Your Guide to Social Security, Part Three

Understanding how benefits are set will help you make the best decisions for your retirement needs.

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Understanding how Social Security works should be an essential part of your thinking as you plan for your later years. Those were the years we used to call retirement. Now, as the recession moves into its third year, they may be the years when you contemplate continuing to work. And as you labor, you may wonder what ever happened to your retirement dreams. Where is that lakeside cabin, stuffed with a lifetime's mementos and nestled near a crook in a cool stream?

As 2010 draws to a close, it marks the end of a very difficult decade. If you're like me, it's also an alarming reminder of how relentlessly time marches on. Just yesterday, I was concerned about the Y2K bug as the 20th century ended. Now, the first decade of the new millennium has already snuck by me into the history books.

[See Best Affordable Places to Retire.]

But if the recession has taught us anything, it's that we can't take things for granted and that a successful future will not happen by accident. We have to work at it, and this includes improving our financial planning and money skills. Social Security is far and away the most valuable retirement benefit for most people. Reading this three-part guide explaining how your Social Security benefits are determined might just help you stock that cool stream with some fish, or at least an occasional six-pack of your favorite brew.

The first two installments explained how Social Security collects your lifetime earnings history. It then adjusts your wages to even out the impact of inflation, determines what it calls your average indexed monthly earnings, and uses this number to set your primary insurance amount (PIA). This is the level of benefits you are set to receive when you reach what the agency calls full retirement age.

Everyone's full retirement age used to be 65, but Congress approved permanent increases to this age more than 30 years ago in its last major Social Security reform. The full retirement age was bumped up by two months for each birth year between 1938 and 1943, winding up at 66 for someone born in 1943. It stays at 66 for people born between 1943 and 1954, and then rises again in two-month increments from 66 to 67 for people born between 1955 and 1960. Given continued increases in life spans, and the fact that the program is once again running out of money, Congress will be required to shore up the program again in the near future. Many people expect retirement ages to be raised beyond 67 for younger workers when this happens.

The examples here are all for people whose full retirement age is 66. If you were born before 1943 or after 1954, and want to see the slightly different details for your Social Security calculations, you can find them on page 112 of the detailed annual report that Social Security is required to prepare each year. It sets forth the financial condition of the program.

Here are the percentages of the primary insurance amount that a person would receive at the various ages at which they can elect to begin receiving benefits:

  • Age 62: 75 percent of PIA.
  • Age 63: 80 percent of PIA.
  • Age 64: 86 23 percent of PIA.
  • Age 65: 93 13 percent of PIA.
  • Age 66: 100 percent of PIA.
  • Age 67: 108 percent of PIA.
  • Age 68: 116 percent of PIA.
  • Age 69: 124 percent of PIA.
  • Age 70: 132 percent of PIA.
  • Expressed as a dollar example, a person entitled to a $1,000 monthly primary insurance amount at age 66 would receive only $750 a month if they began taking benefits at the age of 62. If they waited until the age of 70, their monthly benefit would increase to $1,320. Often, people can't afford to wait and begin taking benefits as soon as they turn 62. This certainly has been the case during the recession.

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    But if you can wait, your Social Security benefits will increase by 8 percent a year, and will increase your odds of being able to live comfortably for the longer life spans that are becoming common. The average life expectancy in the U.S. is about 78 but this includes people who died when they were younger. People who already have reached their 60s can expect to live, on average, into their 80s, and a substantial percentage will hit 90.

    Another thing to keep in mind is that people who begin receiving benefits before their full retirement age can reset these percentages if they go back to work. Stephen C. Goss, chief actuary of the Social Security Administration, provided this example: A woman stops working and begins taking benefits at the age of 62, receiving 75 percent of her PIA. She then decides to go back to work. If she worked another year and stopped receiving Social Security benefits during that period, she would receive 80 percent of her PIA when she resumed receiving benefits. However, Goss said, this higher percentage would not kick in until she had reached the full retirement age of 66.

    If she kept receiving Social Security, her benefits would be reduced by $1 for every $2 of her annual earnings between $14,160 and $37,680. For earnings above $37,680, her benefits would be reduced by $2 for every $3 she earned. However, Goss explained, she would still get a proportional credit that would raise her PIA when she reached full retirement age. For example, if she worked for three years and her Social Security benefits were cut in half because of outside earnings, she would get six months of credit toward a higher PIA for each of those three years, or 18 months in total.

    The step-up also applies if you go back to work at even later ages, he said. Say you began receiving benefits when you reached the full retirement age of 66. You'd be getting 100 percent of your PIA. If you went back to work for a year at the age of 68 and stopped your benefits, you'd start receiving 108 percent of your primary insurance amount when you resumed collecting benefits at the age of 69. And if those new earnings are large enough to make this year one of your top 35 earnings years, your PIA will be increased a bit as well. (There is no test on outside earnings once someone reaches full retirement age. So, if you could afford it, you could elect to forgo Social Security benefits even without getting a job. The percentage of your PIA that you would receive when you resumed benefits would rise by 8 percent for each year your benefits were suspended.)

    People who delay receiving benefits beyond the age of 62 also will get inflation protection for each year they delay, Goss said. That's because the agency's annual cost of living adjustment will be applied to your PIA each year after you turn 62, whether you've begun taking benefits or not. The COLA is zero for 2010, and might even be zero in 2011 based on current inflation trends. But it will go up again in future years.

    For couples, the timing of when to claim Social Security often is more complex. That's because the lower-earning spouse might be better off, at least for a few years, with spousal benefits than with benefits based on their own earnings history. Considerations about survivorship benefits also may influence a couple's claiming decisions. Social Security provides extensive online help. Your local area agency on aging also might be able to help advise you. Finally, the Center for Retirement Research at Boston College has a helpful Social Security Claiming Guide.

    You can find your estimated primary insurance amount in the annual recap of benefits sent to you by the agency and called "Your Social Security Statement." Goss advised consumers to check the annual wage income figures listed on this statement, and compare them with their past W-2 statements and any self-employment earnings (Form 1099s). Roughly 1 percent of the wage forms don't have a correct match between the person and their Social Security number, Goss said. While the agency tries to eventually correct these problems, it doesn't find all the errors.

    [See Social Security Makes the Call: No 2010 COLA.]