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The Science Behind Social Security Benefits Calculations

Social-securityWhile the Social Security Administration calculates Social Security benefits, it is your due diligence to know the basics so that you can understand how an additional year of earning will affect your clients’ projected benefit.

Some people think Social Security benefits are complicated to figure out; in actuality, it’s pretty straightforward. Social Security benefits are computed through this two-step process:

  1. Compute the average indexed monthly earnings, called AIME.
  2. Compute the primary insurance amount, based on the AIME.

AIME Breakdown

  • For each year in which a person has taxed Social Security earnings, those earnings are indexed to bring each of those prior year’s earnings to near-current wage levels. This process basically involves adjusting for inflation.
  • Each prior year’s index is different and computed by dividing the national average wage index for the year the client attains age 60 by the average wage index for each prior year. The index used for the year a person attains age 60 and each year after is 1.0.
  • The resulting index factor is then multiplied by the person’s actual earnings for that particular year to bring earnings up to the indexed earnings amount.

For example, if a clients’ earnings record showed $15,562 of taxed Social Security earnings in 1984, it must be multiplied by an index factor of 2.7469 to calculate an inflation-adjusted earnings amount of $42,748 in 2014. This same calculation is performed each prior year.

The highest 35 years index earnings are then added together and divided by 420—the number of months in a 35-year period—to arrive at AIME. If you have less than 35 years of earnings history when you turn 62, the index is calculated as previously shown, added together and still divided by 420 months.

What is PIA?

PIA is the monthly benefit a person would begin receiving at full retirement age. This is calculated with a formula that is composed of three tiers. These tiers are separated by two “bend points,” depicted on a benefits calculation graph when a bend in the lines exists at two points. The levels for the bend points are determined for the year in which one reaches age 62. Each year, the bend points are adjusted based on average wage indexes.

The CPA’s Guide to Social Security Planning from the AICPA Personal Financial Planning Section has detailed examples of AIME and PIA calculations, as well as commonly asked client questions and adviser solutions on a variety of Social Security planning issues. You can download a free excerpt on the AICPA PFP Section’s retirement resources page.

Interested in building your financial planning knowledge? Register for all or a portion of the three-part series: From Tax Preparer to Financial Planner: The Road Best Traveledto learn how CPAs have built their financial planning practices off of their existing tax practices, and take a holistic approach in the delivery of financial planning services to ensure all of their clients’ needs are met, including tax, estate, retirement, investments and insurance.

Theodore J. Sarenski, CPA/PFS, CFP®, AEP, CEP and President, Blue Ocean Strategic Capital, Inc. Ted’s firm delivers customized service for individuals, retirement plans, non-profit organizations, endowments and foundations. He is the author of The CPA’s Guide to Social Security Planning and will be speaking on the “Nuances of Social Security” at the 2015 AICPA Advanced PFP Conference.


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