In this episode of The Retirement Guide, George Jameson, CFP® and founder of Capital Wealth Group in Columbia, SC explains how Social Security is funded and calculated and some advice on the best time to start your benefits.
Welcome to "The Retirement Guide" Podcast! I'm your host George Jameson, owner of Capital Wealth Group, a Fee Only Advisory firm. Whether you’re nearing retirement or already retired, Join me each week as we explore the world of retirement planning and equip you with the knowledge and tools you need for a successful retirement.
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This is for education only.It is not tax, legal, or investment advice. Before acting on any information consult your tax, legal, or investment advisor.
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Episode Transcript
I'm George Jamison, certified financial
planner and founder of CapitalWealth Group, a fee only firm
based in Columbia, SouthCarolina.
And today we're exploring socialsecurity.
So social security is one of thecornerstones of retirement
planning, yet many of us aren'tcompletely sure how it works or
how we can maximize thebenefits.
In this episode, I'll walk youthrough how Social Security is
(00:20):
funded and the unique way itcalculates your benefits.
And then my following episode, Iwill share five actionable
strategies.
That may help boost your monthlycheck in retirement.
So now let's look at how SocialSecurity is funded and
calculated.
First, social Security is fundedthrough payroll or FICA taxes,
or part of FICA taxes.
(00:41):
If you're a W2 employee, youcontribute to social security
through FICA taxes.
You pay 6.2% of your income upto a cap of 176,100 for 2025.
Your employer also contributes6.2% of taxes up to the same
salary cap 176,100.
In other words, both you andyour employer are contributing
(01:04):
to your future Social Securitybenefits for a total of 12.4%
tax.
If you're self-employed, you paythe full amount, but that's for
another discussion.
The ceiling on income subject tothese taxes rises each year.
For example, in 1993, themaximum subject to FICA taxes
was only 57,600.
(01:26):
Now that you know how SocialSecurity is funded, let's look
at how your benefits aredetermined.
First, your earnings are indexedeach year.
Since wages and prices haverisen over time, earnings from
past years need to be adjustedto reflect current wage levels.
This is called indexing.
So the Social SecurityAdministration uses an average
(01:46):
wage index to adjust your pastearnings.
This index reflects the generalincrease in wages since the year
that you earned the moneyIndexing ensures that your
earlier lower dollar incomes arefairly considered in today's
terms when calculating yourbenefits.
After indexing your earnings,the Social Security
(02:07):
Administration looks at yourhighest 35 years of earnings.
If you've worked fewer than 35years, the years with no
earnings are counted as zeros.
Keep that in mind.
And third, once your highest 35years of earnings are indexed,
they are then all added up.
This total is then divided by420, the number of months in 35
(02:29):
years to calculate your averageindex monthly earnings, also
called AIME AIME.
AIME is the foundation forcalculating your primary
insurance amount.
You'll also see the acronym PIA.
This amount is your estimatedbenefits, assuming you start
Social Security at your fullretirement age.
(02:49):
FRA is currently age 67 if bornon or after 1960, next, the PIA
is not a simple percentage ofyour AIME.
Instead, it is calculated usinga formula, what's called bend
points.
These bend points create aprogressive benefit structured
to help lower income workers.
(03:11):
The bend points start at 90%.
And then 32% and then finally15%.
I know this sounds complicatedand it's good to know, but you
do not actually need to know howto do all the calculations, of
course.
But let's look at a simplifiedexplanation just for those who
are curious.
Let's say Sarah is retiring in2025 and the Social Security
(03:33):
Administration calculates herAIME at 6,000.
Then we'll need to calculate herPIA, which remember the PIA
stands for primary insuranceamount and really PIA is your
benefits at your full retirementage.
So the first bend point you, youcalculate again is 90%, and for
2025 you calculate 90% on thefirst$1,226 of the AIME.
(03:59):
So 0.9 times 12, 26 equals$1,103.
And then the second bend pointyou calculate, is 32% of your
AIME between$1,226 and$7,391.
However, for Sarah, her AIME isonly 6,000, so we do 6,000 minus
(04:21):
1226, which equals$4,774.
So we multiply that by 0.32 toget approximately$1,528.
Again, since Sarah's AIME was6,000, we don't need to
calculate the third Bend point.
So Sarah's projected PIA usingofficial 2025 figures.
(04:42):
Is the sum of 1103 plus 1528,which comes out to be
approximately$2,631.
So now let's look at one moreexample.
Let's say Michael has an AIME of9,000 and he is 67 and he's
retiring in 2025.
His first bend point, again, isthe same as Sarah's, 90% of the
(05:05):
first$1,226, which equals 11.03.
And then second bend point is32% of AIME between$1,226 and
$7,391.
So you do 7,391 minus 1226,which equals$6,165, and we
(05:28):
multiply that by 0.32 to getapproximately 1,973.
Michael has an of$9,000.
We'll also calculate the thirdbend point, which is 15% of
AIME, anything above$7,391.
So we do 9,000 minus 73 9 1,which equals 1609, and we
(05:52):
multiply that by 0.15, whichgets him an extra$241.
So now we sum up all threecalculations.
The 1103.
1973 and the 241, and it giveshim approximate$3,317 for his
monthly benefits, assuming he's67 and retired in 2025.
(06:18):
So let's review how socialsecurity benefits are
determined.
First, your work history andearnings and then number two,
indexing past earnings for wagegrowth.
And then three, focusing on yourhighest 35 years of earnings.
And four, calculating your AIMEfrom those earnings.
And then finally using aprogressive bend point formula
(06:42):
to calculate your actual PIAprimary insurance amount.
And then six, adjusting your PIAbased on your retirement age.
How to get your own benefitestimate.
I highly recommend going to mysocial security account, and the
best way to get an accurateestimate for your future
benefits is to create a mysocial security account@ssa.gov.
(07:04):
You can view your earningsrecords to make sure they're
accurate, and again, you don'tneed to know how to calculate
all of this.
Definitely want to make sureyour earnings are correct on the
website.
So I hope this sheds some lighton how social Security works.
Next week will be aboutmaximizing social security
benefits and the best time tostart.
Hope everyone has a great day.
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