How Are Social Security Benefits Calculated? Several Facts & Issues Having Effect On The Benefits

Among the most popular Social Security questions that I hear from baby boomers getting ready to retire is "how are Social Security benefits calculated?" This is a vital question because it could affect how long you need to work, whether you should continue to work during your retirement years, or any other aspects of your retirement plan.

First, please note that you receive a Social Security retirement benefit estimate every year in the mail, usually near your birth date. There are also several calculators available on the Social Security website to assist you estimate how much your retirement benefits will be, so you don't need to know the ways to calculate the benefit yourself.

It's still useful to know how Social Security is calculated, however, so here are the basics:

Basically, your highest 35 years of earnings are indexed for inflation, then averaged to determine the basis for your per month benefit. If you worked less than 35 years, the missing years will be calculated as nothing for purposes of determining your benefit amount.

Planning tip: If you have close to 35 years of earnings and you're close to retirement, you will benefit greatly by continuing to work until you've 35 full years of earnings to include in your benefit calculation. The majority of people this will affect are women who took time off work to raise a family.

The top 35 years of earnings are then divided by 35 to get your average indexed monthly earnings (AIME). A formula is applied to your AIME to determine your primary insurance amount (PIA). We won't go into the details of the formula; the significant thing to notice is that your PIA is the full unreduced benefit you would receive if you retired at your full retirement age (at the age of 66 for people born between 1943 and 1954). This amount will be reduced if you take early retirement or increased if you retire after age 66.

The PIA is also the base for other benefits like spousal benefits, so it's significant to understand that your Primary insurance amount is not necessarily the same amount that you will receive. If you're married and your spouse will be collecting benefits based on your earnings rather than her own, then you may want to maximize your own PIA to maximize the total Social Security benefits you & your spouse will receive.

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