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Open Social Security: New Feature & Social Security Planning Takeaways

The Open Social Security calculator has a new feature.

Specifically, the output now includes a color-coded graph that shows the desirability of many of the different filing dates all at once. (In most cases, it shows all of the options, but there are some situations where a 2-dimensional graph simply cannot represent every possible option.) The benefit is that you can immediately see which filing dates are almost as good as the recommended filing date(s), which dates are “pretty good,” and which dates are not so good.

In addition, you can click on that graph to very quickly compare many different alternative options. (It functions as an alternative to the dropdown inputs for filing dates on the “test an alternative claiming strategy” part of the page.)

Also, when the option to assume a future cut in benefits is activated (under “advanced options”), the graph has radio buttons that allow you to quickly flip back and forth between “benefits are cut” and “benefits are not cut” calculations to see how different strategies fare under the different assumptions.

Credit where credit is due: both the original idea for this feature and the overwhelming majority of the code involved were contributed by Brian Courts.

For reference, the new feature is intentionally designed to not be displayed when the calculator is being used on a device with a display width of 710px or less. (On a larger display you can quickly click all over the graph and see the corresponding output, but on mobile you would have to constantly scroll back and forth. So, with the goal of providing the best mobile experience, the calculator still works how it always has.)

In short, the new feature allows you to make a lot of comparisons in a short time, which can both:

  1. Help you make a more informed decision about your own Social Security benefits, and
  2. Speed up the learning process about Social Security planning in general.

With regard to that second point, some of the things that you will likely find include:

One: what matters most isn’t picking the very best strategy. What matters most is just avoiding a really bad one. There are usually plenty of strategies that are practically as good as the very best strategy. That is, for most people, moving the filing date a few months in one direction or the other won’t have a huge impact. (So, for example, if there’s a compelling tax-planning reason to do so, go for it.)

Two: the filing ages that work best for a person depend significantly on their marital status and earnings history.

  • It’s usually very advantageous for the higher earner in a married couple to wait.
  • It’s usually somewhat advantageous for an unmarried person to wait. (But anywhere from age 68-70 is generally pretty similar.)
  • It’s not especially advantageous for the lower earner in a married couple to wait. But it’s not usually very impactful (in either direction) either.

Three: whether the strategies that work well in a “benefits will not be cut” scenario also work well in a “benefits will be cut” scenario depends significantly on your date of birth.

To be clear, these are the very same things that people have been telling me that they’ve learned from the calculator over the last couple of years. But, again, I hope that this new feature can help speed up that learning process.

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 in a Down Market: Does it Make More Sense to File Early?

The most common question I’ve gotten from readers over the last few weeks has been whether the current stock market downturn is a point in favor of filing for Social Security earlier than would otherwise make sense.

Let’s try to tackle this question in a few different ways.

Which Assets Are You Spending Down?

As we’ve discussed in various places in the past (e.g., here, here, or my book), the money that is being used to fund the delay should be invested in something like a short-term bond fund, bond ladder, or CD ladder. That is, the portfolio that’s being used to delay Social Security should be (mostly) inoculated against market risk and sequence of returns risk.

Here’s how retirement expert Steve Vernon explains it:

In the years leading up to retirement, an older worker might want to use a portion of their retirement savings to build a “retirement transition bucket” that enables them to delay Social Security benefits. While there’s some judgment involved with the necessary size of this bucket, a starting point would be an estimate of the amount of Social Security benefits the retiree would forgo during the delay period.

[…]

The retirement transition bucket could be invested in a liquid fund with minimal volatility in principal, such as a money market fund, a short-term bond fund, or a stable value fund in a 401(k) plan. This type of fund could protect a substantial amount of retirement income from investment risk as the worker approaches retirement, since the retirement transition bucket would be invested in stable investments and Social Security isn’t impacted by investment returns.

In Social Security Made Simple, I suggest something similar, using a CD ladder instead.

More broadly, assuming that you have bonds (or other fixed-income) in your portfolio, the Social Security decision is primarily, “do I want to exchange some bonds (or other fixed-income) for more Social Security?”

And that decision isn’t especially impacted by what the stock market has done lately. It is impacted by market interest rates. Right now, real interest rates are super low, which is a major point in favor of delaying Social Security (because the bonds that you’re giving up have lower expected returns than they would if interest rates were higher).

Do the Analysis: Using a Calculator

One useful thing to do when answering the question of “do I want to exchange some bonds for more Social Security?” is to use a Social Security calculator. Naturally, I’m partial to Open Social Security because:

  1. It’s free,
  2. It’s open-source,
  3. It uses more realistic mortality modeling than other calculators do, and
  4. I built it, so I’m super duper biased.

But use a different calculator if you’d like.

When you do that analysis, you will find that in most cases:

  • Spending down bonds in order to delay filing is very beneficial for the higher earner in married couples (with some specific exceptions, such as when there is a minor child or adult disabled child, or when the lower earner does not qualify for a retirement benefit of his/her own and will be at least full retirement age by the time the higher earner reaches age 70);
  • Spending down bonds in order to delay filing is somewhat beneficial for unmarried people (i.e., beneficial on average — more beneficial if you’re in good health and less beneficial if you’re in bad health); and
  • Spending down bonds in order to delay filing is not especially beneficial for the lower earner in married couples. (Though if the lower earner is significantly older than the higher earner and/or both are in very good health, delaying would be more beneficial.)

What About Risk?

A common counterargument to the idea of spending down bonds more quickly in order to delay Social Security is something to the effect of, “but then I’m left with a higher stock allocation! And that’s too risky!”

But that makes no sense. Spending down bonds in order to delay Social Security doesn’t leave you with any more dollars in stocks than you would have had otherwise (i.e., when we look at dollars, which is what matters, rather than percentages, you have not increased your exposure to stock market risk).

For example if you have $400,000 in stocks and $400,000 in bonds — and you spend down $150,000 of those bonds in order to delay Social Security — you still have $400,000 in stocks. A stock market decline of a given percentage would not result in a larger loss than it would have previously.

In fact, a strong case can be made that a stock decline (or, in today’s case, a potential further stock decline) becomes less damaging when you exchange bonds for Social Security. The ultimate reason that stock market declines are a source of risk for retirees is that they mean an increased probability of outliving your portfolio. But if you have more Social Security income and less bonds:

  1. You are less likely to outlive your portfolio, because the Social Security income lasts for life and because it supports a higher level of spending than bonds do (which allows for you to spend from the rest of the portfolio at a lower rate), and
  2. If you do outlive your portfolio, you’re in a better situation with a higher Social Security check each month.

And yes, in some cases, it can make sense to spend bonds all the way down to zero in order to delay Social Security.

In case you think that that sounds crazy, here’s what Wade Pfau wrote in his recent book Safety-First Retirement Planning:

As for bonds, ultimately, the question is this: why hold any bonds in the part of the retirement portfolio designed to meet spending obligations? The income annuity [Mike’s note: Social Security is an income annuity.] invests in bonds and provides payments precisely matched to the length of retirement, while stocks provide opportunities for greater investment growth above bonds. Bonds alone hold no advantage.

Or here’s what Steve Vernon has to say:

Our analyses support investing the [unannuitized portion of the portfolio] significantly in stocks – up to 100% – if the retiree can tolerate the volatility. The resulting volatility in the total retirement income portfolio is dampened considerably by the high proportion of income produced by Social Security, which doesn’t drop if the stock market drops.

Spending/Withdrawal Rates

It can also be helpful to look at spending rates (i.e., the percentage of your portfolio that you’re spending each year in retirement).

Forget about Social Security for a moment. And forget about what the market has done over the last few weeks. Just look at where your portfolio balance is right now in relation to your spending. That is, what is your current spending rate when expressed as a percentage of your portfolio balance?

Almost certainly, your current spending rate (as a percentage) is noticeably higher than it was a month ago. Maybe it’s still low, and you’re not worried at all. Or maybe it’s now high enough that you’re starting to worry.

When a retiree’s desired spending level is high relative to their portfolio balance, that’s precisely the scenario in which annuitizing (i.e., buying a lifetime annuity with a part of the portfolio) is most likely to make sense.

Lifetime annuities allow you to safely spend more money than a stock/bond portfolio. We’ve discussed this before, but in brief the idea is that with lifetime annuities, the annuitants who die prior to their life expectancy end up subsidizing the retirement of people who live beyond their life expectancy. So each individual person can essentially spend an amount that’s based on their life expectancy, whereas in a normal (no-annuity) situation you have to spend less because you don’t actually know how long your retirement will last (e.g., spend a low enough amount each year such that you’d be confident your portfolio would last 30 years, even if your life expectancy is only 20 years).

And if you’re in a situation where a lifetime annuity makes sense, delaying Social Security is the best annuity around. (Though again, that’s much more true for higher earners in married couples and less true for lower earners in married couples.)

To Summarize

  1. Use the Open Social Security calculator. It helps you identify the filing age (or combination of filing ages) that is most likely to maximize the total amount you can spend over your lifetime.
  2. If you are concerned about the possibility of depleting your savings, please note that exchanging bonds for Social Security (i.e., spending down bonds in order to delay filing) generally has the effect of a) reducing the likelihood that you outlive your savings and b) reducing the ramifications if you do outlive your savings (i.e., you’ll be left with more income than if you hadn’t delayed).
  3. As far as the lower earner in married couples, it is generally not particularly advantageous for them to delay (though today’s very low interest rates do make it more advantageous than otherwise).
  4. The recent stock market downturn does not affect points #2 or #3 above.
  5. The Open Social Security calculator can help you identify the exceptions to points #2 and #3 above.

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 67, 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 124% of his primary insurance amount, as compared to Alex who is receiving a monthly benefit equal to 70% of his primary insurance amount).

In the end, Bob’s cumulative benefit surpasses Alex’s cumulative benefit at age 80 and 5 months. From that point onward, Bob’s lead over Alex continues to grow.

The takeaway: for an unmarried retiree, from a breakeven perspective, if you live to roughly 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 85.1. For a male, it’s 82.3. 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 67. If her benefit at full retirement age would be $1,000 per month, her benefit at age 62 would be $700 per month, and at age 63 it would be $750 per month.

Therefore, waiting from age 62 to age 63 is the equivalent of paying $8,400 (that is, $700 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 $8,400 shows us that delaying Social Security retirement benefits from age 62 to 63 provides a 7.14% payout. Let’s see how that compares to other sources of retirement income.

A single premium immediate lifetime annuity is essentially a pension 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 for the rest of your life. In other words, such annuities are a source of income 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 5.38%. For a male, the highest available payout would be 5.62%. As you can see, the 7.14% payout that comes from delaying Social Security from 62 to 63 is a higher payout than you can get from annuities of this nature. An even more important difference is that the income from Social Security gets adjusted upward over time to keep up with inflation, whereas the income from these annuities would be fixed.

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 67. 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:

  • $1,750 per month ($21,000 per year) if he claimed benefits at age 62, or
  • $3,100 per month ($37,200 per year) if he claimed benefits at age 70.

If Daniel claims his retirement benefit at age 62, he’ll have to satisfy $29,000 of expenses every year from his portfolio (because Social Security will only be satisfying $21,000 out of $50,000). That is, he’ll be using a 4.83% withdrawal rate ($29,000 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 $12,800 (i.e., $50,000, minus $37,200 in Social Security benefits), plus an additional $37,200 for each of the eight years until he claims Social Security.

If Daniel allocates $297,600 (that is, $37,200 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 $302,400. With a portfolio of $302,400 Daniel can satisfy his remaining $12,800 of annual expenses using a withdrawal rate of just 4.23%.

In effect, Daniel is spending down a portion of his portfolio in order to purchase additional Social Security benefits in the amount of $16,200 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 $37,200 of Social Security per year rather than $21,000.

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 to age 80 and 5 months. (And, for reference, the average total life expectancy for a 62-year-old female is 85.1. For a male, it’s 82.3.)
  • 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.

As with the when-to-claim decision for an unmarried person, the decision for married people depends largely on life expectancies. But in this case, each spouse’s decision depends on both spouses’ life expectancies.

When Should the High-PIA Spouse Claim Benefits?

As we discussed in the previous chapter, delaying Social Security is akin to buying an inflation-adjusted lifetime annuity—one that’s a heck of a deal for many investors because it comes with a significantly higher payout and lower credit risk than annuities you can buy in the private marketplace.

In most cases, for the spouse in a married couple who has the higher of the two primary insurance amounts, delaying Social Security is just like that, but better. In addition to an unusually high payout and unusually low credit risk, the annuity now comes with the possibility of a survivor benefit as well.

EXAMPLE: Allan and Liz are married, both age 62. Liz’s career earnings are rather low, because she spent many years out of the paid workforce doing volunteer work and caring for their children. As a result, Allan’s primary insurance amount is much larger than Liz’s. After either Allan or Liz dies, the surviving spouse will be receiving an amount equal to Allan’s benefit. (If Liz is the surviving spouse, it will be partially in the form of a widow’s benefit.) As a result, if Allan chooses to hold off on claiming his own retirement benefit, he increases not only his own benefit while he’s alive, but also Liz’s widow’s benefit in the event that he predeceases her.

In short, the decision for the higher-earning spouse includes the same considerations as for an unmarried retiree, with one major modification: the life expectancy in question is no longer just the person’s own life expectancy, but rather the joint life expectancy of the two spouses (because delaying benefits will increase the amount paid out as long as either spouse is alive).

In other words, from a breakeven perspective, for it to be advantageous for the higher-earning spouse to delay his/her retirement benefit, only one spouse needs to make it to the breakeven point. As you can imagine, this often means that it’s a very good deal for the high-PIA spouse to wait until age 70 to claim retirement benefits.

When Should the Low-PIA Spouse Claim Benefits?

For the spouse with the lower primary insurance amount, the decision of when to claim benefits works in much the same way as the decision for an unmarried person, but with one major modification: it’s somewhat less advantageous for the low-PIA spouse to delay benefits, because doing so only increases the amount the couple will receive while they’re both still alive.

For example, if we look back at Allan and Liz from above, having Liz hold off on claiming Social Security does not increase the amount Allan will receive at any point. And it only increases the amount Liz will receive while Allan is still alive as well (because once Allan dies, Liz will begin receiving her widow’s benefit).

Simple Summary

  • For married couples, both spouses’ respective life expectancies should be considered in each spouse’s claiming decision.
  • It is usually advantageous to have the spouse with the higher primary insurance amount delay claiming his/her retirement benefit as long as possible, because doing so increases the amount the couple will receive as long as either spouse is alive.
  • For the spouse with the lower primary insurance amount, there’s less to be gained as a result of waiting to claim benefits, because doing so only increases the amount the couple will receive while they’re both alive. (And in some cases there’s nothing to be gained from waiting beyond full retirement age, because spousal benefits do not continue to increase as a result of waiting past FRA.)

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 2022, his or her primary insurance amount would be:

  • 90% of any AIME up to $1,024, plus
  • 32% of any AIME between $1,024 and $6,172, plus
  • 15% of any AIME above $6,172.

Note that these figures change to account for wage inflation each year. So, for example, for somebody turning age 62 in 2023, 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 $12,288 of average annual wage-inflation-adjusted earnings, plus
  • 32% of average annual wage-inflation-adjusted earnings from $12,288 to $74,064, plus
  • 15% of average annual wage-inflation-adjusted earnings from $74,064 to $137,160.

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 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 1962, 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.

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 1960, so his full retirement age is 67. His primary insurance amount is $2,000. If he waits until age 70 (that is, 36 months after FRA) to claim his retirement benefit, he will receive $2,480 per month, calculated as:

  • His PIA of $2,000 per month, plus
  • 2/3 of 1% x 36 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 or widow/widower benefit if your spouse should outlive you).

A common misconception is that you must have already filed for your benefit in order to get the cost-of-living adjustment in a given year, but that is not the case. The cost-of-living adjustment is applied to your PIA regardless of whether or not you have filed for 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).

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 is Social Security Taxed?

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.

Each year, the portion of your Social Security income that’s subject to federal income tax depends on your “combined income.” Your combined income is equal to:

  • Your adjusted gross income (line 11 on the 2021 version of Form 1040), not including any Social Security benefits, plus
  • Any tax-exempt interest you earned, plus
  • 50% of your Social Security benefits.

If your combined income is below $25,000 ($32,000 if married filing jointly), none of your Social Security benefits will be taxed.

For every dollar of combined income above that level, $0.50 of benefits will become taxable until 50% of your benefits are taxed or until you reach $34,000 of combined income ($44,000 if married filing jointly).

For every dollar of combined income above $34,000 ($44,000 if married filing jointly), $0.85 of Social Security benefits will become taxable — all the way up to the point at which 85% of your Social Security benefits are taxable.*

Important note: to say that 85% of your Social Security benefits are taxable does not mean that 85% of your benefits will disappear to taxes. Rather, it means that 85% of your benefits will be included as taxable income when determining your total income tax for the year.

How Does This Affect Tax/Retirement Planning?

The big takeaway of the above calculations is that, once you start collecting Social Security, your marginal tax rate (that is, the total tax rate you would pay on each additional dollar of income) often increases dramatically. That’s because, if your “combined income” is in the applicable range, each additional dollar of income is not only taxed at your regular tax rate, it also causes an additional $0.50 or $0.85 of Social Security benefits to be taxable.

This change in your marginal tax rate often creates significant tax planning opportunities.

For example, if you haven’t yet begun to collect Social Security and you realize that your marginal tax rate will increase once you do, you may benefit from funding most of your current spending via withdrawals from tax-deferred accounts (as opposed to taxable accounts or Roth accounts), thereby allowing the withdrawals to be taxed at your current, relatively-lower tax rate, and thereby preserving your Roth accounts for funding spending needs in the future when your tax rate will be higher.

Or you might even want to take it one step further by converting a portion of your traditional IRA(s) to a Roth IRA in the years of retirement prior to collecting Social Security.

Or, if you are already collecting Social Security, once your combined income nears the range where Social Security benefits will start to become taxable, you may want to fund the rest of your spending (to the extent possible) with assets not from tax-deferred accounts (so as to stay below the range where your benefits would become taxable).

Alternatively, if your combined income is already near the high end of the range in question (such that most or all of your benefits are 85% taxable), it may make sense to withdraw more from your tax-deferred accounts (perhaps just enough to put you up to the top of your current tax bracket) so that you can withdraw less next year, thereby allowing you to stay in the range where your benefits will not be taxable.

Simple Summary

  • Depending on how high your “combined income” is in a given year, your Social Security benefits could be nontaxable or partially taxable (with a maximum of 85% of them being included in your taxable income for the year).
  • If it looks like your marginal tax rate is going to increase sharply once you start collecting Social Security, it may make sense — in the years prior to collecting Social Security — to fund much of your spending from tax-deferred accounts (and potentially execute Roth IRA conversions) to take advantage of the fact that your tax rate is lower than it will be in the future.
  • Once you start collecting Social Security, you may be able to reduce your overall tax bill by carefully planning which accounts you spend from each year (tax-deferred as opposed to Roth as opposed to taxable) so as to minimize the portion of your Social Security benefits that will be taxable.

*These are the general rules. As with so many aspects of the tax code, there are exceptions. For more information, see IRS Publication 915.

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."
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