To generate our custom reports, we ask our customers to provide the benefit available to them at their full retirement age, or their primary insurance amount (PIA). All of our calculations are done based on that number, but we don’t discuss how SSA determines it. It’s fairly common knowledge that someone with higher wages over their lifetime will have a larger benefit than someone with lower wages. However, the details of the calculation are little known.
One’s PIA is based on the highest earning 35 years. If a beneficiary did not earn wages for a full 35 years, zeros are used for the remaining years. Earnings are adjusted for wage growth so that they are comparable across time. They are also capped at a certain level ($110,100 for 2012), beyond which additional wages are not subject to the Social Security portion of the FICA tax and do not contribute to one’s benefit. Using these adjusted, capped earnings, an average monthly wage is calculated. This average monthly wage forms the basis of the PIA.
The PIA increases as the average monthly wage increases, but the increase is not linear. Each dollar in the average monthly wage contributes positively to the PIA, however, the first dollars contribute more than the later dollars. For individuals turning 62 in 2012, the PIA is equal to the sum of the following:
- 90% of the first $767 in the average monthly wage,
- 32% of the average monthly wage between $767 and $4624, and
- 15% of the average monthly wage above $4624.
The maximum possible average monthly wage for those turning 62 in 2012 is $8199, and the maximum possible PIA, based on the calculation above, is $2460. The chart below shows the PIA under different proportions of the maximum possible average monthly wage. For example, an individual with an average monthly wage that is half of the maximum has a PIA of approximately $1760, over 70% of the maximum possible PIA. Someone with an average monthly wage that is a quarter of the maximum has a PIA of about $1100, about 44% of the maximum possible PIA.
Fortunately, the Social Security Administration does this calculation for you, but it’s interesting to see how the calculation is consistent with the notion that Social Security is in place to provide a minimum standard of living to those in retirement.