How Your Social Security Benefits Are Calculated

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Social Security is an entitlement program. You are entitled to benefits because you pay (or have paid, or will pay) into it. Whether it’s survivor benefits, spousal benefits, or any other program, you deserve every penny.

We explain the steps you should take to calculate your Social Security benefits, and what you need to know to make the Social Security Administration (SSA) retirement program work for you.

What Factors Can Change Your Social Security Benefits?

Several factors will have an impact on your benefit amount. At the SSA’s website, applying for Social Security benefits is easy once you create a “my Social Security” account.
However, you should be educated about what could change your monthly benefits, for example:

  • The age you retire
  • Work history
  • Earnings record
  • Working while taking benefits (this is okay, but watch how much you earn)
  • The age you claim your benefits

Of these, the age you choose to retire and the earnings you had while in the workforce are the two factors that will make the biggest difference. The more you earned, and the older you are when you retire–the higher your monthly benefits will be.

Several Factors Contribute to the Benefits Formula

The SSA uses your highest earning, inflation-adjusted 35 years, so working 35 years or longer is best. For each year under 35, the SSA uses “$0” for your income that year. It doesn’t take a rocket scientist to understand that this will result in lower payments.

If you earned high wages, you are better off; however, in the low-earning years (typically when you were young) SSA will add a cost-of-living adjustment to your annual income.

If you retire at full retirement age, which depends on your birth year, you will receive more.

If you choose a claiming age of 62 (the earliest possible), you may receive up to 76% less than if you wait till the highest age (70) to retire.

Average Indexed  Monthly Earnings

Knowing a little about your Average Indexed Monthly Earnings (AIME) will help make sense of how the SSA calculator comes up with an estimate for your eventual monthly retirement check.

AIME is an initial calculation with the ultimate goal of determining another important amount: your “primary insurance amount” or PIA. The PIA is used to approximate the value of an individual’s total SSA benefits.

How AIME Is Calculated

The AIME chooses your top 35 best earning years (till the age of 60) and breaks them down through a process called “indexing.” This index approximates your wage growth, and that wage growth is then averaged over the total number of months (420) to come up with a monthly amount. The reason the AIME exists is to estimate a whole lifetime (up to 35 years) of earnings, but at current wage levels. (The number 420 is 35 years times 12 months).

Most people use the Social Security benefit calculator to get a sense of AIME.

Breaking Down the  AIME

Primary Insurance Amounts

When you receive SSA benefits, the number that will be used to calculate your benefit is from the PIA. In the example just below, where we explain how PIA is calculated, you’ll notice we’ve chosen specific dollar amounts. These are called “bend points” and they are different for each individual. Your bend points will be based on the year you retire at age 62, become disabled before 62, or if you die before age 62.

How To Calculate Your PIA

Of course, your AIME is affected by years (within 35) that you didn’t work (remember, you receive a “0” as income for those years). It is also affected, naturally, by how much you earned each year. In the example below, we’ll discuss a person with a monthly income (over a lifetime) of around $5,000.

Consider Hank, a former structural steel worker, who has an AIME of $5,000. The PIA calculation takes different percentages out of that $5,000. In Hank’s case, it would take 90% from the first $744, and 32% from earnings between $744 and $4,483.  Any monthly earnings of over $4,483, this PIA would take 15%.

The PIA in Hank’s case is: $1,943.63.

Hank’s Social Security bend points are because he retired at 62 in the year 2019.

Whenever an individual’s benefit is computed,  the national average wage indexing series or index factor is used to calculate that person’s earnings. By using an index factor any worker’s future benefits are a realistic assessment of the rise in the cost of living.

As with other SSA factors, age of retirement and birth date are important.

Cost of Living Adjustments

SSA has considered the fact that each year, we will have some inflation. It simply costs more to live each year as food, gas and housing prices rise. The “cost of living” is therefore adjusted each year; in 2019, SSA had their biggest increase ever, with a 2.8% Cost of Living Adjustment, or COLA.

This big increase shouldn’t fool savvy Americans, however; increases in Medicare could wipe out all the gains to retirees.

Determine the Effect of COLAs

Your years of earnings will work harder for you, and you’ll get a greater net amount from COLA if you retire later. Putting off retirement for additional years (living off your IRA instead, for example) and–especially–waiting till full retirement age is the best option if you can manage it.

If you reach full retirement age, you have no limit on your Social Security earnings, but if you retire early, there are limits. For example, the SSA earnings limit for people turning 66 in 2019 will increase to $46,920.

COLA exists to make sure that the power of retirement and Supplemental Security Income (SSI) benefits will persist as inflation rises.
COLA is specifically based on the percentage increase in the Consumer Price Index or CPI for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of the prior year.

Therefore, COLA fluctuates from year to year.

The CPI-W is the official measure SSA uses to come up with COLA, and the CPI comes directly from the U.S. Department of Labor.

Full Retirement Age

There are many reasons to wait for the full retirement age. Obviously, full benefits are the goal for all of us, no matter what kind of Social Security income we hope for.

Every retirement credit that you can get should be considered. Sometimes, your actual earnings aren’t reflected in your AIME or PIA–so take a look your year’s income, or which years you worked (this can be found on your Social Security statement) to calculate your maximum Social Security benefit at full retirement age.

Full Retirement Age is often referred to as “FRA” – and this varies depending on when you were born; for those born in 1938, the FRA is 65 and two months, but for those born after 1960, the FRA is 67. The FRA continues to rise each decade.

If You Retire Early

Your benefit calculation for retiring early is determined with a different benefit formula from full retirement, and it depends on which age (beyond 62) you choose to retire. We recommend reviewing the SSA retirement calculator here; remember, too, that if you retire at 62 you are not eligible to receive Medicare for three more years.

If You Retire Late

The only issue with late retirement is that it may be difficult to continue working; if you can work, you should wait until age 70 to retire. You receive numerous benefits, including delayed retirement credit if you retire after the age of 69. The delayed retirement credit ranges from 3% to 8% more benefits, depending on your date of birth (those born earlier receive more).

How To Estimate Your Actual Social Security Retirement Benefits

The best way to estimate  SSA benefits is to consider all the factors we’ve mentioned, plus Social Security taxes, to calculate your own benefit.

You will need to have your Social Security statement at hand. Do not count on trying to estimate your average wage over a lifetime without it.

You should calculate your:

  • AIME and PIA (including your bend points)
  • Your FRA
  • COLAs for the year you plan to retire
  • Any spousal benefit or survivor benefit

Run scenarios for both early retirement (whatever age you think is reasonable) and your full retirement age.
We recommend using the SSA calculator to assist you, but you should understand what each of the above terms means.

Opportunities for Social Security Bonuses

To maximize your Social Security earnings, consider all of these:

  • Work 35 years
  • Note what the conditions are for the age you plan to retire
  • Earn as much as possible, especially in your later years
  • Wait till Full Retirement Age
  • Delay until age 70
  • Claim spousal payments
  • Don’t earn too much money after you retire
  • Be aware of Social Security taxes and minimize them
  • Make sure all the work you do is counted
  • Maximize any possible survivor benefits

Start Thinking About Your Retirement Benefits Now

It isn’t easy when you are young to imagine yourself old, but if you can make that mental leap you will be far ahead of your peers. The effort you put into contemplating your future relationship with the Social Security Administration will pay off in spades when you reach the end of your working life. As an American, you are entitled to Social Security. Make it work for you!