About a month ago, Max got motivated and calculated his Average Indexed Monthly Earnings (AIME) for 2021. I found the calculation simple, and basic arithmetic got us a value. In short, we averaged 35 years of my earnings history and adjusted it to the current years’ dollars.
At the end of 2021, my AIME will come in at $2,940. That comes to $35,280 annually.
If $35,280 seems low, that’s because it is. I make much more than that per year right now. The problem is about 15 of my 35 years have $0.00 in earnings. This averages down my number. That’s not to mention several other years of marginal fast-food wages.
But my $2,940 AIME figure is just the starting point for projecting my Social Security benefit. The Social Security Administration will only pay me a portion of this figure at retirement age. But how do I put a valuation on my Social Security benefit as things stand today?
As the Social Security rules stand, if I were to stop working at the end of 2021 permanently and never contribute another dime to the Social Security program, I would only get paid about 52% of my AIME at the age of 67. That comes in at about $1,518 a month or about $18,000 annually. Social Security calls this monthly benefit my primary insurance amount, and it’s indexed to inflation. But how do we get there?
Unfortunately, calculating our benefit is not as simple as multiplying our average indexed monthly earnings by a fixed percentage.
So, now we need the steps for solving for this new variable: Primary Insurance Amount.
Primary Insurance Amount
Last month we also verified I have the credits to qualify for Social Security at retirement. So barring no major changes in that realm of the program, I already qualify for a monthly benefit at retirement.
The Social Security Administration has a term to represent the monthly benefit we will receive at normal retirement age. It’s called the primary insurance amount. For those of us born after 1960, the normal retirement age is considered 67. Here is the definition directly from Social Security:
“The “primary insurance amount” (PIA) is the benefit (before rounding down to next lower whole dollar) a person would receive if he/she elects to begin receiving retirement benefits at his/her normal retirement age. At this age, the benefit is neither reduced for early retirement nor increased for delayed retirement.”
Max likes to keep things simple. So in this post, we will stay away from early and delayed Social Security concepts. We will assume a normal retirement age of 67.
Social Security and Bend Points
As I mentioned, the Social Security Administration will use my AIME (currently $2,940/month) to determine my annual Social Security payment at retirement. But the program is not designed to replace my average monthly earnings completely. They are only going to pay me a percentage of what I made in my prime working years. And a lot like our marginal income tax tables, it is not a fixed percentage.
As I mentioned above, this post will assume I retire at the full retirement age of 67. It will also assume I completely stop working at the end of 2021.
Here is how the calculation works: They break our payment into three different buckets. Social security calls each bucket a bend point because once we cross each point, we get less benefit for each dollar added to our AIME. This makes it much easier for those with a lower income to realize their benefit. They call it to PIA formula.
- (a) 90 percent of the first $996 of his/her average indexed monthly earnings, plus
- (b) 32 percent of his/her average indexed monthly earnings over $996 and through $6,002, plus
- (c) 15 percent of his/her average indexed monthly earnings over $6,002.
See now why the AIME is so important?
Mrs. Max OOP is a math teacher. So I will make her proud here and “show my work” below. We are going to work through each of the buckets mentioned above.
Since my AIME is only $2,940 in 2021, I just need to worry about the first two buckets.
The first bucket holds $996 and is the easiest to fill up. This one gets us the biggest bang for our buck. On the first $996 of my $2,940 AIME, Social Security will pay me 90 cents on the dollar at normal retirement age. This comes in at $896, or $10,757 annually and I am fully maximizing this bucket.
$996 X 90% = $896/month at retirement
As I said, Social Security refers to this $996 as a “bend point”. That’s because, once you pass $996 in AIME, Social Security only pays out $0.32 of every dollar added to your AIME at the time of normal retirement. That’s a pretty significant drop.
So now I subtract $996 from my AIME to calculate how much of the remainder is paid at 32%.
$2,940 (AIME) – $996 = $1,944 (AIME paid at 32%)
Now, I multiply this by 32% to get the rest of my projected payment for the second bucket.
$1,944 X 32% = $622
Add these together, I get my full projected monthly payment.
$896 + $622 = $1,518 payment per month in 2021 dollars
Multiply this by 12 to get my annual benefit.
$1,518 X 12 months = $18,221 in 2021 dollars
So, as I stand here in 2021, Social Security is theoretically set to replace 52% of my AIME.
$1,518 / $2,940 (AIME) = 52%
If I remain on my current trajectory, the Social Security program projects my monthly Social Security payment at $2,770 per month in 2021 dollars. That’s about $33,000 per year.
But that’s contingent on me continuing to work at my current earnings rate until retirement. If I do that, my AIME will continue to rise as I replace my $0.00 income years with much more significant amounts.
But that’s a big assumption when doing long-term planning.
If I were to stop working at the end of 2021 altogether, my benefit would be reduced to about $1,518 per month or $18,221 annually. This is equivalent to an investment portfolio of approximately $450,000. So if I were to put a value on my Social Security benefit at retirement as of today, I think this is a better and more conservative number to use for planning purposes. I have essentially already earned it.
As we already know, $18,000 isn’t chump change to the Max Out of Pocket crew. An $18,000 annual benefit would cover nearly 40% of our 2020 living expenses (ignoring healthcare premiums). I would just need to make it to 67.
It sure pays to have a reasonable standard of living.
Will the Social Security program change? Sure. But Max is convinced it will be there in some shape or form particularly for those on the lower end of the AIME spectrum. I think this $18,000 will be there when I need it, and it will continue to grow with inflation.
How much would Social Security put back in your pocket at the age of 67 if you were to stop working today?