As farmers approach retirement, many will wonder how much extra self-employment or wage income they should report to maximize social security benefits. If they paid in little or no FICA tax during their career (pushing tax down the road or using commodity wages), paying a larger chunk into social security might make sense.
Social security calculation can sound complicated, but here are the basics:
- You take your highest 35 years of indexed income. Each year before you reach age 60 has an indexed factor. Once you reach age 60, this factor remains at one until you elect to retire.
- These indexed annual earnings are accumulated, and the 35 highest indexed earnings amounts are divided by 420. This number is your average indexed monthly earnings (AIME).
- Each year, two bend points are calculated. The first bend point is the current U.S. average wage index divided by the average wage index from 1979 and then multiplied by $180. The second bend point uses the same math, but you multiply it by $1,085.
- Finally, all dollars generated after the second bend point are valued at 15%.
If you still have not reached the top of the first bend point, it makes sense to maximize that quickly. The payback on filling that bucket is short.
For example, assume you report an additional $10,000 of income and pay $1,530 of self-employment tax. Your AIME adjustment would be $23.81, and you would get credit for 90% of this number or $21.43. If we divide $1,530 by $21.43, we get 71.4 months or about six years to break even.
However, if you are past the first bend point and before the second, the value of the $23.81 now drops to 32% or $7.62. This now takes at least 200 months, or 16.7 years, to break even. However, social security is indexed for inflation, so the break-even period is likely pretty close to this number.
Finally, if you are past the second bend point, your $23.81 monthly increase is now only valued at 15%
or $3.57. This now takes 429 months or 35.75 years.
Post Calculation Steps
If you have not reached the first bend point, pay in as quickly as you like. If you are past the first, it will take at least 17 years to break even.
If you're healthy and want to be sure you don't run out of income, investing your funds in this area has some merit, but substantially less than being in the first area. If you are past the second bend point, don't waste your funds. You might do better investing that money in stocks, bonds or more farmland.
Learn more about calculations for social security bend points at AgWeb.com/bend-points
Paul Neiffer is a tax principal with CliftonLarsonAllen and author of the blog, The Farm CPA.