For example, in 2015, the maximum amount of earnings that was subject to payroll tax was $118,500. So, when making your list, your 2015 figure would be either your actual earned income for the year or this taxable maximum -- whichever is lower.
After all of your annual income figures are listed, they are then indexed for inflation. The Social Security Administration (SSA) publishes a worksheet of index factors that you would use for each year's earnings. As an example, the index factor for 1995 is currently 1.97, so if you earned $50,000 that year, you would multiply it by 1.97 to arrive at $98,500 in inflation-indexed earnings. You would then repeat this process for every year you worked.
After you've indexed all of your annual earnings for inflation, the next step is to narrow down the list to your 35 highest-income years.
The Social Security benefit formula is based on your income during the 35 years in which you earned the most (again, adjusted for inflation). If you worked for fewer than 35 years, you would use zeros to fill in the missing spots. For example, if you only worked for 32 years, your list should contain all 32 years of inflation-indexed earnings and three entries of "0."
The next step is to calculate your average indexed monthly earnings, or AIME, which serves as the basis of your Social Security retirement benefit.
To calculate this, add up all 35 of your highest inflation-indexed income figures and then divide the total by 35 to get your annual average. Divide again by 12 to arrive at your AIME.
Once your AIME has been calculated, it can be plugged into a formula to determine your base retirement benefit. This is also known as your primary insurance amount, or PIA. Note that your PIA is not necessarily the amount the Social Security Administration will pay you each month -- but we'll get to that in a moment.
As of 2018, PIA is calculated by adding up the following:
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90% of the first $895 of AIME
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32% of AIME above $895 and less than or equal to $5,397
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15% of AIME greater than $5,397
The sum of the above amounts will be your PIA.
There's an often-overlooked point you should be aware of: Your PIA is calculated using the benefit formula that was in effect during the year when your first became eligible for Social Security, not the formula in effect when you actually claim your benefit. In other words, the SSA will use the formula that was in effect when you turned 62, even if you wait until much later to start collecting your retirement benefit.
To be clear, you consider all of your earnings when calculating your average indexed monthly earnings, including any income you earned after you turned 62. However, you'll still use the formula in effect when you were 62, even if you work for several more years.
The good news is that the structure of the formula stays the same each year, meaning that the 90%, 32%, and 15% multiplying factors don't change. Only the income thresholds, also known as "bend points," change from year to year (they're $895 and $5,397 in the 2018 formula). If you're trying to determine your Social Security benefit and you turned 62 before 2018, you can find historical bend points on the SSA's website.
The primary insurance amount, or PIA, is the Social Security benefit you'd be entitled to if you decided to claim benefits at exactly your full retirement age. This is the age at which you would be entitled to claim your full calculated Social Security benefit, and it's often referred to as the age at which you'd be taking Social Security "on time." However, Americans can choose to claim at any point between age 62 and age 70, and the majority don't claim benefits at their full retirement age. In fact, the most common Social Security claiming age is 62 -- the earliest age possible.
Choosing to claim Social Security before you reach full retirement age will result in a permanently reduced Social Security benefit, while choosing to delay Social Security beyond your full retirement age will result in a permanently higher benefit.
We'll get into how much your benefit decreases or increases based on when you file, but first, here's a quick chart to help you find your full Social Security retirement age:
| Year of Birth | Social Security Full Retirement Age |
|---|
| 1954 or earlier | 66 years |
| 1955 | 66 years, 2 months |
| 1956 | 66 years, 4 months |
| 1957 | 66 years, 6 months |
| 1958 | 66 years, 8 months |
| 1959 | 66 years, 10 months |
| 1960 or later | 67 years |
Data Source: SSA.
If you do not claim Social Security retirement benefits at your full retirement age, then the effect on your monthly benefit will depend on how early or late you filed. Here's how your PIA will change based on when you claim benefits:
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If you claim Social Security no more than 36 months before your full retirement age, your benefit will be reduced by 0.56% per month you claimed early. That works out to 6.67% per year during the three years leading up to your full retirement age.
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If you claim Social Security more than 36 months before your full retirement age, your benefit will be reduced by 20% plus 0.42% per month beyond 36 months early (that's another 5% per year).
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If you claim Social Security after your full retirement age, your benefit will be permanently increased by 0.67% for every month you choose to delay. These benefit boosts are known as delayed-retirement credits.
Let's consider an example. We'll say that you turn 62 in 2018 (so you were born in 1956) and want to estimate how much you can expect from Social Security if you claim your benefit this year. We'll say that you've worked for a total of 40 years and that the average indexed monthly earnings from your 35 highest-earning years is $6,000. (Note: This covers steps one through four as discussed earlier.)
To calculate your PIA, which is the amount you can expect at full retirement age, we can plug $6,000 into the benefit formula outlined in step five:
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90% of the first $895 = $805.50
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32% of the amount greater than $895 and less than or equal to $5,397 = $1,440.64
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15% of the amount greater than $5,397 = $90.45
Adding the three parts of the formula together gives us a PIA of $2,336.59. This is the amount you would be entitled to at your full retirement age of 66 years and four months, plus any cost-of-living adjustments that are given between now and then.
However, if you chose to claim your retirement benefit at age 62, this would be four years and four months before your full retirement age. Based on the reduction formula outlined in step six, your monthly benefit would be reduced by a total of 26.67%. So, if you claim Social Security as soon as you turn 62 this year, you'll receive a monthly retirement benefit of $1,713.50 -- about $623 less per month than you'd get if you waited until full retirement age. On the other hand, if you were to wait until age 70, your benefit would be permanently increased to $3,022.
In short, the age at which you decide to claim Social Security makes a big difference.
This formula may look a little complicated, and it is. Additionally, there are a few issues with this, especially if you aren't 62 or older. For example, you don't know for sure how much you'll earn for the rest of your career, and there's no way to know what the Social Security formula's bend points will be when you turn 62.
However, if you want to get a good estimate of how much your future Social Security benefits could be, there's an easy way to do it that doesn't involve any calculations: look at your latest Social Security statement.
The SSA produces annual Social Security statements for all American workers, and you can find yours by creating a "my Social Security" account on www.ssa.gov if you haven't done so already. Your statement contains an estimate of your full retirement benefit based on your actual work history and estimated future earnings. In addition, your Social Security statement can tell you the estimated effect of claiming benefits early or late, how much you'd get from disability benefits if you happen to become disabled, how much your survivors could be entitled to if you were to die prematurely, and eligibility information for Medicare health benefits.
In a nutshell, your Social Security statement has some valuable information, and all Americans should take a few minutes to read through theirs once a year.
As I mentioned earlier, if you didn't work, or if your career earnings were small compared to your spouse's, a spousal benefit based on their work record could provide you with retirement income.
Here's the general idea of how it works. Your own retirement benefit (if any) will be calculated and paid to you first. If your calculated retirement benefit is less than one-half of your spouse's benefit at their full retirement age, then the SSA can pay you a spousal benefit to make up the difference. In other words, if your spouse is entitled to a $2,000 monthly benefit at full retirement age (their PIA), then a spousal benefit could provide you with a maximum of $1,000 per month in retirement income.
There are a few important things to know if you think you (or your spouse) might be eligible for a spousal benefit.
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To receive a spousal benefit, the primary earner must also be collecting their own benefit.
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There's no separate application for a spousal benefit; the SSA will automatically consider your marital situation and pay you whichever type of benefit is larger.
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Spousal benefits can be permanently reduced if they are claimed before the spousal benefit recipient's full retirement age. In my example of a couple whose primary-earning spouse is entitled to a $2,000 benefit at full retirement age, a spouse who never worked wouldn't be entitled to $1,000 unless they waited until their own full retirement age to claim.
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The spousal benefit reduction rates are slightly different than for normal retirement benefits. If claimed before full retirement age, spousal benefits will be reduced by about 0.69% per month for up to 36 months early, and by another 0.42% for each month beyond 36.
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Unlike Social Security retirement benefits, spousal benefits don't accrue delayed-retirement credits. In other words, there's no financial reason to wait past full retirement age to claim a spousal benefit.
Another factor that could affect how much you get from Social Security, especially if you're at least a few years away from claiming your benefit, is inflation.
Each year, Social Security gives beneficiaries cost-of-living adjustments, or COLAs, to help retirees maintain the purchasing power of their benefits. Under current law, Social Security COLAs are based on the Consumer Price Index for Urban Wage Earners, or CPI-W.
So, in a given year, if the Bureau of Labor Statistics (BLS) determines that the CPI-W has risen by 2%, then the Social Security Administration will raise benefits by 2%. Over a period of several years, or even decades, cost-of-living adjustments can have quite an impact on the amount of Social Security benefits you receive.
The bottom line is that if you're trying to get an estimate of your future Social Security benefits, it's important to keep in mind that the calculation methods outlined here, as well as the estimates found on your Social Security statement, are all in today's dollars.
For example, if you're 62 now, you calculate your primary insurance amount at $2,000 per month, and cost-of-living adjustments average 3% per year going forward, then you'll get about $2,250 per month if you wait until full retirement age to claim your benefit.
While Social Security's financial condition is too complex to thoroughly discuss here, I'd like to address a common misconception -- that Social Security is broke.
Social Security is not broke. In fact, Social Security has nearly $3 trillion in reserves, and the program ran a surplus last year. For the time being, Social Security has plenty of money.
Having said that, the program is expected to run a deficit in 2018, and the annual shortfall is projected to get larger over time. In a nutshell, the combination of baby boomers retiring in droves and Americans' longer life expectancies will lead to more people drawing Social Security benefits for longer periods of time. According to the latest projections, Social Security's reserves will be depleted by 2034 if nothing is done.
To be perfectly clear, if Social Security's reserves run out as expected, it doesn't mean that benefits will disappear. The incoming payroll taxes are expected to be enough to cover 77% of all promised benefits, so as a worst-case scenario, we're talking about an across-the-board 23% cut. However, history tells us that Congress will do something before the money runs out -- even if it's a short-term, kick-the-can type of solution.
As a final thought, keep in mind that because Social Security's financial future isn't exactly bright, it's likely that some sort of reform package will need to be implemented.
At this point, it's anyone's guess how Congress will fix Social Security, but the options boil down to two basic categories: tax increases and benefit reductions. Tax increases are the more popular option among the American public, as most people say it's important to preserve Social Security benefits for future generations.
However, some form of benefit reduction could certainly be a part of a reform package. Across-the-board reductions are extremely unpopular, but other forms of benefit reductions could include a further increase in the full retirement age or a modification to the benefit formula.
Now, virtually everybody in power who has voiced an opinion on the matter wants to keep Social Security exactly the same for those who are in or near retirement, so if you're older than 50 or so, you probably don't have much to worry about. On the other hand, if you're younger, there's a significant chance that your Social Security benefit calculation will look a little different.
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