We hear a lot of the same questions over and over. It tends to happen when you’ve been in business as long as we have and you’ve helped as many retirees and soon-to-be-retirees with their planning as we have. We thought it would be a good idea to answer a couple of these questions every week.
Please note this very important fact. Our answers do not take into account your particular investment objectives, financial situation, or risk tolerance and may not be suitable for all investors. Our answers are not financial advice and should not be taken as advice. This material is provided for educational purposes only.
How do I estimate my Social Security benefit accurately?
Figuring out what your Social Security benefit is going to be is a calculation performed by a lot of folks who are getting ready to retire, but “ballpark” figures can lead to costly surprises. Nevertheless, plenty of folks give the old college try to figure out their monthly Social Security benefit, officially known as their Primary Insurance Amount, or PIA.
If you try to calculate what your Social Security monthly benefit is going to be by hand, you’re in for a world of hurt. First, you will have to calculate what the Social Security Administration calls your Average Indexed Monthly Earnings (AIME). AIME, no matter what the Pure Prairie League says, is your top 35 years’ worth of earnings averaged against the total number of months in that span. Since we haven’t added any new months to the calendar since 46 BCE, that’s 12 months times 35 years, or 420 months. Once you know what your AIME is, what you gonna do? You’re going to apply three separate percentages to different dollar amounts of your AIME to determine your PIA, and the dollar amounts change each year.
If doing math on a napkin or on Excel isn’t your strong suit, you may find solace in an online calculator like the one offered by the Social Security Administration at ssa.gov. By plugging in your birth date, your earnings in the current year, and giving them the month & date you plan to file, you can get a benefit estimate in today’s dollars or in inflated future dollars relevant to the sample date you provided.
The gold standard, however, is registering for a my Social Security account on ssa.gov and letting the administration calculate for you. Their determination, remember, is the one that matters. But some folks doing quick math, understandably, don’t always want to go through the hassle of creating an account just to get a ballpark figure.
Regardless of the source you choose for your estimate, whether you get your PIA and what percentage of the PIA you see is going to depend on if you file early, file at your Full Retirement Age (FRA), or file later. The earliest most folks can file for their own Social Security is age 62, at a significant discount. Full retirement age is, depending on your birth year, 66 and some months or 67. And if you want to increase your Social Security benefit, you can wait to file after your FRA, with your amount increasing each month up to the day you turn 70.
But don’t think your job is done calculating your Social Security benefit once you have a number in hand. You can’t forget the impact of taxes and Medicare Part B premiums, which are often deducted directly from your check. Yes, Social Security is taxed. For that you can thank Reagan… and Clinton.
How are Social Security benefits taxed?
If reading this column was your first time hearing that Social Security benefits are taxed, sorry. But it is true.
When Social Security was created in 1935 by FDR, the benefits paid out were not subject to income tax. Some 48 years later, however, with Congress telling the public Social Security was in trouble, they passed a law allowing 50% of Social Security benefits to be taxed. And 10 years later, in 1993, the maximum portion of Social Security benefits that can be taxed was raised to 85%.
Today, if you are filing as an individual and your combined income is between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits. If your income exceeds $34,000, up to 85% of your benefits may be taxable. For couples filing jointly, the thresholds are slightly higher: between $32,000 and $44,000, you may pay tax on up to 50% of benefits, and above $44,000, up to 85% can be taxed.
Quick clarification: This does not mean your Social Security benefits are taxed at 85%. It means that 85 cents of every dollar you receive is taxable as income and taxed at your ordinary marginal income tax rate. If your only source of income is Social Security, you likely won’t owe any federal income tax at all. However, if you have a pension, distributions from retirement accounts, or investment income, you will likely cross these thresholds quickly and be taxed on your Social Security income.
Beyond federal taxes, you must also consider your state. While the majority of states do not tax Social Security, a handful still do, though many offer exemptions based on age or income level. In Pennsylvania, where we are headquartered, Social Security income is not taxed.
For those with higher incomes who will likely have their Social Security benefits taxed, you can choose to have federal taxes withheld from your benefits by selecting a tax option on your my Social Security account or by filing IRS Form W-4V.