A complex formula determines how your Social Security benefits are calculated. The following factors go into the formula: Show
Take a look at how these factors affect the benefits you will receive and how the Social Security Administration calculates its figures. Key Takeaways
How Is Social Security Calculated?There is a three-step process used to calculate the amount of Social Security benefits you will receive. Step 1: Use your earnings history to calculate your Average Indexed Monthly Earnings
(AIME). You can use a copy of your Social Security statement that provides your earnings history to plug your own numbers into the formulas below. Step 1: Calculate Your Monthly EarningsYour Social Security benefit calculation starts by looking at how long you worked and how much you made each year. It is used to calculate your AIME. Here's how to find it. List Each Year's EarningsYour earnings history is shown on your Social Security statement, which you can now obtain online. In the table below, sample earnings for a hypothetical worker born in 1953 are shown in Column C. Only earnings below a specified annual limit are included. This annual limit of included wages is called the "Contribution and Benefit Base" and is shown as Max Earnings in Column H in the table. Adjust for InflationSocial Security uses a process called "wage indexing" to determine how to adjust your earnings history for inflation. Each year, Social Security publishes the national average wages for the year. You can see this published list on the National Average Wage Index page. Your wages are indexed to the average wages for the year you turn 60. For each year, you take the average wages of your indexing year (which is the year you turn 60) divided by average wages for the years you are indexing, and multiply your included earnings by that number. Example:
NoteBecause of how the wage indexing formula works, if you are not yet age 62, your calculation to determine how much Social Security you will get is only an estimate. Until you know the average wages for the year you turn 60, there is no way to do an exact calculation. However, you could attribute an assumed inflation rate to average wages to estimate the average wages going forward, and use those to create an estimate. Average the Highest 35 YearsThe Social Security benefits calculation uses your highest 35 years of earnings to calculate your average monthly earnings. If you do not have 35 years of earnings, a zero will be used in the calculation, which will lower the average. In the table below, the highest 35 years are listed in Column G. Total the highest 35 years of indexed earnings, and divide that amount by 420, which is the number of months in a 35-year work history, to find the Average Indexed Monthly Earnings. For our example worker, who was born in 1953 and turned 60 in 2013, the highest 35 years of wages total $1,919,040. Divide by 420 to get an AIME of $4,569.
Step 2: Calculate Your Primary Insurance Amount (PIA)Once you have calculated your average indexed monthly earnings (AIME), you'll plug that number into a formula to determine your primary insurance amount, or PIA. This formula is based on something called "bend points." Social Security Bend PointsThe Social Security benefits formula is designed to replace a higher proportion of income for low-income earners than for high-income earners. To do that, the formula uses what are called “bend points," which are adjusted for inflation each year. Bend points from the year you turn 62 are used to calculate your Social Security retirement benefits. The example in the table below uses 2020 bend points. It works like this:
The result is your primary insurance amount, or PIA, the amount you will receive if you begin benefits at your Full Retirement Age (FRA). Your PIA is rounded to the next lowest dime, and your benefit amount is rounded to the next lowest dollar. NoteTechnically, your PIA is calculated and rounded to the next lowest dime, and then any inflation adjustments are applied. That number is then rounded to the next lowest dime. Next, any increase or decrease based on age is applied. That number is then rounded down to the next lowest dollar. You can see current and historical bend points and the current year's bend points on the Bend Formula Bend Points page of the Social Security Administration's website. If you are not yet 62, your benefit calculation is only an approximation, as you do not yet know what the final bend point amounts for the year you turn 62 will be. You can use an estimated inflation rate to approximate future years' bend points to develop a pretty accurate approximation. In the example in the table below, you can see how the AIME calculated in the previous step was plugged into the bend point formula to calculate the PIA.
Can Your PIA Change After You Reach Age 62?There are two things that affect your PIA after you reach age 62:
NoteYou may get the wrong answer when running your own calculations on when to begin Social Security if you simply take the numbers off your statement and do not properly apply inflation adjustments. Step 3: Adjust Your PIA for the Age You Will Begin BenefitsThe final amount of Social Security retirement benefit that you receive is based on the age when you begin benefits. The earliest you can begin retirement benefits is age 62 (age 60 if you are eligible for a widow or widower's benefit on a deceased spouse's or ex-spouse's record). You will get more by waiting until a later age—as late as age 70—to begin receiving benefits. Of course, another complex formula is used to determine how much more you will receive if you wait. This formula uses your Primary Insurance Amount (PIA) calculated in the previous step. This is the amount you will get if you start benefits at your full retirement age (FRA). Your FRA can vary, depending on the year you were born. For people born between 1943 and 1954, as in our example, the FRA is age 66.
NoteFor people born on January 1, the FRA is based on the year prior. Someone born on January 1, 1955, will have an FRA based on 1954. A reduction is applied to your PIA if you begin benefits before your FRA. A credit, referred to as a "delayed retirement credit," is applied if you begin to receive benefits after your FRA. Beginning Benefits Before FRAIf you choose to begin to receive benefits before you reach your full retirement age, one or both of the following calculations will apply:
Therefore, if your FRA is age 66, your benefits would be reduced by 25% if you begin taking them at age 62. Find that figure by taking 5/9 of 1%, or 0.56; multiply by 36 months to get 20%. Then, 5/12, or 0.42, multiplied by the remaining 12 months, is 5% for a total of 25%. Credit for Taking Benefits Later Than FRAIf you were born in 1943 or later, your benefits will increase by 2/3 of 1% per month, or 8% per year, for each month that you are past your FRA when you begin to receive benefits. Survivor benefits for a widow or widower will also receive these delayed retirement credits. Therefore, If your FRA is 66, your benefits would be increased by 32% by waiting until age 70 to begin (8% per year times four years). How Inflation Impacts Your PIAYour PIA is calculated at age 62. If you wait beyond age 62, cost-of-living adjustments (COLAs) will be applied to your PIA for each year afterward. If you have already had most of your 35 years of earnings, and you are near age 62 today, the age 70 benefit amount you see on your Social Security statement will likely be higher due to these cost-of-living adjustments. Many people do not account for this when doing their own calculations, which can lead them to think that taking Social Security early is a better deal, when waiting is often the better deal. In the table below, our hypothetical worker, born in 1954, is eligible for full retirement at age 66. The column on the right shows the effect of inflation for waiting beyond age 62 to take their benefits.
How Do You Calculate Your Social Security Taxes?"Social Security taxes" can refer to taxes paid into the Social Security system or taxes paid on Social Security benefits. The taxes that fund Social Security come from the payroll tax, which is 6.2% for employees or 12.4% for self-employed individuals. When you're receiving Social Security benefits, you'll still have to pay income taxes, but you won't owe taxes on all of your benefits. Those whose total annual income tops $34,000 ($44,000 for those filing joint returns) will pay income tax up to 85% of their Social Security benefits. Otherwise, incomes between $25,000 to $34,000 may have to pay income tax on up 50% of their Social Security benefits. How Do You Calculate Spousal Social Security Benefits?Spouses who do not meet earnings requirements may receive up to 50% of their partner's PIA, but claiming benefits before reaching full retirement age can reduce this amount. When Will I Receive My Social Security Check?The Social Security Administration's payment calendar helps recipients plan for payments. If you were born in the first 10 days of your birth month, then you receive payments by the second Wednesday of the month. Those born on the 11th-20th receive payments by the third Wednesday. Those born from the 21st-31st receive payments by the fourth Wednesday. However, those who began receiving payments before May 1997 receive payments by the third day of each month. |