Once in a while, a real-life question arises in our office that is simply too complex for an immediate answer. That happened a couple weeks ago, when the question arose, “What earnings are considered for determining Social Security benefits?” Like most Social Security issues, the answer is complicated, reflecting the complexity of the entire Social Security system.
There are two central issues regarding Social Security benefits; (a) What You Will Receive, and (b) What You Will Keep.” Explaining these concepts requires an understanding of a few basic concepts:
- Earned Income is money you received as direct compensation for current work, plus compensation for some of your past efforts that are classified as work
- Social Security Earnings are computed from Earned Income per individual
- Lifetime Social Security Earnings means the aggregate Social Security Earnings of an individual’s lifetime
- Filing Date refers to the day you choose to start receiving Social Security benefits.
- Full Retirement Age (FRA)is the first day when you are allowed by law to file for unreduced Social Security monthly benefits.
What You Will Receive (in monthly benefits) is a function of both your personal Lifetime Social Security Earnings and your Filing Date relative to FRA. (For this discussion, we are ignoring the possibility that at some point you might claim spousal benefits.) Pensions, retirement annuities, etc. do not count, as those are considered fringe benefits, similar to insurance payments.
Items classified as Earned Income are primarily reported on Line 1 of your 1040, plus Schedule C if applicable. The highest 35 Earned Income years of a person’s working life are aggregated for the Lifetime Social Security Earnings.
FRA is a moving target, depending on your year and month of birth. Initially, FRA was 65 for everyone, but in the 1980s the Social Security System was amended to delay its own future bankruptcy. One of the primary changes was to increase FRA for people who would not be claiming for many years. We received sufficient notice of the changes. (A similar revision is likely in the next few years to again delay bankruptcy of the Social Security System.)
“What You Will Receive” is a function of individual earnings: “What You Will Keep”is an entirely different topic, and will be the subject of next week’s Blog.
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