The Benefit Structure

1
The Benefit Structure

• Old-Age, Survivors, and Disability (OASDI)
  Benefits
• Eligibility
• Types of OASDI Benefits
• Retirement Benefits
• Survivor Benefits
• Disability Benefits
• OASDI Benefit Computation
• Cost-of-Living Adjustment
• Average Indexed Monthly
  Earnings
• Primary Insurance Amount

2
Eligibility for OASDI Benefits

• Amount of benefits depends on
• Wages earned
• Amount of time working
• Unit of measurement
• earn a quarter of coverage for each 890 in
  annual earnings (in 2003) up to 4 per year

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Eligibility for OASDI Benefits

• Quarters of coverage Basic unit of measurement
  for determining insured status. The amount of
  earnings required for a quarter of coverage is
  subject to annual automatic increases in
  proportion to increases in average wages.
• Earings required for a quarter of coverage for
  years after 1978 http//www.ssa.gov/OACT/TR/TR03/
  V_programatic.htmlwp137200

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Eligibility for OASDI Benefits

• Quarters of coverage Category of Coverage
• 40 quarters
• or 1 per year from fully insured
• age 21 to 62
• 6 quarters currently insured
• 20 quarters during last 10 years
• 40 quarters ending with disability insured
• onset of disability

5
Types of OASDI Benefits

• Retirement
• similar to defined benefit retirement plan
• Survivor
• life insurance
• Disability
• disability insurance

6
Fully Insured

• To be fully insured, you need at least one credit
  for each calendar year after you turned 21 and
  the earliest of the following
• the year before you attain age 62,
• the year before you die, or
• the year you become disabled.

7
Permanently insured

• You are permanently insured if you are fully
  insured and you will not lose your fully-insured
  status when you stop working under covered
  employment.

8
OASDI Benefit Computation

• Benefits are based on Primary Insurance Amount
  (PIA)
• The monthly benefit amount paid to workers who
  initially accept OAI benefits at the normal
  retirement age or who receive disability benefits
  at any age.
• The base figure from which monthly benefit
  amounts are paid to the workers family members
  or survivors.

9
OASDI Benefit Computation

• Determination of an individuals PIA
• Index past earnings to growth in average wage
  rates so all earnings are comparable
• Determine AIME (Average Indexed Monthly
  Earnings), an approximation of workers average
  real earnings over their work lives
• Calculate PIA (Primary Insurance Amount)

10
OASDI Benefit Computation

• Index past earnings to growth in average
  earnings
• Relative to the second year before first
  eligibility for retirement, disability or death
  benefits
• Index factor equals 1 after second year
  beforeeligibility year
• Example a worker died in 2000
• earned 10,000 in 1973
• average labor earnings was 28,861.44 in 1998
• average labor earnings was 7,580.16 in 1973
• His 1973 earnings would be adjusted for
  average earnings growth between 1973 and 1998
• 10,000 x 28,861.44/7580.1638,075 for 1973

11
OASDI Benefit Computation

• For retirement benefit, a factor will always
  equal one for the year in which the person
  attains age 60 and all later years.
• The indexing factor for a prior year Y is the
  result of dividing the average wage index for the
  year in which the person attains age 60 by the
  average wage index for year Y.

12
OASDI Benefit Computation

• Determine average indexed monthly earnings (AIME)
• take highest 35 years of indexed earnings
• divide by number of months

13
OASDI Benefit Computation

• Computing the PIA
• Use PIA formula in the year of first eligibility
• PIA in 2003 90 of first 606 in AIME
• 32 of AIME between 606 and 3,653
• 15 of AIME over 3,653
• 606 and 3,653 are called bend points

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Determination of an individuals PIARetirement
Benefit

• 1. Index past earnings to growth in average wage
  rates
• Indexing factor Average wage index in the year
  of age 60
• for year Y Average wage
  index in year Y
• Index factor equals 1 after the year of age 60
• Indexed earnings nominal earnings x
  Indexing factor
• of year Y of year Y
  for year Y
• 2. Determine average indexed monthly earnings
  (AIME)
• Add the highest 35 years of indexed earnings
• If you have fewer than 35 years, use zero for the
  remaining years
• Divide by number of months, i.e. 35x12420months

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Determination of an individuals PIARetirement
Benefit

• 3. Computing the Primary Insurance Amount (PIA)
• Use the PIA formula in the year you reach 62
• Bend points in 2003 606, 3,653
• PIA in 2003 90 of first 606 in AIME
• 32 of AIME between 606 and 3,653
• 15 of AIME over 3,653
• Three cases
• if AIME
• if 606(AIME-606)
• if AIME3,563 PIA90 x 606 32 x (3,653-606)
  15 x (AIME-3,653)
• For those who retire later than 62, PIA increases
  annually by cost-of-living adjustments (COLA)
  until the year you reach 65

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Example

• Worker A born in 1942, retires at age 62, 2004
• Worker B born in 1939, retires at age 65, 2004
• Both workers have covered earnings from 1964
  through 2003
• Worker A attains 60 in 2002
• Worker B attains 60 in 1999

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OASDI Benefit Computation

• For those who retire at age 62, your PIA is
  calculated from last slide.
• For those who retire later than 62, you
  calculated the PIA at age 62, then increase this
  value annually by cost-of-living adjustments
  (COLA) until the year you reach 65
• COLA is based on the rate of increase in the
  Consumer Price Index (CPI) for the previous year.
  
• Bend points are increased each year in proportion
  to increases in the average annual earnings
  level.
• http//www.ssa.gov/OACT/TR/TR03/wp137200

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Normal Retirement Age
19
Early retirement reduces benefits

• In the case of early retirement, a benefit is
  reduced 5/9 of one percent for each month before
  Normal Retirement Age, up to 36 months. If the
  number of months exceeds 36, then the benefit is
  further reduced 5/12 of one percent per month.
• M the month between retirement and NRA
• if M
• if M36Reduction5/9 x 1 x 36 5/12 x1 x (M-36)

20
Delayed retirement increases benefits

• Delayed retirement credit is generally given for
  retirement after the normal retirement age. To
  receive full credit, you must be insured at your
  normal retirement age. No credit is given after
  age 69. Delayed retirement credits increase a
  retiree's benefits.

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Delayed retirement credit
22
Relationship of PIA to AIME in 1998
23
Retirement Benefits

• Required
• Benefit Payable Cessation of Benefits Insured
  Status Amount of Benefit
• Retired worker Death Fully insured 100 of PIA
  at age 65
• aged 62 or older
• Spouse aged 62 Death (or divorce Fully
  insured 50 of workers PIA
• or older (or divorced if married less than
  at age 65 (or 100
• spouse if married 10 years) of working
  spouses
• at least 10 years) own PIA, if greater)
  
• Spouse under age Non-disabled Fully
  insured 50 of workers PIA
• 62 with dependent dependent child
• child under age 16 reaches age 16
• or disabled child
• Unmarried dependent Age 18 (19 if full-time
  Fully insured 50 of workers PIA
• children elementary or high
• school student
• no age limit if disabled

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Survivor Benefits

• Benefit Payable Cessation of Benefits Insured
  Status Amount of Benefit
• Spouse under age Age 60 or non-disabled Fully
  or 75 of workers PIA
• 60 with dependent child reaches age 16
  currently insured
• child under age 16 or
• disabled child
• Spouse aged 60 or Death Fully insured 100 of
  PIA at age 65
• Older (or divorced
• spouse if married
• at least 10 years)
• Disabled spouse Age 60 or cessation Fully
  insured 71.5 of workers PIA
• aged 50-59 of disability
• Unmarried de- Typically age 18 Fully or 75
  of workers PIA
• pendent children (see Table 20-1) currently
  insured
• Deceased worker Death remarriage subject Fully
  insured 82.5 of workers PIA
• dependent parents to certain limitations at
  age 62 (150 total

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Disability Benefits

• Benefit Payable Cessation of Benefits Insured
  Status Amount of Benefit
• Disabled worker Death, cessation of Disability
  insured 100 of workers PIA
• disability, or age 65
• (when retirement
• benefits begin)
• Dependents Limits generally similar Disability
  insured Similar to retirement
• (similar categories to retirement benefits
  benefits
• to retirement benefits)

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Social Security Online Calculator

• http//www.ssa.gov/planners/calculators.htm

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Other Features

• Retirement Earnings test
• Retirement benefits are reduced if wages exceed
  certain thresholds (--Retirement earnings test
  exempt amount) and you are under the Normal
  Retirement Age
• 1 in benefits is withheld for every 2 of
  earnings in excess of the lower exempt amount, 1
  in benefits is withheld for every 3 of earnings
  in excess of the higher exempt amount
• Earnings in or after the month of NRA attainment
  do not count toward the retirement test.

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Annual Retirement Earnings Test Exempt Amounts
29
Other feathers

• Income taxation of benefits
• Higher income individuals pay tax on part of
  their benefits
• This will apply to you only if you also have
  other substantial income (such as wages,
  self-employment, interest, dividends and other
  taxable income that you have to report on your
  tax return) in addition to your benefits.
• If you file a federal tax return as an
  "individual"
• If your combined income is between 25,000 and
  34,000 pay income tax on 50 percent of your
  Social Security benefits.
• If your combined income is above 34,000, up to
  85 percent of your Social Security benefits is
  subject to income tax.
• If you file a joint return,
• you may have to pay taxes on 50 percent of your
  benefits if you and your spouse have a combined
  income that is between 32,000 and 44,000.
• If your combined income is more than 44,000, up
  to 85 percent of your Social Security benefits is
  subject to income tax.

30
Double Indexation

• In 1972, Congress decided to create automatic
  cost-of-living adjustments to help Social
  Security benefits keep pace with inflation.
  Previously, each adjustment had to await
  legislation, causing beneficiaries' monthly
  payments to lag behind inflation.
• Unfortunately, this new benefit adjustment method
  was flawed and was corrected in 1977.
• As a result, those who were born between 1917 and
  1921 receive benefits lower than that of persons
  born both before and after them. North Issue

31
Double Indexation--History

• Before 1972, benefit amounts were determined by
  using a table that related basic benefit amounts
  to average "covered" wages. Benefits determined
  from this table would not change unless Congress
  amended the law.
• Average covered wages was calculated by
  averaging the actual wages he or she earned (in
  "covered" jobs) over a period roughly equivalent
  to a working lifetime.
• Inflation routinely ate into the real value of
  these static benefits. So, from time to time,
  Congress would revise upward the benefit amounts
  in the table.

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Double Indexation
33
Double Indexation--History

• In 1972, Congress passed legislation to adjust
  benefits annually if the CPI rose three percent
  or more since the last benefit increase.
• Unfortunately, the new law was flawed in that it
  simply adjusted benefits using the same method
  Congress had employed when creating previous ad
  hoc increases.
• This meant higher benefits not only for those
  already on the rolls, but for new beneficiaries
  a coupled system.

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Problem of the coupled system

• For the currently retired, inflation has no
  effect on the average monthly earnings used in
  the PIA formula
• For those still in the labor force, this
  adjustment mechanism gives future retirees a
  double increase in benefits every time there is
  an increase in the cost of living
• first from the adjustment of the benefit formula
• second from the higher taxable wage base owing to
  higher earnings.

35
Financing Problem of 1972 law

• Inflation soared in the 1970s, ultimately
  reaching double digits and averaging close to
  eight percent over that period.
• Stagflation" in 1970s both inflation and
  unemployment were high.
• This peculiar economic circumstance undermined
  the financing of Social Security
• slowed the flow of taxes into the Trust Funds
• produced rapid increases in benefits, both for
  existing beneficiaries and for newly retiring
  workers
• further increased the amount of benefits paid as
  older unemployed workers took early retirements.

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Financing Problem of 1972 law
37
Financing problem of 1972 law

• For those already on the rolls, the new law
  worked as expected Changes in benefit levels
  reflected inflation.
• For new beneficiaries, initial benefit levels
  grew faster than wage levels.
• The percentage of wages replaced by Social
  Security benefits would increase from year to
  year, eventually rising to the point that many
  new beneficiaries would receive benefits higher
  than their earnings before retirement.

38
Financing problem of 1972 law

• By the mid-1970s, Social Security's long-range
  costs were projected to exceed income by more
  than 50 percent.
• Without corrective action, Social Security's
  funds would be exhausted, and the system would be
  unable to meet its statutory obligations by the
  early 1980s.

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Solution Wage Indexing

• The flawed 1972 method was replaced with a wage
  indexing method on December 20, 1977.
• Existing beneficiaries continued to receive
  annual increases (COLAs) based on the percentage
  increase in the CPI.
• The way initial benefits were calculated was
  completely revised A fixed formula for
  determining initial benefits
• 90 percent of the lowest range of average indexed
  monthly earnings, plus
• 32 percent of the mid range of such earnings,
  plus
• 15 percent of the highest range of such earnings
  (up to a maximum based on amount of earnings on
  which taxes are paid).

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Solution Wage Indexing

• Anyone born before January 2, 1917 still had
  their benefits calculated under the old law
• Congress created a special five-year
  "transitional method" for people who would become
  eligible for benefits beginning in 1979

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Solution Wage Indexation

• The new method stabilized the relationship
  between initial benefits and pre-retirement
  earnings.
• These changes made the financing of Social
  Security more stable.
• The law was intended to ensure
• each year's cohort of new beneficiaries began at
  the same replacement rate relative to their
  pre-retirement earnings, as beneficiaries in
  prior years, and
• their benefits would keep up with inflation.

42
Impact of 1977 law

• For most beneficiaries who reached 62 after 1978,
  the new method produced lower benefits than would
  have been received under the old law
• The benefit levels at 65 dropped for those born
  in 1917-1920. After that, benefit levels at 65
  begin to climb North Issue.

43
Benefit Level of people born in different years