# Appendix D: Computing a Retired-Worker Benefit

## Overview

This section provides instructions and a worksheet for computing a retired-worker benefit. The worksheet can be used for persons born in 1930 through 1943—that is, those who attained the age of 62 in 2005 or earlier and were under the age of 75 at the end of 2005. The worksheet assumes that the worker had no prior period of entitlement to disability benefits and also did not work after becoming entitled to retired-worker benefits.

The worksheet describes the various steps used in computing a benefit. The steps are based on the following Social Security program goals.

• To provide a benefit based on lifetime earnings. Benefits are related to earnings over a period of time that the worker could be expected to have worked in covered employment—from age 22 through age 61. The years of earnings considered are termed computation years. The worker's 5 lowest earnings years, including years of no earnings at all, are not considered in the computation. They are termed the drop-out years.
• To index lifetime earnings. Earnings used in the computation are not the actual covered earnings but an amount for each year that reflects earnings increases in average wage levels after the year the earnings were paid. This procedure is termed wage indexing. Currently, earnings are generally indexed to wage levels in the year the worker turns age 60. For example, for a person attaining age the of 62 in 2005, actual earnings in 1984 of \$20,000 are indexed to \$42,224.73, on the basis of 2003 wage levels. Earnings after age 60 are included at their actual (nominal) value.
• To replace a portion of the indexed earnings. Indexed earnings are averaged over the number of computation years to calculate the average indexed monthly earnings (AIME). A benefit formula is applied to the AIME to produce the primary insurance amount (PIA), the amount payable to a worker who retires at the full retirement age (FRA). The benefit formula is weighted to provide a higher replacement of earnings for lower-wage workers. The formula for persons aged 62 in 2005 is 90 percent of the first \$627 of AIME; plus 32 percent of the next \$3,152; plus 15 percent of the AIME over \$3,779.
• To permit early retirement. Persons can retire as early as age 62, but the monthly benefit is reduced. The reduction is 5/9 of 1 percent for each of the first 36 months of entitlement immediately preceding the age at which 100 percent of PIA is payable (66 in 2005 but scheduled to increase to age 67 by 2022), plus 5/12 of 1 percent for each of up to 24 earlier months. For a person aged 62 in 2005, the maximum reduction is 25 percent if the individual is entitled to benefits for all 48 months between 62 and 66.
• To provide for price indexing after the age of 62. Benefits are adjusted annually in December to reflect increases in the consumer price index (CPI-W). The benefit increase in 2004 was 2.7 percent. These cost-of-living adjustments are applied to the benefit for each year after the person attained the age of 62—even if the person was not actually receiving benefits.
• To give credit for earnings after age 61. Earnings after the age of 61 (which are not indexed) can be substituted for earnings in earlier years if they result in a higher benefit. In addition, persons who do not receive benefits between the FRA and age 69 may receive increased benefits as a result of the delayed retirement credit (DRC) provision. The benefit is increased by a specified percentage for each month a benefit was not received. (See Table 2.A20 for percentage increases.)

## Clarifying the Worksheet Procedure

### Step 1 - Determining the Number of Computation Years

For persons who attain age 62 before 1991, the number of years used in the benefit computation equals the number of years after 1950 up to the year of attainment of age 62, minus 5 years. For workers who attain age 62 in 1991 or later, the number of computation years is 35.

### Step 2 - Wage Indexing of Earnings

The following description and examples are provided for persons who wish to compute the index factors and indexed earnings. The indexing year is the second year before attainment of the age of 62. However, beneficiaries born on January 1 are deemed to have attained age 62 in the prior year, and consequently, the applicable indexing year, factors, and bend points are those for that year.

The average wage for the indexing year is divided by the average wage in each prior year to obtain the factor for each prior year. For example, a person attains age 62 in 2005. The indexing year is 2003. The average annual wage for 2003 was \$34,064.95. The average annual wage for 1990 was \$21,027.98. The amount, \$34,064.95 divided by \$21,027.98, yields a factor of 1.619982.

The worker's actual earnings covered under Social Security in that year, up to the maximum earnings creditable, are multiplied by the indexing factor to obtain the indexed earnings. For example, actual covered earnings of \$10,000 in 1990, multiplied by 1.619982, result in indexed earnings of \$16,199.82; actual earnings of \$51,300 (the maximum creditable) result in indexed earnings of \$83,105.07.

### Step 3 - Computing the Average Indexed Monthly Earnings (AIME)

After the earnings in each year have been indexed, they are used in computing average indexed monthly earnings. The years of highest indexed earnings corresponding to the number of computation years are selected and totaled. This total is then divided by the number of months in the computation years. The result, rounded to the nearest lower dollar, is the average indexed monthly earnings.

For example, for a person attaining age 62 in 2005, the highest 35 years of indexed earnings are used. If the sum of these earnings equals \$400,000, the AIME is \$952 (\$400,000 divided by 420 = \$952.38, rounded to \$952).

### Step 4 - Computing the Primary Insurance Amount (PIA)

The PIA, the amount from which all Social Security benefits payable on a worker's earnings record are based, is computed by applying a formula to the AIME. The formula consists of brackets in which three percentages are applied to amounts of AIME. The dollar amounts defining the brackets are called bend points, and the bend points are different for each calendar year of attainment of age 62. The PIA is rounded to the nearest lower 10 cents.

For retired workers who attained age 62 in 2005, the bend points are \$627 and \$3,779. Thus the formula is 90 percent of the first \$627 of AIME; plus 32 percent of the next \$3,152 of AIME; plus 15 percent of AIME above \$3,779. The following are examples of PIA computations for such workers with different AIME amounts.

Example 1 - AIME of \$300
PIA is \$270
Based on: 90 percent of \$300

Example 2 - AIME of \$952
PIA is \$668.30
Based on: 90 percent of \$627 (\$564.30); plus
32 percent of \$325 (\$104.00)

Example 3 - AIME of \$4,000
PIA is \$1,606.09 rounded to \$1,606
Based on: 90 percent of \$627 (\$564.30); plus
32 percent of \$3,152 (\$1,008.64); plus
15 percent of \$221 (\$33.15)

The above calculations are applicable to workers who attain the age of 62 in 2005. For workers who attained age 62 in prior years, the bend points will be different, and the PIA must be increased to reflect cost-of-living adjustments between the year of attainment of age 62 and the year 2005. Worksheet 2 shows cost-of-living increase factors for 1979 through 2004. After the PIA is calculated for the year of attainment of age 62, cost-of-living increases are applied for each year through 2004. The result is the current 2005 PIA.

For example, a worker who attained age 62 in 2002 would receive cost-of-living adjustments for the years 2002–2004. The adjustments are cumulative, with each step rounded to the next lower dime. If the PIA at age 62 was \$500, the cost-of-living adjustments would be:

2002: \$500 multiplied by 1.014 = \$507
2003: \$507 multiplied by 1.021 = \$517.60
2004: \$517.60 multiplied by 1.027 = \$531.50
\$531.50 would be the PIA effective December 2004.

### Step 5 - Computation of the Monthly Benefit

The full PIA is payable to a worker who retires at the full retirement age (FRA). Beginning in the year 2000, the FRA, scheduled to be gradually raised to age 67 for workers attaining age 62 in 2022, began to be phased in. Workers can still retire as early as age 62, but the monthly benefit is reduced by 5/9 of 1 percent for each of the first 36 months of entitlement immediately preceding the full retirement age plus 5/12 of 1 percent for each of up to 24 earlier months. Workers attaining the age of 62 in 2005 have their benefits computed based on the full retirement age of 66. See Table 2.A17.1 to determine the FRA based on the year of birth as well as the reduction factors. For individuals electing benefits at exactly age 62 in the year 2005, the maximum reduction is 25 percent.

For example, in 2005 a worker with a PIA of \$500 would receive \$375 at the age of 62. The PIA is reduced by \$124.99, reflecting a reduction rate of 5/9 of 1 percent for each of 36 months and a rate of 5/12 of 1 percent for each of 12 months for a total reduction of 25 percent. After reduction of the PIA by \$124.99, the benefit amount is rounded down to the nearest lower dollar.

Worksheet 1: Indexing of earnings
Year Your
earnings
Maximum
taxable
earnings
(dollars)
Lower of
columns
2 or 3
Indexing
factor
Column 4
times
column 5
Highest
indexed
earnings
1 2 3 4 5 6 7
1951   3,600
1952   3,600
1953   3,600
1954   3,600
1955   4,200
1956   4,200
1957   4,200
1958   4,200
1959   4,800
1960   4,800
1961   4,800
1962   4,800
1963   4,800
1964   4,800
1965   4,800
1966   6,600
1967   6,600
1968   7,800
1969   7,800
1970   7,800
1971   7,800
1972   9,000
1973   10,800
1974   13,200
1975   14,100
1976   15,300
1977   16,500
1978   17,700
1979   22,900
1980   25,900
1981   29,700
1982   32,400
1983   35,700
1984   37,800
1985   39,600
1986   42,000
1987   43,800
1988   45,000
1989   48,000
1990   51,300
1991   53,400
1992   55,500
1993   57,600
1994   60,600
1995   61,200
1996   62,700
1997   65,400
1998   68,400
1999   72,600
2000   76,200
2001   80,400
2002   84,900
2003   87,000
2004   87,900
Worksheet 2: Computing the primary insurance amount (PIA) for workers retiring after age 62
Year 1st bend point
(dollars)
2nd bend point
(dollars)
Cost-of-living
increase
(percent)
Cost-of-living
factor
Years
aged 62
or older
PIA
(dollars)
1 2 3 4 5 6
Age 62 PIA:
1979 180 1,085 9.9 1.099
1980 194 1,171 14.3 1.143
1981 211 1,274 11.2 1.112
1982 230 1,388 7.4 1.074
1983 254 1,528 3.5 1.035
1984 267 1,612 3.5 1.035
1985 280 1,691 3.1 1.031
1986 297 1,790 1.3 1.013
1987 310 1,866 4.2 1.042
1988 319 1,922 4.0 1.040
1989 339 2,044 4.7 1.047
1990 356 2,145 5.4 1.054
1991 370 2,230 3.7 1.037
1992 387 2,333 3.0 1.030
1993 401 2,420 2.6 1.026
1994 422 2,545 2.8 1.028
1995 426 2,567 2.6 1.026
1996 437 2,635 2.9 1.029
1997 455 2,741 2.1 1.021
1998 477 2,875 1.3 1.013
1999 505 3,043 2.5 s 1.025
2000 531 3,202 3.5 1.035
2001 561 3,381 2.6 1.026
2002 592 3,567 1.4 1.014
2003 606 3,653 2.1 1.021
2004 612 3,689 2.7 1.027
2005 627 3,779 . . . . . .
NOTE: . . . = not applicable.
a. The December 1999 cost-of-living adjustment (COLA) was originally determined to be 2.4 percent, based on the consumer price index (CPI). The underlying CPI was later recomputed by the Bureau of Labor Statistics; a 2.5 percent COLA would have been consistent with the recomputed CPI. Pursuant to Public Law 106-554, benefits were calculated and paid in August 2001 and later as if the December 1999 COLA had been 2.5 percent. Affected beneficiaries received a one-time payment to cover the shortfall that occurred before August 2001.

CONTACT: Dena Berglund (410) 965-0162.