The Great Mystery of Personal Finance
Windowofworld.com – One of the great mysteries of personal finance is: How are social security pension benefits calculated? Computing itself is a mystery. It’s so complicated that I’m not sure who could have dreamed it. I’m sure most members of Congress don’t understand it. In this article we’ll all take a brief look at what goes into the calculations.
We will concentrate on the method of calculating pension benefits that has been applied since 1979. Previously a different, but just as odd, method was used. The changes were instituted in 1979 to help keep the benefits more or less inflation resistant. The calculation starts by determining the employee’s Average Indexed Monthly Income (AIME). AIME is based on workers’ social security wages or income from self-employment after 1950, but only up to the maximum social security for each year.
Workers’ earnings are then “indexed” by adjusting them for increases in the national average wage. The purpose of indexing is to express wages in terms of wage rates in the second year before social security eligibility. Generally you qualify for social security at age 62, so we index it to the year in which you reached 60.
Now that you have “adjusted” your income, you must next determine your average. Start this process by determining the number of years after 1950 (or 21 if later) and before when you hit 62. Got that number? Good, now subtract five. (Why five? Beat me.) Social security refers to this figure as the “number of computational base years.”
Now, go back to the indexed annual income and select the highest earning year until you have enough earnings to match the “number of base compute years.” For example, suppose you started working at age 22 and worked until you were 62 years old. Your benefit will be calculated based on the highest indexed income for 35 (40 – 5) years. Finally, add up all the years indexed and divide by the number of months in those years. Congratulations, you just calculated AIME. Drink… ..or six.
If you think you’re done, guess again. The amount of social security benefits is the same as the number of main insurance (PIA). Luckily, you don’t have to do this calculation yourself. The Social Security Administration is happy to do this for you. Just get the SSA-7004-PC Form from your local Social Security Office, fill it out and send it. Within a few weeks, the good guys on Social Security will send you an estimate of your profit.
They will also send you a printed “income record.” Your record income is the amount your Social Security says you earn each year. It pays to check this periodically, say every three years. Mistakes may occur and they could cost you your social security benefits at a later date.