How Are Social Security Benefits Calculated? Some Facts & Factors 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 an important question as it could affect how long you need to work, whether you need to continue to work during your retirement years, or other factors of your retirement plan.

First, please note that you get a Social Security retirement benefit estimate every year in the mail, usually around your birth date. There're also several calculators available on the Social Security site to help you estimate how much your retirement benefits will be, thus you don't require to know the methods to calculate the benefit yourself.

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

Generally, your top 35 years of earnings are listed for inflation, then averaged to determine the base for your per month benefit. If you worked less than 35 years, the missing years will be calculated as zero for purposes of determining your benefit amount.

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

The highest 35 years of earnings are then divided by 35 to arrive at your average indexed monthly earnings (AIME). A formula is applied to your Average indexed monthly earnings to determine your primary insurance amount (PIA). We will not go into the details of the formula; the important thing to note is that your Primary insurance amount is the full unreduced benefit you'd receive if you retired at your full retirement age (age 66 for people born between 1943-1954). This amount will be reduced if you take early retirement or increased if you retire after age 66.

The Primary insurance amount is also the base for other benefits such as spousal benefits, therefore it's vital to understand that your PIA isn't necessarily the same amount that you'll receive. If you're married and your spouse will be collecting benefits based on your earnings instead of her own, then you might want to maximize your own Primary insurance amount to maximize the total Social Security benefits you and your spouse will get.

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