Five Myths About Social Security: Myth #2 – Social Security Is Based on Your Last Five Years of Earnings

October 01, 2014

Last week, I addressed the first myth about Social Security benefits, namely that they won’t be there by the time you’re eligible to receive them. For this week’s post, I’d like to address another common myth related to how benefits are calculated: Benefits are based on your last five years of earnings.

While it’s true that Social Security benefits are tied to earnings, it’s not just the last five years that matter. Unlike some pension formulas that use final average earnings as a way of calculating benefits, Social Security actually looks at your ENTIRE earnings history to calculate your benefit. That means even the $1,200 you earned at your summer job in high school may be part of the equation. These earnings are then “indexed” to account for inflation, which is a good thing because what you earned when you were 16 is worth a lot more today.

Once your earnings have been adjusted, Social Security uses the HIGHEST 35 YEARS of adjusted earnings to calculate an average indexed monthly earnings amount. This amount is then applied to a special formula to arrive at your basic benefit, which Social Security affectionately calls your “primary insurance amount.” This is how much you would receive if you waited until full retirement age to receive your benefit.

So now that you know how your retirement benefits are calculated, here are some things you may want to do to make sure you get the most you are entitled to:

  • It is unlikely that you will remember how much you earned 20 years ago, so check your earnings history regularly to make sure there are no errors.
  • Years without earnings will appear as zeros in the formula so if you don’t have at least 35 years of earnings, consider working a few extra years to knock some of those zeros out of the equation.
  • Taking your benefit before your full retirement age will reduce the amount you receive so if you are planning to retire before your full retirement age, consider using your 401(k) or IRA to supplement your income until you reach full retirement age. If you can afford to wait until age 70 before taking your benefit, that’s when it will be its highest.
  • If you already have 35 years of earnings history and are thinking of working longer to increase your Social Security benefits, run an estimate. You may find that those additional years do not make an appreciable difference.

For those of you turning 62 this year, you can use the worksheet found on page two of this resource to estimate your retirement benefit. For the rest of us, we can go to the retirement estimator found on the home page of the Social Security website. In any case, don’t worry too much about those last 5 years.