Calculating The Income Replacement Rate For Social Security Benefits
Although not commonly understood, the calculation of Social Security benefits is really nothing more than an income replacement formula, similar to a pension. Just as a pension might offer an up-to-70% replacement rate based on the average of your last 5 years of wages, Social Security also provides benefits that are a replacement of your earnings based on your years of service. The primary difference is simply that Social Security uses a 35-year average of earnings that accrue based on your years of service , and the replacement rate itself is based on your income .
The individuals 35-year average of earnings is known as AIME Average Indexed Monthly Earnings and is calculated as a monthly average income over 35 years , and is inflation-adjusted . Notably, the lifetime earnings used to calculate the 35-year average of inflation-adjusted income is based on the highest 35 years of historical earnings, regardless of whether they were consecutive years or not.
Replacement rates are then calculated based on the highest-35-year AIME amount with the first $885/month replaced at 90%, the next $4,651/month replaced at 32%, and anything else replaced at 15%.
The final benefit is known as the Primary Insurance Amount , and becomes available to the retiree at Full Retirement Age .
Determining Which Retirement Age Is Best For You
Should you take the money and run at age 62? Or hold out until you’re 70? Approximately 50% of people don’t wait past age 62, usually because they need the money, are convinced that Social Security might collapse at a later date, or are fearful of a short life span.
But is early retirement a good option for you? The questions below will help you decide.
Are you still working? Some people, especially construction workers and other physical laborers, are less physically able to handle work at 62, even though they don’t qualify for disability. They may be good candidates for early retirement. However, if you’re still able-bodied and interested in working, you might want to avoid claiming early retirement benefits. If you’re earning a high salary, you’ll miss the opportunity to boost your Social Security payment amount.
Second, you’ll lose one dollar in benefits for every two dollars you earn over the SSA’s earnings limit . There are no such deductions if you work after reaching full retirement age. The SSA provides an online earnings test calculator to determine whether working will lower your retirement benefits.
How’s your health? If you’re convincedâeither by genetics, research, or the amount of time you spend in doctors’ officesâthat you’ll have a shorter lifespan than your peers, it doesn’t make much sense to delay your retirement benefits.
You could be eligible for up to $3,148 per month in SSDI benefits
Is There A Maximum Benefit
Yes, there is a limit to how much you can receive in Social Security benefits. The maximum Social Security benefit changes each year. For 2022, itâs $4,194/month for those who retire at age 70 . Multiply that by 12 to get $50,328 in maximum annual benefits. If that’s less than your anticipated annual expenses, youâll need to have additional income from your own savings to supplement it.
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The Self Employed Have An Option Too
The SEP-IRA is a simplified Employee Pension Individual Retirement Account. This is used by business employers to provide a savings plan for themselves and their employees. The SEP-IRA follows all the rules for a traditional IRA. In this program, the employer, not the employee makes contributions to the account. The employer is allowed to contribute up to 25% of the employee’s compensation and has the option to change the % each year. The contribution % must be the same for the employer and all his eligible employees. The contributions are tax deductible and earnings tax-deferred, making this an attractive option for business owners.
How To Calculate Your Social Security Break
Deciding when to take Social Security retirement benefits is important because it can directly affect your benefit amount. While you can technically start taking benefits as early as 62, youd receive them at a reduced amount. On the other hand, you could delay taking benefits up to age 70. Calculating your Social Security break-even age can help you decide when the best time is to begin taking benefits. You can do that using a Social Security break-even calculator. Additionally, it may be a good idea for you to consult with a financial advisor about when its best for your particular situation to begin receiving Social Security.
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How A Social Security Break
Figuring out the right time to start taking Social Security benefits isnt always a straightforward process. A Social Security break-even calculator can help you get some perspective on the numbers so you know what you stand to gain or lose by taking benefits earlier versus later.
Social Security break-even calculators help you find the best age to start taking retirement benefits. They do this by comparing your cumulative Social Security retirement benefits paid at age 62, your full retirement age and at age 70 and estimating how long it would take the benefits paid at age 70 to break even with benefits paid to start at age 62.
Heres a simple calculation to give you an idea of how a Social Security break-even calculator works. Say that you have the option to begin receiving $1,200 a month in benefits at age 62. Youd receive $1,700 in benefits if you wait until full retirement age at 66. Or you could receive $2,200 a month in benefits by delaying them until age 70.
The break-even point represents when the cumulative benefits even out. So if you wait until age 70 to start taking benefits, it would take you until age 79 to break even with the benefit amount youd receive if you started taking them at age 62. If you were to start receiving benefits at age 66, it would take you until age 75 to break even with the benefits youd receive if you started them at 62.
Is It Possible To Leave Your Job Behind
Several schools of thought govern the ways people think about leaving the workforce. On one hand, some would-be retirees believe their golden years should be spent enjoying the good life, without pinching pennies. Planners committed to this philosophy are more likely to stay the course as long as possible, to generate substantial holdings before stepping away from work. Others measure quality of life using different standards, so accumulating vast fortunes for retirement is not a priority. To them, freedom means simply getting by, without sacrificing family and leisure time for affluence upon stepping down.
A blogger named Pete, who runs a site called Mr. Money Mustache, decidedly favors early retirement over other alternatives, having himself left the workforce while in his thirties. His blog shares insight about the process, which sometimes flies in the face of conventional wisdom. And while his posts are clearly shaped by personal values, various strategies espoused there provide food for thought.
And Pete isn’t alone. Countless others have made moves toward early retirement, proving that it is not only possible, but feasible for many families. If it is on your mind, consider its two-pronged nature, in order to make it a reality.
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What Does It All Mean To Me
I am happy to report that if The Wine Squirrels never earn another penny, and wait as long as possible to start collecting, Social Security will pay out about $50k/year . Remember this is indexed to inflation. The actual number will grow over time in order to provide the same buying power. I really cant complain about that!
My pension will provide some income as well, but Ill save that for another blog post. I need to run some future value calculations that take into account the impact of inflation over time.
While not the most frugal family ever, we are very conscious of our spending and generally our needs are low. We live a very fulfilling life and definitely want for free time much more than material things at this point. This is evident by the fact that our savings rate is high as we dont have a bunch of stuff we need/want to buy. Assuming that trend continues, and in fact reduces over time as mortgages are paid and kids become less dependent, this $50k+ is definitely going to fund a large percentage of our old age retirement.
Knowing that a good chunk of our needs in our 70s and beyond are already taken care of opens up options for the years between now and then!
Retiring Early From Declining Income Below The Highest 35 Years
After all, the reality is that if the worker already has 35 years of work history, all of which are at least as high as current earnings , then the prospective retiree isnt actually earning any further increase in benefits by continuing to work! Because the AIME formula only counts the highest 35 years and drops the rest. So if the prospective retiree isnt adding new years that are higher than the existing ones, the additional years of work have no impact. Which means stopping work early has no adverse impact, either.
For instance, the chart below shows an individuals historical earnings over a career, including a substantial ramp-up in the early years, followed by a career transition , then a steady series of raises, with a few wind-down years of consulting work at the end. The top 35 years are shown in blue, and the low years are shown in orange.
As the chart above shows, additional years of work at the current consulting levels will have no impact on benefits because there are already 35 years of historical earnings at even higher levels. As a result, quitting work after age 64 wont have any impact on the benefits that were originally projected to begin at full retirement age of 66.
What If I Delay Taking My Benefits
If you retire sometime between your full retirement age and age 70, you typically earn a “delayed retirement” credit for your own benefits . For example, say you were born in 1960, and your full retirement age is 67. If you start your benefits at age 69, you would receive a credit of 8% per year multiplied by two . This means your benefit would be 16% higher than the amount you would have received at age 67.
At What Age Do You Plan To Retire
The age at which you retire can have a major effect on the size of the Social Security benefits youll receive. The longer you wait up until age 70, the more benefits you may be able to collect.
Enter the age at which you would like to retire and begin collecting benefits. You can get retirement benefits as early as age 62.
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% Of Full Retirement Age Calculator
When planning when to file for Social Security, its helpful to know how much your benefit will be increased, or decreased, based on the month you file.
This calculator will tell you two things:
- your full retirement age
- the percent of your benefit you can expect to receive based on your chosen filing age.
The math behind this calculator is based on the calculations used by the Social Security Administration.
If you file at your full retirement age, youll receive the full benefit.
If you file before your full retirement age your benefit will be reduced. You can file as early as age 62, but doing so could result in a benefit reduction of up to 30%. The monthly reduction percentage is 5/9 of one percent for each month before normal retirement age, up to 36 months. If the number of months exceeds 36, then the benefit is further reduced 5/12 of one percent per month.
If you file after your full retirement age, you can receive delayed retirement credits up until age 69 & 11 months. These delayed retirement credits will increase your full retirement age benefit by 2/3 of 1% per month that you delay.
Thankfully, you dont need to remember all this math. Just use the calculator below.
Factors That Affect How Much You’ll Get In Retirement
Gordon Scott has been an active investor and technical analyst of securities, futures, forex, and penny stocks for 20+ years. He is a member of the Investopedia Financial Review Board and the co-author of Investing to Win. Gordon is a Chartered Market Technician . He is also a member of CMT Association.
Most retirees rely on Social Security. One in four gets 90% of their retirement income from the program. About half rely on it for 50% of their income.
Although Social Security is only one part of a secure retirement plan, it’s helpful to get a rough idea of how much you can expect. If you’re eligible for Social Security, your monthly benefit is based on two factors:
- How much money you earned during your working career
- The age you choose to start getting payments
Let’s look at how each of these affects your future Social Security income.
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What A Social Security Break
In a nutshell, a Social Security break-even calculatorcan tell you when the best age is to start taking Social security benefits, in terms of how much money you could expect to receive over time. Going back to the previous example, lets assume that you track your benefit amounts over a 10-year, 20-year and 30-year period. Heres how your total benefits received would look over each of those periods, for all three starting points.
Your cumulative benefits after 10 years:
- $144,000, starting at age 62
- $122,400, starting at age 66
- $52,800, starting at age 70
Your cumulative benefits after 20 years:
- $288,000, starting at age 62
- $326,400, starting at age 66
- $316,800, starting at age 70
Your cumulative benefits after 30 years:
- $432,000, starting at age 62
- $530,400, starting at age 66
- $580,800, starting at age 70
You can see that youd draw the most Social Security benefits in total if you wait until age 70 to start taking them, assuming you live to age 100. But that could be a big if when youre not in the best health.
What you have to keep in mind when using a Social Security break-even calculator is that the numbers are hypothetical. They dont take into things that could affect your ability to draw benefits or how far those benefits might go, such as:
Financial Security Of The Past Is Slipping Away
Depending on your age, retirement may be decades away or just around the corner. Either way, you should not procrastinate and start today to save for your twilight years. Past generations could rely on what was called, the three legged stool, referring to the three main sources of income in retirement- social security, company pension and personal savings. Many companies also provided healthcare coverage in retirement.
That was then, this is now when individuals are ultimately responsible for their own retirement. Gone is the company pension and Social Security is not guaranteed. In fact, two of three projections of the Social Security Trustees estimate that unless changes are made, the Social Security trust fund will remain solvent for only another 20 years. So now more than ever, you need to take charge of your future and save for retirement.
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How To Guide Yourself To Early Retirement
Ideally, work life is rewarding, both financially and in terms of personal fulfillment. For workers on one end of the spectrum, doing what they love is the same thing as bringing home the bacon. Still others work primarily for the monetary rewards. Apart from each individual’s level of job satisfaction, however, looking forward to retiring is a natural part of most workers’ employment progression. In fact, as some workers age, it becomes the light at the end of the tunnel, which keeps them toiling.
The concept of retirement has traditionally been tied to reaching a particular age or station in life, allowing people to step out of customary work roles. For generations, the magic number stood at 65 the age at which many employers and government agencies recognized the end of working years and awarded pensions and other benefits. As the cost of living continues to increase and social values shift among workers, the standard age has crept upward, keeping would-be retirees in the workplace longer than they once were.
Although Social Security benefit timing and other benchmarks have changed, requiring workers to stay employed longer, there is a simultaneous movement afoot among those wishing to leave the workforce before reaching traditional retirement age. The drive is influenced by personal goals and values, prompting many to entertain the prospect of an early exit.
Disability & Industrial Disability Retirement
If you have a disabling injury or illness that prevents you from performing your usual job duties with your current employer, you may be eligible for disability or industrial disability retirement. If your disability or industrial disability retirement is approved, you’ll receive a monthly retirement payment for the rest of your life or until you recover from your injury or illness.
|An injury or illness that doesn’t need to be job related
|A job-related illness or injury
Generally, you must have at least five years of service credit to be eligible. members must have 10 years.
Some exceptions apply to the service requirement. Contact us to see if you qualify.
If you’re a patrol member in Bargaining Unit 5 of the Department of California Highway Patrol, you may be eligible for an enhanced industrial disability retirement benefit. You must have sustained a serious bodily injury as the result of a single event and must be unable to participate in substantial gainful employment.
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