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Boomers beware: Are online Social Security benefit calculators safe?

Retirement PlanNot understanding what you’re inputting to an online Social Security benefit calculator could result in a wildly inaccurate benefit estimate. Photo courtesy of Kick Images via Getty Images. _Larry Kotlikoff’s Social Security original 34 “secrets”, his additional secrets, his Social Security “mistakes” and his Social Security gotchas have prompted so many of you to write in that we now feature “Ask Larry” every Monday. We are determined to continue it until the queries stop or we run through the particular problems of all 78 million Baby Boomers, whichever comes first. Kotlikoff’s state-of-the-art retirement software is available here, for free, in its “basic” version

As I’ve now done a couple of times, I’m posing a question to myself. This week’s question is whether it’s safe to use any old online Social Security benefit calculator.

You might think that online calculators, including the ones that are free, will give you a straight answer. Think again. Some will, but many, if not most, won’t. There are two ways online calculators can go badly wrong. They can take in the wrong inputs, and they can make the wrong calculations with those inputs.

Take AARP’s Social Security calculator, for example. The tool gives you two ways to enter your Primary Insurance Amount (PIA), which is the building block for calculating all the benefits you and yours can get on your earnings record.

The first way is to enter your average earnings. But what’s the meaning of “average earnings”? The instructions say, “If your earnings have gone up and down over the years, enter an average salary, even if it’s different than your current salary.” Okay, but is this an average salary measured in today’s dollars or is it an average of the actual dollars you earned each year in the past?

The website doesn’t say. But it can make a huge difference to the calculated PIA. And even if you knew whether to enter your past average earnings in actual dollars or today’s dollars, that doesn’t suffice to determine your PIA. Indeed, if you didn’t work for 40 quarters in covered employment, your PIA will be zero because you won’t be eligible for any benefits, period. If you do have 40 quarters under your belt and if you enter your average past covered earnings correctly, your PIA may still be miles off. The reason is that the accurate calculation of your PIA requires precise knowledge not of your average past covered earnings, but of each year’s separate level of earnings. In other words, when you made what matters.

The reason is that Social Security takes each year’s past covered earnings up through age 60 and then blows them up using its Average Wage Index. It then puts each of these blown up values into a pot, adds to the pot each year’s covered earnings after age 60, and then takes from the pot the 35 largest values. Then it averages these amounts, divides by 12 and, voila, it’s made your own personal Average Indexed Monthly Earnings (AIME). But that’s still not your PIA. Getting your PIA requires running the AIME through a progressive formula with three brackets that ensure that those with lower AIMEs end up with a better deal than those with higher AIMEs. A better deal here means that the ratio of your ultimate PIA to your AIME is larger.

Great chefs don’t take the average amount of different spices called for in each recipe and use that amount for each spice. If they did, they’d be fired. But this is the care with which AARP is “helping” you make what could well be your most important decision regarding your retirement finances.

Moreover, the AIME calculation only uses past covered earnings, not your total earnings. But the AARP calculator doesn’t tell you to enter your average past covered earnings. It just tells you to enter your average earnings, which users will likely take to mean their total, not their covered earnings.

To understand how bad just this mistake can be with respect to getting a benefit estimate from AARP, we ran a single person — call him Dan — twice through software that incorporates precise earnings histories. In each case, the person’s average nominal earnings are $50,000. But in one case, Dan earns exactly $50,000 each year for 40 years. In the other case, Dan earns $100,000 each year for 20 years and zero otherwise. Although Dan’s average earnings are the same, his benefits in the first case are one-third larger than in the second case!

But, hold on, I’m not done fuming.

How long will you continue to work? The AARP calculator must assume you’ll work through full retirement age, but it doesn’t say. And if you are only going to work for two more years and full retirement age is eight years away, well, bingo, that’s yet another potentially decent-sized mistake entering into your PIA calculation. This is particularly the case for workers who earn above the taxable maximum after age 60. For such workers, their AIME is guaranteed to go up for each year they work after age 60 because each extra year’s worth of covered earnings thrown into the pot will always be larger than the other ones in the pot.

Furthermore, without exactly correct data on your past covered earnings, it’s impossible for an online calculator to properly implement Social Security’s Recomputation of Benefits, which can lead to larger benefits if you work into your 60s or beyond. It’s also impossible to properly calculate Social Security Windfall Elimination Provision, which applies to workers who spent some time in Social Security non-covered employment.

Understanding these problems with AARP’s first way to use its calculator might lead you to say, “forgetaboutit,” and proceed to AARP’s second way. But the second way to use the calculator assumes you won’t work at all in the future. It also takes you to one of Social Security’s online calculators, which will provide a PIA estimate that is guaranteed to come back with the wrong estimate of your PIA. The reason is that, as just indicated, it assumes the economy will experience zero growth in average wages and also zero inflation from now until the end of time. That’s unreasonable given that we’ve had both real wage growth and inflation in all but one year in the last half century.

Now, why would Social Security make these assumptions and, thereby, purposely understate your PIA, with a greater understatement the younger you are? The answer is to prompt workers to save more on their own for their retirements. Specifically, the Social Security Administration doesn’t want workers to compare their future benefit with their current earnings and think they will have a high replacement rate in retirement, ignoring, in their thought process, the fact that if the economy’s average wages continue to rise, their earnings will likely also rise, leaving them with a higher level of earnings before retirement and a lower replacement rate, when the denominator of the replacement rate is not their current earnings but their pre-retirement earnings.

Since the AARP calculator is taking in, in this case, a Social Security-produced bogus PIA estimate, the question is whether the underlying code is fixing the problem with the PIA so entered. From running the program, it’s clearly not because the annual benefit it shows at full retirement age should be larger than 12 times what you enter. It’s actually less. For married spouses, where one partner’s optimal strategy depends on what the other does and vice versa, starting off with PIAs that are too differentially biased can easily undermine the calculation of what’s best for the couple to jointly do.

Now you might say, “Well, let me mosey on over to the local Social Security office and ask them for my PIA, but make sure they adjust for future economy-wide real wag growth and inflation.”

This is a step in the right direction, but beware. If you ask for your retirement benefit, the good folks at Social Security may quote your benefit in dollars of the year you will reach full retirement. That could screw up the AARP calculator very nicely. Or they may quote you not your full retirement benefit, but your reduced retirement benefit if you start talking to them about taking benefits early. This too will screw up the AARP calculator since it’s looking for the full retirement benefit. Then there’s the issue of your Medicare Part B premiums and automatic federal income tax withholdings. You may be given a “benefit amount” that’s net of one or both of these things. Finally, if you are eligible for an excess spousal or an excess survivor benefit, it’s just possible you’ll be quoted a benefit amount that’s inclusive of these auxiliary benefits, which will also wreak havoc on your use of AARP’s calculator.

Jason Zafrin — New Haven, Conn.: My wife and I were together for 15 years before she lost her battle with cancer. We were never married legally but have five children together. I was told that since we were never married legally, I am not entitled to any benefits. Is there anything I can do? We lived in New York the first eight years together then moved to Florida in 2000 until she got sick in 2008 and moved back.

Larry Kotlikoff: I very sorry for your loss and for having to tell you that there is nothing you can do to receive survivor benefits on your wife’s earnings record because you weren’t legally married. If any of the children are under age 18 (or 19 if still in high school) or if any became disabled prior to age 22, those children would be able to collect survivor benefits based on your deceased wife’s earnings record.

Eva Adams — Miramar, Fla.: If a resident alien moves back to her own country, can she get Social Security checks deposited in her native country? I heard that the Social Security Administration withholds 25 percent in that case. I have not worked for many years and don’t plan to start now. I am 78 years old. How can I convince them of that and avoid the withholding?

Larry Kotlikoff:I asked Jerry Lutz, a former Social Security technical expert, to weigh in on your question. He wrote the following: “Payments outside the U.S., as well as the Alien Tax Withholding, depend on the country of residence and the various totalization agreements the U.S. has with other countries. SSA has a good pamphlet on this topic.”

And, Eva, I don’t know why our country calls people born in other countries “aliens.” I always thought aliens were from outer space. But if you’re an alien, I’m one too. Well, a third generational alien, anyway. Paul, from personal knowledge, is definitely from another planet.

Rebecca Slade — Gosport, Ind.: I have been married two years. My husband receives Social Security disability. I am 54 and still working full time. Am I eligible for spousal benefits? Also I have a minor son whose father is deceased, and he receives benefits from that account. Is he still eligible for benefits from his stepfather?

Larry Kotlikoff: You need to be 62 to receive spousal benefits. It would actually be excess spousal benefits if you take your spousal benefit before full retirement age. To get full spousal benefits starting at full retirement age, read my column about Social Security benefits for the disabled.

Former Social Security technical expert Jerry Lutz (Amen for Jerry!) informs me:

There are potential benefits for stepchildren who are not adopted. However, they need to prove that they have been receiving at least one half of their support from the stepparent in order to be eligible. That’s a really involved calculation because you must consider multiple possible periods of support. Here’s an example of the math involved: Step-father’s annual income = $50,000
Mother’s income = $19,000
Child’s SS income = $6,000 (i.e. $500 per month)
In this example, the total family income is $75,000, or $25,000 per person. The stepfather would be assumed to be providing $19,000 to the child’s support, which is more than half of the total. So the child would meet the dependency requirement and qualify as a stepchild. If the child is under age 16 or disabled, the mother could potentially be eligible under the child-in-care provision. However, she would be subject to the annual earnings test. The child would only receive benefits from the stepfather’s account if they were higher than the benefits he receives from his deceased father’s account.

MB — Fairfield, Ill.: My husband is 71 and I am 60. My husband retired from teaching school in 2000 and began receiving a pension, which now amounts to about $25,000 a year. He also worked in schools for which Social Security taxes were collected on his income, and he receives a reduced Social Security benefit of about $500 a month. He did not apply for Social Security until he reached age 70 (he continued to work as an adjunct teacher paid on a per class basis and was not paid more than his pension in any year of his retirement.)

We were never advised of the “file and suspend rule.” My husband’s pension is set up so that I will receive it after he dies. I have 40 quarters of qualifying income for Social Security, though my earnings were never high. I do not have 30 years of “substantive earnings” (re Government Pension Offset and/or Windfall Elimination Provision).

I received an annual statement from Social Security stating that if I retired at age 62, I would collect $725 a month. If I waited until age 70, the amount would be $957 a month. Can I retire on my own benefit, either at age 66 or 70? Is my personal benefit affected by the GPO or WEP? Does it matter at what age I retire? Or will I not receive any Social Security at all?

Larry Kotlikoff: I’m going to assume you did not work in uncovered employment — in other words, that you worked in jobs for which Social Security taxes were deducted. So you won’t get hit by the Government Pension Offset (GPO) with respect to your receiving either spousal or survivor benefits on your husband’s work record. Also, the Windfall Elimination Provision (WEP) does not apply to the calculation of your own retirement benefit or to the spousal and survivor benefits your husband might be able to collect on your earnings record. This may all sound like good news, but it may mean little or nothing in terms of actual dollars.

First, you still get hurt with respect to your spousal benefits because they are based on your husband’s Primary Insurance Amount (his Social Security full retirement benefit), which is reduced due to the WEP.

Fortunately, your survivor benefits are based not on the WEP-reduced PIA, but on the standard PIA.

Second, if you take your spousal benefit before full retirement age, it will be calculated as your excess spousal benefit and may be very small or close to zero. Third, in applying for early spousal benefits, you’ll be forced to apply for early retirement benefits. Hence, you’ll get stuck with the $725 per month — if, indeed, this is your age-62 reduced retirement benefit — as your permanent retirement benefit. A better option may be for you to wait until full retirement age (66), apply just for your full spousal benefit, which will be half of your husband’s full retirement benefit, and then, at 70, apply for your own retirement benefit.

Finally, I want to point out that your husband will be subject to the GPO with respect to receiving spousal or survivor benefits based on your earnings record.

This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions

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