According to the Urban Institute, the average couple receives $556,000 in lifetime Social Security benefits. This makes Social Security a huge hidden part of the retirement nest egg for most people. Social Security is both a great benefit and a one-time decision that many people get wrong. Today and in a follow-up article, we are going to talk about some of the best approaches to ensuring you get the most out of this hidden asset.
Through the years, people purchase things and don’t get their money’s worth out of the investment because they never get past page two in the owner’s manual. They just have no appreciation for what the purchase can do for them if used to its fullest potential. Social Security is a bit like that. We have paid for our Social Security benefits over our entire working lives, but, with over 2,700 rules and regulations, most people choose to stop on page two of the manual and just pick an option. Most Americans have retirement assets in their Social Security that are disguised or hidden from view due to their lack of recognition or understanding as to what these assets are and how to use them. Unfortunately, they are needed most when we retire and are looking for sustainable income for life. Today and in a subsequent article, we will look at this hidden asset that is, in many cases, the largest asset a retired couple may have.
There are four unique characteristics of Social Security:
- It has an annual cost of living adjustment (COLA), which helps offset inflation. The average cost of living since automatic cost of living adjustments went into effect in 1974 up until 2017, has been 3.92%. For 2019, the increase will be 2.2%.
- It is tax advantaged. If you are single with income over $34,000 or married with income over $44,000, only 85% of your Social Security benefit is taxable, or so we think. If you look at IRS Publication 915, you will see that our government can write some complicated rules. In working through the outlined process for calculating your taxes owed on Social Security you find that generally your income must be over $100,000 before 85% of your Social Security is taxable; if your income is less than the $100,000 level, your benefits will be taxed at a lesser rate.
- It has longevity. You cannot outlive your benefit.
- It is backed by a government promise.
Just how much of your income will be represented by Social Security? According to statistics from the EBRI Databook on Employee Benefits, Social Security benefits make up about 88 percent of retirement income for the poorest in our country, 17 percent for the richest, 75 percent the middle class, and 50 percent for the upper middle class. These percentages are significant, and retirees need to get all they are entitled to from the Social Security system.
So how does the government arrive at your monthly benefit?
Your monthly benefit, or Primary Insurance Amount (PIA), is calculated by indexing your average monthly earnings and applying a formula to those earnings. Your PIA is the sum of the following:
- Ninety percent of your first $791 of Average Indexed Monthly Earnings (AIME), plus
- Thirty two percent of any AIME over $791 but less than $4,768, plus
- Fifteen percent on AIME over $4,768
For example, if your AIME is $6,000 you would be entitled to:
90% of $791= $711.90
32% of $4,768 – $791 = $1,272.64
15% of $6,000 – $4,768 = +$184.80
Monthly PIA = $2,169.34
Although the PIA is somewhat complicated, it is the building block upon which all benefits are based. In short, if you want to get the most out of your Social Security benefits, you must understand PIA. For baby boomers, PIA is calculated at the full retirement age of sixty–six. If you want to take benefits earlier, the benefits will be reduced. But if you are willing to wait beyond age sixty–six, you will get a bonus. For married couples, there are hundreds of calculations that need to be made to determine the best way to structure benefits.
With a firm understanding of the basics of Social Security under our belts, in our next article, we will look at some common mistakes that people make while filing for access to this hidden asset.