### Let’s meet John

For this article, I want to introduce you to John. First though, let’s take the time machine back to 2010. When we get there, we notice he does not have a high paying job, but John has lived frugally and saved obsessively throughout his working career and he wants to retire early. Not just early by Social Security rules, but really early. Well, not before any gray hair early, but early enough that he is getting advice from all corners that he should work longer. He has worked for 39 years, 1971 through 2009 and has saved his money and he believes he has enough to retire now (in 2010) at the age of 54.

### Calculate estimate of social security income

Before he retires though, he wants to get an estimate of what his Social Security benefit, SSI, will be when he claims it at age 62. He gets the same letter with that estimate from the Social Security Administration, SSA, that we all do. There is a problem with that number though in that it assumes he keeps working until at 62 at his current wages. John wonders what the affect of not working on those last 7-8 years will have on his SSI. He begins his research. He comes across the SSA website and finds this file that tells him how SSA calculates his benefit.

Source: www.socialsecurity.gov - EN-05-10070-1948.pdf

This is not exactly what John is looking for but he plugs in his earnings anyway and makes the calculations. For each year, he multiplies his earnings by the index factor to get the index earnings for the year. Adding the highest 35 years of index earnings gives the lifetime indexed earnings. In Johns case, the lifetime earnings are $2,335,829. I will save you from looking at the table of years. Here is the summary table and calculation of benefits.

Source: Author spreadsheet following SSA instructions.

The next step is to divide the lifetime indexed earnings by the number of months in 35 years or 420. The result is the Average Indexed Monthly Earnings (OTC:AIME) of $5,561. Next, multiply the first $761 by 90% (shown in the table as tier 1), then multiply the amount between $761 and $4,586 by 32% (shown in the table as tier 2), finally multiply the amount over $4,586 by 15%. Add the three tiers for the total benefit at full retirement of $2,055. Multiply the full retirement benefit by 75% to get the benefit of $1,541 at age 62. The instructions for these calculations are above the table in the above figure from the social security website. The “magic” cut off amounts of $761 and $4,586 are called bend points by the SSA.

John looks at this number and thinks it is not really the information he is wants. But doesn’t have any other way to estimate his future SSI and he thinks that amount would be enough when combined with his savings. He takes his chances and retires in 2010 at the age of 54.

### Calculate actual social security income

Now we can get back into the time machine and come back to 2018 and John is getting ready to file for SSI. But he wants to estimate his benefit before he does so he goes back to the internet and finds this file at the SSA website.

Source: Social Security website: https://www.ssa.gov/pubs/EN-05-10070.pdf

John takes his earnings history and makes the same calculation of indexed earnings using the same years, 1971 – 2009. Now the resulting lifetime indexed earnings are $2,701,521.

Source: Author spreadsheet.

Following the instructions at the top of the figure, John calculates his full retirement benefit is $2,401 and at age 62 it is $1,761. Both of these are more than the amount John estimated in 2010. The full retirement benefit is 16.8% higher and the age 62 benefit is 14.3% higher. The reason for the difference is that the early retirement “penalty” is 26.67% in 2018 and only 25% in 2010. John does some more research and finds the reason those factors are different is because the early retirement penalty is 5/9 of 1% per month for the first 36 months and 5/12 of 1% for each additional month. You can find the details here (https://www.ssa.gov/OACT/quickcalc/earlyretire.html). Because 2010 and 2018 had different full retirement ages, the penalties were different.

### Can we reconcile the difference

John is happy to see the amount is more than he estimated back in 2010. The reason it is higher is because the SSA makes a Cost of Living Adjustment (COLA) each year based on the Consumer Price Index (CPI). The COLA’s for the time between the two calculations are below.

Source: Cropped image of page on the SSA website.

The compounded result of the years 2011-2018 is 14.5% which just about matches the increase of the age 62 benefit. However, the full retirement benefit increases more than the COLA increases. This does not really explain all the difference.

In addition to the COLA adjustment, the SSA changes the index factors and the bend points in proportion to the annual average increase in the national wage level. After John retired, his full retirement benefits kept going up at the pace of the national average wage.

I looked up the table on the social security website to see if this matched up to the increase that John saw. Alas, it did not. I’m not posting the table but you can find it here if you are interested. (Average Wage Index (NYSE:AWI)). There is another table here (Automatic Determinations in Recent Years) that shows the increased average wage index. There is not an explanation of how these are calculated and I cannot make the math make sense. I can find nowhere on the website that explains the calculation of the bend points. However, SSA does adjust the amount by some unpublished, I think, formula that considers the rising cost of living and the rising national average wage.

### Summary

For those that retire before the age of 62, you can get an estimate of your future SSI by using the most current table and assuming some reasonable rate of increase, say 2% per year or so. To be conservative, just assume it will be the same as the most recent table. Be sure to consider the normal retirement age for your birth year and apply the appropriate early retirement penalty instead of blindly use the one from the year you are using to estimate.

You can find the benefit calculation pdf files for years other than 2010 and 2018 by typing the following into your favorite search engine.

EN-05-10070-xxxx

Where xxxx is the year you want to calculate benefits for minus 62. For example, for a 2004 retirement, use 1942.

In this article I introduced John and described his journey from estimating his social security benefit in 2010, 8 years before filing to his actual benefit when he filed in 2018. This method can be used by anyone curious to estimate what his/her future SSI might be. It is not a perfect calculation but it will show the range one can expect when checks start to arrive.

GrayBeard Retirement writes about retiree appropriate investments, asset allocation and other financial aspects of retirees, especially those that retire early. Please give me a follow and take a look at my article here on one strategy to withdraw from your 401-K penalty free as soon as age 54.

**Disclosure:** I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.