Guided Path 2-2 How is Your Social Security Benefit Calculated?

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Retirement benefits like Social Security make a world of difference for people in retirement. So how much should you expect to receive from these benefits? And in addition, where does the money from these benefits come from? In this episode, Zacc Call and Laura Hadley dive deeper into the ins and outs of Social Security by explaining how you can estimate how much you will receive, how to maximize your benefit if you are self-employed, how the government accumulates the money in the Social Security trust fund, and more. Zacc and Laura discuss: What FICA tax is and how you benefit from it in the future - “Primary insurance amounts” and how yours is calculated - How to maximize your government retirement benefits if you’re self-employed - What compensation you can expect from the government when retired - And more

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[00:00:00] Welcome to The Financial Call. We are financial advisors on a mission to guide you through the financial planning everyone should have, whether you're doing it yourself or working with a financial advisor, these episodes will help you break down complicated financial topics into practical, actionable steps. [00:00:17] Our mission is to guide motivated people to become financially successful. Welcome to The Financial Call. This is Zacc Call and we have Laura here as well. Hello everybody. We're excited to. And if you've made it this far, you're through season one and into season two, today is how is your benefit calculated? [00:00:35] We're talking specifically about Social Security benefits, and it's important to understand this, especially for those who are contributing to Social Security, which is just about everyone. And I guess this is also super helpful for those who are receiving it at that point, though. It's pretty baked. Yeah. [00:00:50] I mean, if it is baked, yeah. They've already put it into it, but a lot of people have questions while they're working. What am I doing now? That will affect my Social Security. If I stop working [00:01:00] earlier, if I retire earlier, if I'm self-employed, you know, how much should I pay myself? And we're not trying to teach you the Social Security benefit calculation. [00:01:08] So you have to calculate your own benefits. We won't go into the nitty gritty details of it, but it's helpful to know the overall idea. So you know what to do now. Yeah, I think, I think today you need to understand FICA tax. So here's your outline for today. This will help, you know, why we're going through it in this order: FICA tax, which is the money you pay in towards Social Security and Medicare two would be how your benefit is calculated in terms of like it's Called a primary insurance amount. [00:01:36] I think we've mentioned that acronym. I think we touched on it last time. We're somewhat recording some of these outta orders, so I'm hoping. Hoping that that was covered. Pia primary insurance amount, calculation details will talk about how they get to that. And then there's something that totally like, it surprised me when I learned about bend points, bend points are points at which you get less bang for your buck for your, uh,  tax dollars. [00:01:58] So we'll talk about bend points. [00:02:00] And then specifically we wanna talk about self-employed people because there's an option, especially for those of you who have an S Corp. And by the way, this is another season where we're gonna go into business entities. And what types of entities make sense for different types of businesses. [00:02:14] But if you have the ability to control how much you pay yourself and how much. Income on which you pay FICA taxes. There can be some strategy here to really maximize your dollars. And then we'll talk a little bit about when you get to retirement, what are the full retirement ages and things like that. [00:02:30] Lastly, if you are working and filing, we have talked about maybe if we have some time we'll cover. How that works and how you might be penalized. Okay. So that's your, that's your outline? That feels like a lot, again, you don't need to be an expert in this, but we're gonna go through it pretty quickly. FICA tax. [00:02:46] My wife used to say, like, who is FICA and why is it, why are they taking it all? Are they taking all of my money? Yeah. Right. So FICA tax is the federal insurance. Contributions act. That's what that stands for federal insurance [00:03:00] is like the federal government saying we're going to have you pay into something and then we're going to give you something later. [00:03:04] That's why they call it insurance, kind of like a premium, but insurance, but not really. Social Security is 6.2%. Medicare is 1.4, 5%. Now the employer is also like at Capita, you know, Laura, your 6.2% comes outta your paycheck. And then the company also sends 6.2% FICA taxes on your behalf. So it's really 12.4% for you. [00:03:30] And then 1.45 for Medicare, you pay 1.45 that the employer pays. So there's 2.9% Medicare. So we're at what? Like 15.30, all in. I think so. Yeah, that sounds right. And this is on top of federal taxes and state taxes. So when people get their, your take home check and you're like, why is this so much less than, you know, my gross pay part of that is because of the FICA tax. [00:03:55] Yeah. And so most people are paying a little over, you know, what is that? [00:04:00] Eight, 9%. I feel like I did this math wrong somewhere in there because there's no way it. Anyway, we'll move on. . So 16.3 I think is anyway, bottom line is most people are only seeing the 6.2 and the 2.9. And self-employed people are seeing that times too. [00:04:17] So that's where they feel the real pain. Okay. So those dollars come in, they hit the Social Security trust fund and then Social Security pays out to current benefits, uh, that money. Right? So that's where. It gets a little confusing, cause some people think that their money's going into some bank account for them in the future. [00:04:33] It's not the case that's going in and there's one big bank account or one big fund we'll Call it. And that money is also being paid out to, to current beneficiaries. Or maybe your parents, if you're, if you're working right now, right. okay. So how do they determine how much they should pay out? It's important. [00:04:50] You understand this so you can determine what strategies you want to do today. So you can tell this, this conversation is a little bit geared towards people still working. For those of you [00:05:00] who are not working, this will be helpful for you to understand what's going on. They take the top 35 years of income. [00:05:06] but to qualify, you only need 10 years of income. Yeah. And a lot of times they'll say 40 quarters, and I think people get confused by that. It's not 40 years. It's 40 quarters of a year. So if you've worked for 10 years and paid into, if you've paid your FICA tax for 10 years, you qualify for a Social Security benefit. [00:05:23] But as you know, as you work more and earn more, maybe you have, you do have 40 years paying into Social Security. The government will take your top 35 years and use that to calculate your benefit. If you have less than 35 years, then some of those top 35 years are going, going to be zeros. You're gonna have some zeros going into the. [00:05:44] Yeah. So someone who barely qualifies has 25 years of zero in there. Right? Mm-hmm and the quarters thing is important because it's not necessarily, they don't have to be consecutive. It doesn't have to be exactly 10 years in a row. It could be, you know, for people who maybe stay at home and help rear children and then go back to [00:06:00] work that can all work well. [00:06:01] Yeah. And it starts as early as you start working, I've had some people ask that like, do you have to be an adult? Do you have to be 21? It's as soon as you start paying the VI tax that it starts to count. And they take those top 35 years. And what people don't realize is that they run an inflation calculator for those years, that were many years ago. [00:06:19] So like we'll have people in their sixties come to us. And they'll say, in fact, I have an example here where we took someone's actual earnings in 1980, she made $623 that gets multiplied by 4.7 for her. So she actually gets to Call. $2,900. So it was like she made 2,900, even though she only made 600 in 85, she made 8,000 and she gets to Call that 28,000. [00:06:47] So anyway, you recognize they're going to normalize all of your income for inflation, and then they do a comparison of the top 35 years. we run into it all the time [00:07:00] where someone will, if we actually rank the years and for this individual we did where she has a year where she made $33,000 in 1994. That is her sixth best year, all time of working and she made much more money later. [00:07:16] But it's still better. I mean, she made over 40, 45, $60,000 in the future, but that year was a really big year for her because of inflation. Okay. So take the top 35 years, then they average that out and figure out your average monthly earnings. And then this is where the bend points come into play. And this can be a little bit confusing, but I'm just gonna go through it to help you understand. [00:07:39] There are three categories of that income. So let's say someone has. $4,000 of average earnings over, they take those 35 years. They adjust for inflation. They divide it by a monthly amount. It comes out magically to $4,000 because we want easy. We love easy enough. Right? So then they would take the first [00:08:00] thousand dollars. [00:08:01] It's actually 1020 $4 and they would multiply that by 90%. So for the first thousand and $24 of the 4,000. She's getting 90% of that back in a Social Security benefit in the future. Then from a thousand to 24, up to $6,172. She's getting 32%. So think about that for a second. If you could draw on a line and we do this internally, we have pinpoint charts that help us estimate these. [00:08:32] So imagine on a graph, this is a really steep hill. She's getting a lot of benefit for every dollar of earnings. It's 90%, right. And then all of a sudden we hit this mark a thousand dollars and it flattens out dramatically. That's the pinpoint. It flattens out dramatically because she's only getting 32% of the next dollar and so on all the way up until 6,172. [00:08:56] And then at that point, there's another pinpoint, it goes from [00:09:00] 32% down to 15%. And then after that, it maxes out and it's zero. So you have a couple bend points along this chart. And the reason that that's important is imagine you are a self-employed individual and you have the ability to choose how much money you pay yourself. [00:09:20] Well, it doesn't make a whole lot of sense to pay 15% in FICA taxes. In order to hopefully get this little incremental benefit. Like let's say you're at $160,000 of income while you'd be over for bike. Let's pick a different number. Let's say it's $120,000 of income and they could choose to pay themselves another $20,000 or not. [00:09:43] Let's say they do. They pay themselves another $20,000. They have to pay FICA taxes, both sides, employer, and self for that extra $20,000. It's a ton of taxes. And then they're gonna throw that into a big average and only get a tiny piece of that back. A [00:10:00] 15% piece of that back in their Social Security benefit. [00:10:03] Now flip that around. Let's say somebody is paying themselves $500 a month. They could pay themselves another $500 a. And help get 90% of that back in a Social Security benefit. So you can see their strategy here. You want to pay yourself a little bit, but you don't want to pay yourself so much that you're in those other bend points. [00:10:26] Um, so in other words, it may make sense to pay yourself kind of at the low end as possible. I know most self-employed people do that anyway, cause they wanna avoid FICA taxes. And I do this myself. I, I like to get that 90%, that first bend point, for sure. Yeah. And into the second. Yeah. And I think this is helpful for people who maybe feel like they didn't earn a lot throughout their life. [00:10:47] You got the most bang for your buck, you know, with the lower income that you had. So another friend or spouse who maybe had a lot higher of an income, their Social Security benefit might not be. Even if they're [00:11:00] in triple what you did, their Social Security benefit might not be triple. No, it definitely won't be. [00:11:04] Yeah, you're right. We see that all the time. Right. We see people come in who have made $60,000 a year for their entire life. Well, an equivalent of that, right. And with inflation, They may have a $2,000 Social Security benefit and somebody else who's making, like you said, almost twice that may only have a 23, 24, 20 $500 Social Security benefit. [00:11:26] So they had to pay twice as much in FICA taxes. For an extra three or four, $500 a month. So we have a calculator because we work with a lot of folks in later in this season, we're gonna talk about some penalties associated with Social Security. And we work with a lot of people who are subject to penalties Called the web and GPO penalties. [00:11:45] We have tools to be able to work through that and model out like, okay, what if you chose to opt in and opt out? And, and we have a whole episode that we're gonna go through those penalties and talk through that. Laura's a nice way of saying like, don't go too deep. That's what I do. It's what I do. We're trying to reduce the time on these [00:12:00] episodes here. [00:12:00] So just helping. Okay. I love it. I love it. Okay. So I just modeled out. Let's pretend that this person is a self-employed individual. And I boosted her income for the last decade of her career to a hundred thousand dollars. And it basically changes her Social Security benefit. So right now it's $45,000 a year for the last decade. [00:12:22] And then if I throw that up to a hundred thousand dollars, it gives her an extra $200 a month on her Social Security benefit. Really, not that much like $200 a month, that is a lot of FICA taxes to pay for $200 a month. Another way of saying this is if this person has control over their income and they chose to, instead of pay that FICA taxes pay the 15% towards an investment portfolio, it's going to earn enough to pay them more than the $200 difference over that. [00:12:51] The rest of their life. Yeah. Or somebody, maybe they can't control their pay. They're not self-employed, but they're thinking about working an extra year or two, just to try and increase [00:13:00] their Social Security benefit. If we ran the numbers and we told them, okay, that's gonna give you an extra $20. Yeah. [00:13:06] Something like that, $20 a month, then they'd probably say, okay, not worth it. I mean, depending on their work, we see that all the time. Yeah. People will hate their job, but stay because they think they're making a bigger benefit on their Social Security than they really are. Yeah. Now, if you have zeros in the mix, That changes things a little bit, right? [00:13:22] A zero in there is bringing down that average by quite a bit. So, yes, if you worked a little bit more, but if you've been working your entire career, it's not gonna change it too much. Yeah. Okay. And Zacc, you did mention earlier, it doesn't matter if your income is above a certain amount, just so people though, after you earn $147,000 in income, you are no longer paying that FICA tax. [00:13:43] Specifically Social Security tax, right? You still have to pay Medicare tax. The 1.9%, oh, sorry. 1.45, 5%. That turns into 2.9. That continues with you. No matter how much you make, except this goes back to [00:14:00] business strategies. Except for those people who pay themselves a reasonable wage through like an S Corp. [00:14:05] That's the conversation for another day. Just understand that there are, if you are self-employed, there are ways of getting out of paying that Medicare tax as well, when you're over 1 47, but that's a good point, Laura, 1 47 even, or was it. 147,000, even in 2022. Yep. Okay. And that's been going up and by the way, a couple years back, they gave everyone a cost of living adjustment of 0.3%. [00:14:26] And in the same year they increased that number by 7%. And I thought that was really funny because to me, it was like, wait a second. So you're telling me like my experiences inflation of 0.3%, but I'm experiencing inflation of 7%. Yeah. In the same year, I feel like. And they don't charge us different for a vehicle, you know? [00:14:46] Yeah. True. It was one of those things that only nerds like us actually pay attention to. And I think that's one of those things they can do to shore up the trust fund a little bit better. They have a lot of levers to pull again. That's a conversation for another day, too. There's so much here with [00:15:00] Social Security to go over full retirement ages. [00:15:02] I mean, what, what should we share here, Laura, about what does that mean? And. And how should people be thinking about that? Yeah. This is the most common question people have. Your full retirement age is the age in which you are eligible to receive 100% of your Social Security benefits. So if you file earlier than that, then it's going to be reduced. [00:15:19] If you file later, it's going to be a little bit larger, but that's the age that you get the full benefits that we've just talked about. The calculation of full retirement age is different depending. When you were born. So if you were before, if you were born 1954 or earlier, your full retirement age is 66. [00:15:38] If you were born in 1960, it's age 67. If you're in between 1954 or 1960, it's a random month, 66 and two months, 66 and four months. And so on. Yeah. And, and that gets people a little bit confused too. I just think it's interesting. The Social Security administration doesn't care. What day you're born on. [00:15:57] Yeah. It’s like what day of the month is your birthday? The [00:16:00] 12th. The 12th. Okay. In what month? January. We won't make you save the year. Okay. So January 12th. So Laura's Social Security month is January. They don't care that it's the 12, 13th, 14th. They just don't care. Your Social Security month is dictated by subtracting a day from your birthday. [00:16:18] Then whatever day, that day falls in that's your month. So it gets really funny if you're born on February 1st, your Social Security month is actually January. Yeah. And then the people who are born on January 1st, their Social Security month is actually December of the previous year. So like somebody born on January 1st of 55, Uses December 31st of 54 as the anyway, I just think that's, I don't know why they do this stuff just to make it complicated, but yeah, probably I'm sure there's a reason in there somewhere. [00:16:47] Right. But anyway, that's one of those weird, weird things about Social Security. And then if you take it early, it's reduced. If you take it late, they give you delayed credits is what they call it, which will [00:17:00] go through some of the strategies in future episodes as to why you would choose one or the. [00:17:04] But let's just go through some basic numbers. So like someone who's full retirement age is 67. So you're talking 1960 and later, like you said, Laura mm-hmm . So the earliest that you can file for a personal benefit is age 62. If you were to file at age 62, you would only get 70% of your calculated benefit. [00:17:24] And that continues if you file at 62, you're gonna have that reduction all through the rest of retirement. So 62 is about 70%. I mean, if you waited till 65, it's about 87%. Obviously at 67, you'd get 100% each year that you wait after age 67, you get an 8% increase on those benefits until age 70. It doesn't keep growing after age 70. [00:17:49] So if you have not filed for a Social Security benefit by age 70, you're missing out on free. We do presentations all around about Social Security education. And it [00:18:00] seems like regularly we get somebody who's 72 and is like, I haven't filed because I don't wanna pay the taxes on it. I'm still working. [00:18:09] Yeah. It's like, oh no, no, no, no, no, no. It's free money. Like you should take the money and pay a part of it in taxes. Yeah, no kidding. Keep the rest Uh Huh. But we run into that regularly and then. Keep in mind, it doesn't mean that one of these strategies or ages is bad. And one of them is better, especially with couples. [00:18:27] Sometimes we'll have the couples do completely different strategies as a measure of longevity, diversification, right? Like diversifying and there we are using jargon like diversifying how long you guys might live or trying to manage the risk of like one of you passing away early, making sure you. [00:18:44] Run out of money if you live long. Yeah. A simple version, I guess. And so then it may make sense for someone to take it early because they're getting that money for five years. Whereas if you wait until full retirement age at 67, you didn't get anything for five years. And depending on how long you [00:19:00] think you'll live and, and your family, my mom doesn't have the best of health. [00:19:03] And my dad, I think, will live a really long time. And I just, it's really hard to know. Obviously you can totally be surprised by those things, but we felt it was wise for, because. If one of them dies, the smaller the benefits disappear. And so it was wise for one of them or for her to take hers as soon as possible, basically. [00:19:20] And help. Anyway, we'll get into some of those spousal strategies later, but don't get the impression that one is good and one is bad. There are different strategies that make sense. Yeah. A lot of people think that when you retire, you have to file for Social Security at the same time. I don't know. I think the way they word it, your retirement benefits, just people think it's the same time. [00:19:40] It's a very common question. I think we touched on this last time. It does not have to be at the same time. You could retire and then still delay taking your benefits, or you could file for benefits while you're still working and something that we wanted to bring up. There are some things that you need to be aware of. [00:19:56] If you are under your full retirement age and you wanna file [00:20:00] for Social Security, you do have some income limits. On there. So if you are before your full retirement age file for Social Security, you have to limit your income. It's about 20,000. It's actually 19,560. If you earn anything over that for every $2 that you earn, they'll take back a dollar of your Social Security. [00:20:22] Here's one little exception. If it's in the year that you're turning your full retirement age. Say your full retirement age is 67. You're gonna turn 67 in July, but you file for your benefits in January. Your income limit for that year actually goes up, going up to 51,960. So you can earn a little bit more. [00:20:40] And for every $3 over that you earn, they take back a dollar of Social Security. So just something to be aware of. If you are filing before your full retirement age, there are some income limits to be. If you're filing after your full retirement age, there are no income limits. So you don't have to worry about it and be clear, of course, be careful. [00:20:57] That's monthly. Even though those [00:21:00] numbers, they give them to us in an annual number. They divide it by 12. So for example, let's say that you are 63 years old and you've worked January, February, March, and April. And you are retiring in may. Then you could start your Social Security benefit in may and not have it be penalized because you don't have earned income in may. [00:21:23] And sometimes people get confused, cause they're like, well, I, I earned more than 19,500 in the first four months of the year. It's not like that. It's. Per month. And when you file for Social Security on the website, they literally have you right in the months that you will have earned over the, what is one 12th of 19,500, but is it like $1,800 roughly a month? [00:21:45] I'm gonna have to do it cause I'm that OCD? No 1630. Okay. That doesn't seem right. Let's try that again. Help me out there, Laura. So while she's figuring that out, it is, they do it monthly. You put in, in the application, how [00:22:00] much you earned in each of the months? Yeah. 1630. You got it. Okay. I gave you a funny face. [00:22:04] That's why you doubted it. You did. I was doing the math in my head. Well, one 12th of it anyway, so the bottom line is it's monthly. And then once you hit full retirement age, these limitations around earnings go away. And sometimes I, I know you kind of mean, you mentioned that already, but let. I get that question all the time. [00:22:24] They're like, I, I can't earn and file at the same time. I'm 68 years old. It's like, no, no, no, no, no, no. You can file and work as much as you want after full retirement. And you'll be totally fine. The other weird part about this, they call this a penalty. It is a penalty, but it's kind of not. So I'm gonna try not to get too far in the weeds here, but help people understand if they are subject to this all is not lost and they need to not feel bad because here's what happens. [00:22:51] Let's say that someone filed for Social Security at 62 years old and made $200,000 a year. So every dollar that [00:23:00] they filed for was taken back because of being over the limits by, by a wide margin. Then the way that the Social Security administration does that is they take the penalty that you were exposed to before full retirement. [00:23:14] And they recalculate your benefit of full retirement and give it back to you prorated over the rest of your life. I've never actually seen anybody do this, but it's my understanding that. It should work out to be the same as if they waited until retirement to file. Anyway, if they had every dollar penalized back, in fact, I've even seen some articles that talk about ways of maximizing your Social Security. [00:23:35] And some people say one of those ways is if you already have filed, go try to earn as much as you can to penalize your benefit, to have it go back and re-give to you at full retirement age in higher benefit. So. Anyway, just be aware, they use that word penalty. It's not the end of the world. You get it back over your lifetime, but it's best to avoid it if you can. [00:23:57] And especially because it doesn't feel great. [00:24:00] But anyway, that's Laura you, you covered it really well in that year that you turn full retirement age. You have more flexibility. Yeah. And if you have filed and you're continuing to work, they're still using those working years towards that calculation. So if you have filed and you are in your top 35 years, that might adjust your benefit and they. [00:24:18] Adjust that benefit for you, even if you're taking it. All right. Let's do a quick recap here. FICA taxes. This is the money they're taking out of your paycheck to cover Social Security and Medicare in the future for you. It's going to your parents' Social Security and Medicare today. right. But somebody else's FICA taxes will pay for your Social Security and Medicare in the future. [00:24:37] Children's hopefully right grandchildren. Yep. Primary insurance amount calculation is done by 35 years. Your top 35 years of earnings. All of those are inflation adjusted. You need 40 quarters or 10 years to qualify. They take those top 35 years. They average them out and then they apply those bend points. [00:24:56] The first one they give you almost all of your money back. They give 90, [00:25:00] 90% of it back then, after that, they give you 32% of your benefit back and then 15, and then. So that's how those bend points work. And then if you are, self-employed, it's, it's important that you understand about where you fall in those bend points so that you can decide if it makes sense to pay yourself a little bit more and get a lot of bang for your buck in Social Security FICA taxes or pay yourself less, cause you're not getting much benefit at all for the last dollars. [00:25:29] Social Security tax. We talked about the full retirement age for most people listening. It's probably 67 for some people listening. It's gonna be 66 and some, some sort of months, 2, 4, 6, 8, or 10. And I think most people, I mean, if you're, if you're already on Social Security, it probably was 66 because that's, we're starting to see that wave of people kind of already beyond benefits and have that go behind us and then talked about penalties for Social Security. [00:25:56] If you are working again, not necessarily a penalty. [00:26:00] What else? Laura, anything else you can think of? I think that's everything we covered next time. We'll be talking about spousal strategies. So you touched on this deck. If you have two people that are eligible for a benefit, there are a lot of strategies as to when each person should file. [00:26:14] We have Mike joining us for the next episode. He's the founder of Capita. He's awesome. With Social Security. So we'll have him on and go through the different spousal strategies. But I think that's everything for today. Let's do it real quick. So after spousal divorced and death benefits, five is the one on penalties, WEP, GPO that we've mentioned today. [00:26:32] And then six is when should you file? So that's gonna be bringing it all together and really saying, okay, based on all of these different concepts and strategies, how do you actually make a decision on this? Thanks for joining us. We love to have you along and stick with us. If Social Security is not your thing, cause you're really young. [00:26:49] Either skip ahead or understand it anyway, because I think it will help you make some decisions around income. Thanks for joining. Thanks. This podcast is intended [00:27:00] for informational purposes only and is not a substitute for personal advice from Capita. This is not a recommendation offer or solicitation to buy or sell any security. [00:27:14] Past performance is not indicative or. For future results. There can be no assurance that investment objectives will be achieved. 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