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