functionality, please be aware that the calculator will take somewhat longer to run. When minor children or disabled children are in the picture, your computer has to do a lot more math in each month of the simulations.

With regard to child-in-care spousal benefits, I expect to do a more thorough writeup of how they work in the not-so-distant future. But for now, a simplified explanation is that they’re like regular spousal benefits, with a few major differences:

  • You don’t have to be age 62 to receive them,
  • There is no reduction for entitlement prior to full retirement age, and
  • Filing for (and entitlement to) child-in-care spousal benefits does not trigger a deemed filing for retirement benefits.

As far as retroactive applications, the calculator now recommends them when a person is eligible for such and when such would be helpful. A simplified explanation of the retroactive application rules is that a person beyond FRA can backdate their application up to 6 months (or 12 months in some disability-related cases) — but no earlier than the month in which they reached full retirement age.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

When Should I Take Social Security Benefits? (Single Investor)

The following is an excerpt from my book Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less.

Even if you are married, the place to start when trying to figure out when to claim Social Security is with a solid understanding of the (less complicated) analysis for unmarried retirees.

And before we go any further, let’s make sure we’re on the same page about an important point: The decision of when to retire is separate from the decision of when to claim Social Security benefits. For example, depending on circumstances, you might find that it makes sense to retire at a given age, yet hold off on claiming Social Security until a later date — maybe even several years later.

The earlier you claim Social Security, the less you’ll receive per month. For example, the following table shows how retirement benefits are affected by the age at which you first claim them:

Age when you claim retirement benefits Amount of retirement benefit
5 years before FRA 70% of PIA
4 years before FRA 75% of PIA
3 years before FRA 80% of PIA
2 years before FRA 86.67% of PIA
1 year before FRA 93.33% of PIA
at FRA 100% of PIA
1 year after FRA 108% of PIA
2 years after FRA 116% of PIA
3 years after FRA 124% of PIA
4 years after FRA 132% of PIA

Background: Your “primary insurance amount” (PIA) is the amount you would receive per month if you claimed retirement benefits at your “full retirement age” (FRA).

In other words, by waiting until age 70 rather than claiming as early as possible at age 62, you can increase your monthly benefit amount by roughly three-quarters. Of course, by waiting, you decrease the number of months in which you’ll be receiving a Social Security check.

So how can you tell if the trade-off is worth it? One way to compare two possible ages for claiming benefits is to compute the age to which you would have to live for one strategy to become superior to the other strategy. Another way to analyze the decision is to compare the payout you get from delaying Social Security to the level of income you can safely get from other retirement income sources.

Computing the Breakeven Point

EXAMPLE: Alex and Bob are both retired and unmarried. Both are age 62, both have a full retirement age of 66 and 6 months, and both have exactly the same earnings history. In fact, the only difference between the two is that Alex claims his retirement benefit at age 62, while Bob waits all the way until 70. Even though Alex claims benefits at age 62, he doesn’t need to spend the money right now, so he keeps it in his savings account, where it earns a return that precisely matches inflation.

By age 70, because he has been receiving benefits for eight years, Alex is far better off than Bob. However, starting at age 70, Bob starts to catch up (because he’s receiving a monthly benefit equal to 128% of his primary insurance amount, as compared to Alex who is receiving a monthly benefit equal to 72.5% of his primary insurance amount).

In the end, Bob’s cumulative benefit surpasses Alex’s cumulative benefit halfway through age 80. From age 80.5 onward, Bob’s lead over Alex continues to grow.

The takeaway: For an unmarried retiree, from a breakeven perspective, if you live past age 80.5, you will have been better off claiming benefits at age 70 instead of claiming as early as possible at age 62.

According to the Social Security Administration, the average total life expectancy for a 62-year-old female is 84.9. For a male, it’s 82.1. In other words, from a breakeven perspective, most unmarried retirees will be best served by waiting to take their retirement benefit.

Comparing Social Security to Other Income Options

When you delay Social Security, you give up a certain amount of money right now (i.e., this month’s or this year’s benefits) in exchange for a stream of payments that will increase with inflation for the rest of your life.

Take, for example, somebody with a full retirement age of 66. If her benefit at full retirement age would be $1,000 per month, her benefit at age 62 would be $750 per month, and at age 63 it would be $800 per month.

Therefore, waiting from age 62 to age 63 is the equivalent of paying $9,000 (that is, $750 forgone per month, for 12 months) in exchange for a source of income that pays $600 per year (that is, a $50 increase in monthly retirement benefit, times 12 months per year), adjusted for inflation, for the rest of her life.

Dividing $600 by $9,000 shows us that delaying Social Security retirement benefits from age 62 to 63 provides a 6.67% payout. Let’s see how that compares to other sources of retirement income.

Inflation-adjusted single premium immediate lifetime annuities are essentially pensions that you can purchase from an insurance company. With such an annuity, you pay the insurance company an initial lump-sum (the premium for the policy), and they promise to pay you a certain amount of income, adjusted for inflation, for the rest of your life. In other words, such annuities are a source of income very similar to Social Security.

As of this writing, according to the website immediateannuities.com (which provides annuity quotes from multiple insurance companies), the highest payout available to a 63-year-old female on such an annuity is 4.04%. For a male, the highest available payout would be 4.33%. As you can see, both of these figures fall well short of the 6.67% payout that comes from delaying Social Security from 62 to 63.

Alternatively, we can compare the payout from delaying Social Security to the income that you can safely draw from a typical portfolio of stocks and bonds. Several studies have shown that, historically in the U.S., retirees trying to fund a 30-year retirement run a significant risk of running out of money when they use inflation-adjusted withdrawal rates greater than 4%. And it’s worth noting that even a 4% withdrawal rate isn’t a sure bet going forward, given that the studies show 4% to be mostly safe in the past, which is a far cry from completely safe in the future.

In other words, for each dollar of Social Security you give up now (by delaying benefits), you can expect to receive a greater level of income in the future than you could safely take from a dollar invested in a typical stock/bond portfolio.

A similar analysis can be performed for each year up to age 70, and the conclusion is the same: Delaying Social Security benefits can be an excellent way to increase the amount of income you can safely take from your portfolio.

EXAMPLE: Daniel is retired at 62 years old. His full retirement age is 66 and 6 months. He has $50,000 of annual expenses and a $600,000 portfolio. He is trying to decide between claiming benefits as early as possible at age 62 or spending down his portfolio while he holds off on claiming benefits until age 70.

Daniel’s primary insurance amount (the amount he’d receive per month if he claimed his retirement benefit at full retirement age) is $2,500, which means he would receive:

  • $1,812 per month ($21,744 per year) if he claimed benefits at age 62, or
  • $3,200 per month ($38,400 per year) if he claimed benefits at age 70.

If Daniel claims his retirement benefit at age 62, he’ll have to satisfy $28,256 of expenses every year from his portfolio (because Social Security will only be satisfying $21,744 out of $50,000). That is, he’ll be using a 4.71% withdrawal rate ($28,256 divided by his $600,000 portfolio) starting at age 62. That’s a higher withdrawal rate than most experts would recommend.

Alternatively, if Daniel delays Social Security until 70, he’ll have to satisfy annual expenses of $11,600 (i.e., $50,000, minus $38,400 in Social Security benefits), plus an additional $38,400 for each of the eight years until he claims Social Security.

If Daniel allocates $307,200 (that is, $38,400 x 8) of his $600,000 portfolio to cash or something else very low-risk (in order to satisfy the additional expenses for those eight years), that leaves him with a typical stock/bond portfolio of $292,800. With a portfolio of $292,800 Daniel can satisfy his remaining $11,600 of annual expenses using a withdrawal rate of just 3.96%.

In effect, Daniel is spending down a portion of his portfolio in order to purchase additional Social Security benefits in the amount of $16,656 per year, starting at age 70. By doing so, he’s reduced the withdrawal rate that he’ll need to use from his portfolio for the remainder of his life, thereby reducing the probability that he’ll run out of money. In addition, if Daniel’s portfolio performs very poorly and he does run out of money, he’ll be much better off in the wait-until-70 scenario than in the claim-at-62 scenario, because he’ll be left with $38,400 of Social Security per year rather than $21,744.

Reasons Not to Delay Social Security

Of course, there are circumstances in which it would not make sense for an unmarried person to delay taking Social Security.

First and most obviously, if your finances are such that you absolutely need the income right now, then you have little choice in the matter.

Second, if you have reason to think that your life expectancy is well below average, it may be advantageous to claim benefits early. For example, if you have a medical condition such that you don’t expect to make it past age 64, it would obviously not make a great deal of sense to choose to wait until age 70 to claim benefits.

Third, the higher market interest rates are, the less attractive it is to delay Social Security. For example, if inflation-adjusted interest rates (such as those on inflation-protected Treasury bonds known as TIPS) were 2-3% higher than they are as of this writing, the payout from inflation-adjusted lifetime annuities might be higher than the payout from delaying Social Security.

Simple Summary

  • For unmarried retirees, from a breakeven perspective, you’ll be best served by waiting until age 70 to claim benefits if you expect to live past age 80.5. (And, for reference, the average total life expectancy for a 62-year-old female is 84.9. For a male, it’s 82.1.)
  • For unmarried retirees, on a dollar-for-dollar basis, the lifetime income you gain from delaying Social Security is generally greater than the level of income you can safely get from other sources. As a result, delaying Social Security can be a great way to increase the amount you can safely spend per year. (Or, said differently, it can be a great way to reduce the likelihood that you will outlive your money.)
  • The shorter your life expectancy and the greater the available yield on inflation-protected bonds, the less desirable it is to delay claiming Social Security benefits.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Social Security Strategies for Married Couples

The following is an adapted excerpt from my book Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less.

In general, the primary factors that determine when married people should take Social Security are the same as those for determining when unmarried people should take Social Security. That is, the longer you expect to live — or the more concerned you are about running out of money in retirement — the more sense it makes to delay Social Security.

If one spouse’s Social Security benefit is significantly higher than the other spouse’s, delaying benefits for the higher-earning spouse is often an especially good deal because it results in an increased payout for the longer of the two spouse’s lifetimes (due to survivor benefits).

In addition to the above considerations, however, there is a strategy available to some married couples that (depending on circumstances) might allow them to maximize their Social Security benefits even further.

[In addition to the restricted application strategy that we will be discussing here, there is also a “file and suspend” strategy that was popular for several years. However, as a result of the Bipartisan Budget Act of 2015, the file and suspend strategy is no longer available to anybody who had not already implemented it as of 4/29/16.]

The “Restricted Application” Strategy

After reaching full retirement age, if you’re eligible for both spousal benefits and your own retirement benefit, you can file a “restricted application” for just spousal benefits. This is in contrast to filing for one benefit or the other prior to full retirement age, in which case you would automatically be “deemed” to have filed for the other benefit as well. (As we’ll discuss below, however, not everybody is eligible to use this restricted application strategy.)

EXAMPLE: Steve and Beth were both born in 1953 and have reached their full retirement age of 66. Beth’s earnings history is slightly higher than Steve’s. As a result, they chose to have Beth delay her retirement benefit until age 70. However, to help with their near-term cash flow, they chose to have Steve take his benefits at age 62.

Because Beth has reached her full retirement age, she can file a “restricted application” for just her spousal benefit. Later, when Beth reaches age 70, she will file for her own retirement benefit.

Result: Beth receives spousal benefits for four years (from age 66 to 70) at essentially no cost to her, since her own retirement benefit is growing the entire time because she had not yet filed for it. Depending on the size of Steve’s primary insurance amount, these four years of spousal benefits could be a large five-figure sum — which Beth and Steve would miss out on entirely if they were less familiar with the Social Security rules.

Are You Eligible for a Restricted Application?

Due to the Bipartisan Budget Act of 2015, the deemed filing rules have changed for anybody who was born after January 1, 1954. For anybody affected by the new rules, deemed filing continues to apply even beyond full retirement age.

As a result, nobody who was born after January 1, 1954 will be able to file a restricted application for spousal benefits. That is, if they file for a spousal benefit at any point, they’ll automatically be deemed to have filed for their own retirement benefit as well (assuming they’re eligible for one), thereby preventing it from continuing to grow as if they had not yet claimed it.

Simple Summary

  • It’s often a good idea to have the spouse with the higher primary insurance amount delay taking benefits, because doing so increases the amount the couple receives as long as either spouse is alive.
  • It’s less advantageous to have the spouse with the lower primary insurance amount delay benefits, because doing so only increases the amount the couple will receive while they’re both alive. That said, depending on circumstances, it can still be a good idea for the lower earner to delay benefits.
  • Via a restricted application, it’s often possible to have one spouse receive spousal benefits for the years between full retirement age and age 70, while allowing the his/her own retirement benefit to continue growing until age 70.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

How Social Security Benefits Are Calculated

The following is an excerpt from my book Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less.

The size of your monthly retirement benefit depends on:

  1. Your earnings history, and
  2. How old you are when you first begin taking benefits.

But first we need to back up a step. In order to understand how Social Security benefits are calculated, you need to be familiar with two terms:

  • “full retirement age” (FRA), and
  • “primary insurance amount” (PIA).

Your full retirement age depends on the year in which you were born (see table below). Your primary insurance amount is the amount of retirement benefits you would receive per month if you started taking them at your full retirement age. As we’ll discuss shortly, your PIA is determined by your earnings history.

Year of Birth Full Retirement Age
1937 or earlier 65
1938 65 and 2 months
1939 65 and 4 months
1940 65 and 6 months
1941 65 and 8 months
1942 65 and 10 months
1943-1954 66
1955 66 and 2 months
1956 66 and 4 months
1957 66 and 6 months
1958 66 and 8 months
1959 66 and 10 months
1960 or later 67

How Earnings History Affects Retirement Benefits

Your primary insurance amount is based on your historical earnings. Specifically, it’s based on your “average indexed monthly earnings” (AIME). Calculating your AIME is a five-step process.

  1. Make a year-by-year list of your earnings, excluding any earnings for each year that were in excess of the maximum amount subject to Social Security tax.
  2. Adjust your earnings from prior years to today’s dollars.
  3. Select your 35 highest-earning years.
  4. Add up the total amount of earnings in those 35 years.
  5. Divide by 420 (the number of months in 35 years).

You do not actually have to do this calculation yourself. The Social Security Administration does it for you. It is, however, important to understand the concept, so that you can understand how your benefit is calculated.

Calculating Your Primary Insurance Amount

For someone becoming eligible for retirement benefits (that is, reaching age 62) in 2019, his or her primary insurance amount would be:

  • 90% of any AIME up to $926, plus
  • 32% of any AIME between $926 and $5,583, plus
  • 15% of any AIME above $5,583.

Note that these figures change to account for wage inflation each year. So, for example, for somebody turning age 62 in 2020, each of these dollar amounts will probably be slightly higher.

Or, to put it in terms of annual income, if claimed at full retirement age, Social Security would replace:

  • 90% of the first $11,112 of average annual wage-inflation-adjusted earnings, plus
  • 32% of average annual wage-inflation-adjusted earnings from $11,112 to $66,996, plus
  • 15% of average annual wage-inflation-adjusted earnings from $66,996 to $123,552.

Two noteworthy takeaways here are that:

  1. Social Security replaces a higher portion of wages for lower-earning workers than for higher-earning workers, and
  2. There’s a maximum possible Social Security retirement benefit. (Few people reach that maximum though, because doing so would require that you earn the maximum earnings subject to Social Security tax for 35 different years.)

If You Worked Fewer than 35 Years

If you have fewer than 35 years in which you earned income subject to Social Security taxes, the calculation of your average indexed monthly earnings will include zeros. For example, if you worked for 31 years, your AIME calculation would include those 31 years of earnings, as well as 4 years of zeros.

As a result, working additional years would result in those zero-earnings years being knocked out of the calculation and replaced with your current earnings. The result isn’t going to make you rich, but it’s worth including in your list of considerations when deciding when to retire.

How Age Affects Retirement Benefits

If you wait until after full retirement age to claim your retirement benefit, the amount you receive will be greater than your primary insurance amount. The increase is 2/3 of 1% for each month you wait beyond full retirement age (up to age 70, beyond which there is no increase for waiting). This works out to an increase of 8% per year.

EXAMPLE: Alan was born in 1954, so his full retirement age is 66. His primary insurance amount is $2,000. If he waits until age 70 (that is, 48 months after FRA) to claim his retirement benefit, he will receive $2,640 per month, calculated as:

  • His PIA of $2,000 per month, plus
  • 2/3 of 1% x 48 months x $2,000.

If you claim your retirement benefit prior to full retirement age, it will be reduced from your primary insurance amount by 5/9 of 1% for each month (up to 36 months) prior to full retirement age. This works out to a reduction of 6.67% per year. For each month in excess of 36 months, the reduction is 5/12 of 1% (or 5% per year).

EXAMPLE: Allison was born in 1960, so her full retirement age is 67. Her primary insurance amount is $2,000. If she claims retirement benefits at age 65 (24 months prior to FRA), her monthly benefit would be $1,733.33, calculated as:

  • Her PIA of $2,000 per month, minus
  • 5/9 of 1% x 24 months x $2,000.

If Allison decides instead to claim at age 62 (60 months prior to FRA), her benefit would be $1,400 per month, calculated as:

  • Her PIA of $2,000 per month, minus
  • 5/9 of 1% x 36 months x $2,000, minus
  • 5/12 of 1% x 24 months x $2,000.

In short, the interaction between the size of your retirement benefits and the age at which you first claim that benefit looks like this:

Age when you claim retirement benefits Amount of retirement benefit
5 years before FRA 70% of PIA
4 years before FRA 75% of PIA
3 years before FRA 80% of PIA
2 years before FRA 86.67% of PIA
1 year before FRA 93.33% of PIA
at FRA 100% of PIA
1 year after FRA 108% of PIA
2 years after FRA 116% of PIA
3 years after FRA 124% of PIA
4 years after FRA 132% of PIA

Adjusting Benefits for Inflation

Every year after you reach age 62, your primary insurance amount is adjusted to keep up with inflation as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). When your PIA is adjusted upward for inflation, it increases not only your retirement benefit, but also any other benefits that are based on your PIA (e.g., your spouse’s spousal benefits).

Simple Summary

  • Your “primary insurance amount” (PIA) is the monthly retirement benefit you would receive if you claimed benefits at “full retirement age” (FRA).
  • Your primary insurance amount is calculated based on your 35 highest-earning years (after adjusting prior years’ earnings for wage inflation).
  • If you claim retirement benefits prior to your full retirement age, you will receive an amount smaller than your PIA. If you wait until after your full retirement age to claim benefits, your retirement benefit will be greater than your PIA.
  • Social Security benefits are adjusted on an annual basis to keep up with inflation (as measured by the CPI-W).

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