How Your Social Security Benefit Is Calculated

Most people know that the amount of your Social Security benefit depends on two things:

  1. The age you are when you elect to begin receiving payments
  2. The highest 35 years of your earnings

However, there is a lot of confusion around how your benefit is affected if you work past age 62, especially if you’re in your highest earning years.

Here’s what you need to know

Your earnings are indexed for economy wide wage growth

In other words, you may be making the most total dollar amount of your working years right now, but that might not mean it’s your highest year for SS purposes.

What that means is that Social Security plugs your annual earnings into a table over all of your years of working and multiplies the earnings by an index to get everything in current dollars. Then they take the 35 highest years from that table to calculate your benefit.

Figuring out your 35 highest earning years

To figure out your 35 highest years, go to this website, then enter the year you will first become eligible to receive payments (the year you turn 62). I was born in 1977, so will turn 62 in the year 2039. Once I have the index factors, I can pull out my earnings report (which you can access through your SS account) and multiply each year’s earnings by the indexing factor.

For example, the first year I had wages was 1992, when I earned a whopping $136. The indexing factor for 1992 is 4.8442967, which means that $659 is the amount used in figuring my highest 35. Do this for each year, then add up the highest 35 (or for me, since I don’t yet have 35 years, I just add them all up), then divide by the total number of months in those years. This is your average indexed monthly earnings (AIME).

If you have 35 years of earnings, you just divide by 420. Since I’ve only had 26 years to date, I’d use 312 for now. So if you add up all your indexed years and get $3,000,000 and divide by total months of 420, your AIME would be $7,143.

Plugging your 35 highest years into the formula

Once you’ve added up the highest indexed 35 years and divided by the total months you’re counting to get your average earnings, you plug it into a formula. Using the example above, here’s how the formula works:

90% of first $885 of earnings: ($885 x .9) =$796.50 Remaining earnings: $6,258
32% of earnings above $885 up to $5,336 ($4,451 x .32) =$1,424.32 Remaining earnings: $922
15% of everything above $5,336 ($992 x .15) =$138.30 TOTAL: $2,359.12

 How to use this information

The good news is that the Social Security Administration does this work for you, but knowing how the formula works can help you if you are trying to figure out whether continuing to work will actually increase your benefit and if so, by how much.

In order to figure it out, you basically have to take a look at your indexed earnings so far, then make sure you’d be able to out-earn your 35th lowest year.

You may be surprised to find that your lowest earning year in actual dollars may NOT be your lowest indexed year. Likewise, your highest indexed year could very well have taken place many years ago, even though you’re earning more in actual dollars today.

Is it worth it?

Finally, even if your projected earnings are substantially higher than your lowest 35th year, you may find that the increase to your benefit would be minimal. When I ran a few examples of a worker just matching highest actual dollar years in continuing to work, the monthly benefit increased by less than $15.

Depending on your projected monthly retirement expenses, that additional $180 per year could make a difference, but most people I know in their 60’s would pay $180 per year in order to retire sooner, no?

 

More like this:

What’s Your Plan For a Financial Independence Day?

What’s Your Plan For a Financial Independence Day?

I personally think of financial independence as consisting of three different levels: ...
Read More
man calculates IRA rollover

Rolling Voluntary 401(k) After-Tax Money To Roth IRA

Using after-tax 401(k) contributions to execute backdoor conversions to a Roth IRA can be an effective strategy if you want ...
Read More
Man saving for retirement

How To Save For Retirement Beyond The 401(k)

Preparing for retirement is an essential part of financial planning. Employer-sponsored retirement plans, such as 401(k) plans, are a common ...
Read More

Subscribe

Be the first to know when new resources are published.