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How Are Social Security Benefits Calculated? Some Specifics And Aspects Having Effect On The Benefits
One of the most popular Social Security questions that I hear from baby boomers getting prepared for retire is "how are Social Security benefits calculated?" This is a significant 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 each year in the mail, normally around 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 methods to calculate the benefit yourself.
It is still helpful 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 monthly benefit. If you worked lower than 35 years, the missing years will be calculated as zero 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 have 35 full years of earnings to include in your benefit calculation. Most of the 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 specifics of the formula; the vital thing to note 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 basis for many other benefits such as 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 are married and your spouse will be collecting benefits according to your earnings instead of 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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