Getting Your Financial Ducks In A Row

How is the Maximum Social Security Benefit Calculated?

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Each year when the Social Security Administration announces the Cost Of Living Adjustment to benefits for the coming year, with similar ballyhoo they announce the maximum benefit amount available for the coming year.  For 2013, the maximum Social Security benefit for someone reaching Full Retirement Age (FRA) in that year will be $2,533, an increase of $20 over 2012.

In the wake of these announcements a couple of weeks ago, a reader (thanks, DS!) sent me a question:

Why is it that the maximum Social Security benefit only increased from $2,513 to $2,533?  This is only an increase of 0.8%, while the COLA increase indicated that benefits would climb by 1.7%?

This is a drawn out and complicated situation to explain, but I think it’s important to fully understand.  First, you have to realize that when the Social Security folks publish this maximum amount, they are talking specifically about someone who reaches Full Retirement Age in the year being reviewed.  For 2012, that would be someone born in 1946; for 2013, the person was born in 1947.  As such, the calculations are based on different maximum wage bases.

The way that the maximum benefit for a particular year is calculated is based upon the maximum wage base for the year, as well as the applicable COLAs that would apply after the PIA (Primary Insurance Amount) has been calculated for that individual.

Maximum Benefit Calculation for 2012

For calculating the maximum benefit amount for 2012, we’re looking at an individual who was born in 1946, turning age 66 in the year 2012.  The table below indicates the maximum wage bases for each year from his age 22 in 1968, through 2011, because his maximum benefit was determined last year.  The third column indicates what the wage base equates to in terms of indexed income – this is based on the Average Wage Index (AWI) Series.

Year Max Wage Base Indexed Wage Base
1968 $ 7,800 $ 54,109
1969 $ 7,800 $ 51,152
1970 $ 7,800 $ 48,734
1971 $ 7,800 $ 46,402
1972 $ 9,000 $ 48,763
1973 $ 10,800 $ 55,069
1974 $ 13,200 $ 63,530
1975 $ 14,100 $ 63,143
1976 $ 15,300 $ 64,095
1977 $ 16,500 $ 65,213
1978 $ 17,700 $ 64,809
1979 $ 22,900 $ 77,104
1980 $ 25,900 $ 80,000
1981 $ 29,700 $ 83,347
1982 $ 32,400 $ 86,181
1983 $ 35,700 $ 90,546
1984 $ 37,800 $ 90,550
1985 $ 39,600 $ 90,985
1986 $ 42,000 $ 93,719
1987 $ 43,800 $ 91,875
1988 $ 45,000 $ 89,960
1989 $ 48,000 $ 92,304
1990 $ 51,300 $ 94,295
1991 $ 53,400 $ 94,630
1992 $ 55,500 $ 93,529
1993 $ 57,600 $ 96,244
1994 $ 60,600 $ 98,608
1995 $ 61,200 $ 95,747
1996 $ 62,700 $ 93,517
1997 $ 65,400 $ 92,168
1998 $ 68,400 $ 91,601
1999 $ 72,600 $ 92,093
2000 $ 76,200 $ 91,592
2001 $ 80,400 $ 94,390
2002 $ 84,900 $ 98,688
2003 $ 87,000 $ 98,710
2004 $ 87,900 $ 95,301
2005 $ 90,000 $ 94,140
2006 $ 94,200 $ 94,200
2007 $ 97,500 $ 97,500
2008 $ 102,000 $ 102,000
2009 $ 106,800 $ 106,800
2010 $ 106,800 $ 106,800
2011 $ 106,800 $ 106,800
When the top 35 years of wage base are averaged, we come up with an annual average wage base of $92,172, or a monthly average wage base (also known as the Average Indexed Monthly Earnings or AIME) of $7,681.  Applying the bend points to this (see the Bend Point article for details) we come up with a tentative PIA of $2,293.  To this we apply the COLAs from the point when the individual reached age 62 (in 2008): 5.8%, 0.0%, 0.0%, and 3.6%.  These are compounded, so the increase by COLAs is 9.61% (1.058 * 1 * 1 * 1.036 = 1.0961).  Multiplying the tentative PIA (Primary Insurance Amount) by these COLAs brings us to the maximum benefit amount of $2,513 for 2012.

Maximum Benefit for 2013

To calculate the maximum benefit for 2013, we are now working with an individual who will reach age 66 in that year, born in 1947.  Below is the table for this individual’s maximum benefit:
Year Max Wage Base Indexed Wage Base
1969 $ 7,800 $ 53,474
1970 $ 7,800 $ 50,946
1971 $ 7,800 $ 48,508
1972 $ 9,000 $ 50,975
1973 $ 10,800 $ 57,568
1974 $ 13,200 $ 66,413
1975 $ 14,100 $ 66,009
1976 $ 15,300 $ 67,003
1977 $ 16,500 $ 68,173
1978 $ 17,700 $ 67,750
1979 $ 22,900 $ 80,603
1980 $ 25,900 $ 83,631
1981 $ 29,700 $ 87,131
1982 $ 32,400 $ 90,091
1983 $ 35,700 $ 94,655
1984 $ 37,800 $ 94,659
1985 $ 39,600 $ 95,115
1986 $ 42,000 $ 97,969
1987 $ 43,800 $ 96,045
1988 $ 45,000 $ 94,046
1989 $ 48,000 $ 96,494
1990 $ 51,300 $ 98,573
1991 $ 53,400 $ 98,924
1992 $ 55,500 $ 97,774
1993 $ 57,600 $ 100,610
1994 $ 60,600 $ 103,081
1995 $ 61,200 $ 100,093
1996 $ 62,700 $ 97,762
1997 $ 65,400 $ 96,354
1998 $ 68,400 $ 95,760
1999 $ 72,600 $ 96,275
2000 $ 76,200 $ 95,753
2001 $ 80,400 $ 98,675
2002 $ 84,900 $ 103,162
2003 $ 87,000 $ 103,191
2004 $ 87,900 $ 99,626
2005 $ 90,000 $ 98,406
2006 $ 94,200 $ 98,477
2007 $ 97,500 $ 97,500
2008 $ 102,000 $ 102,000
2009 $ 106,800 $ 106,800
2010 $ 106,800 $ 106,800
2011 $ 106,800 $ 106,800
2012 $ 110,100 $ 110,100
The reason that this table is different from the one above (look at the indexed wage base for each year) is because the index is always normalized to the year when the individual reaches age 60 – when the PIA is originally calculated.  When we average the top 35 indexed wages for this series, we come up with an average of $96,888, or an AIME of $8,074.  Applying the 2012 bend points to this AIME, we come up with a tentative PIA of $2,404.  To this we add the COLAs for the years from 2009 to 2012: 0%, 0%, 3.6% and 1.7%.  This aggregates to 5.36% increase, up to $2,533.

What does this mean?

Because of the way these calculations are done, and what the Social Security folks mean by them, it’s not really important to compare these two numbers to one another – it’s not even the same person that we’re looking at.  In actuality, a PIA for someone who earned the maximum salary over her entire working life and who reached age 66 in 2012 would be increased to $2,556, exactly 1.7%.
So – when calculating the maximum amount that you will have available to you, keep in mind all of the nuances in the calculation process, and make sure that you are working on your own circumstances, not the sample that SSA is putting forth as the “maximum”.

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