How a Social Security Benefit Is Figured — For Beginners and for Experts

There are some columns I could repeat over and over again — because I’m asked the same questions over and over again. One of the most common questions I’m asked is this: “How is my Social Security benefit figured?” I’ve answered this question many times in past columns, and I’m going to do it again today.

This answer will be in two parts. The first part will provide a relatively simple explanation of the process. It is for those people (probably the majority of my readers) who want a general idea of how their benefit will be figured. They just don’t need or want to know all the nitty-gritty details. The second part of the answer will be for those who want to know it all and want to become experts in the Social Security benefit computation formula.
So, let’s start simple. In a nutshell, a Social Security retirement benefit is a percentage of your average monthly income using your highest 35 years of inflation-adjusted earnings.

When you file for retirement benefits, the Social Security Administration will look at your earnings history and pull out your highest 35 years. They don’t have to be consecutive. If you don’t have 35 years of earnings, the SSA must plug in an annual salary of “zero” for every year you did not work, until the 35-year base is reached.

However, before they add up those “high 35,” they index each year of past earnings for inflation. And this is where the formula gets just a little messy. That’s because there is a different adjustment factor for each year of earnings, AND each year’s adjustment factor is different based on your year of birth.

Here is a quick example. If you were born in 1955 and earned $32,400 in 1982, they would multiply those earnings by an inflation adjustment factor of 3.31, meaning they would actually use $107,244 as your 1982 earnings. But if you were born in 1956 and earned that same $32,400 in 1982, they would use an inflation factor of 3.35, resulting in $108,540 as the 1982 earnings used in your Social Security computation.

You can find a complete breakdown of those inflation adjustment factors for each year of birth (for folks nearing retirement age) at the Social Security Administration’s website: www.socialsecurity.gov.

The next step in the retirement computation formula is to add up your highest 35 years of inflation-adjusted earnings. Then, you divide by 420 — that’s the number of months in 35 years — to get your average inflation-adjusted monthly income.

The final step brings us to the “social” part of Social Security. The percentage of your average monthly income that comes back to you in the form of a Social Security benefit depends on your income. Simply put, the lower your average wage, the higher percentage rate of return you get. Once again, the actual formula is messy and varies depending on your year of birth. As an example, here is the formula for someone born in 1955. You take the first $885 of your average monthly income and multiply it by 90%. You take the next $4,451 of your average monthly income and multiply that by 32%. And you take any remainder and multiply it by 15%.

You can find a complete breakdown of those computation “bend points” at www.socialsecurity.gov.

Believe it or not, that was the simple explanation for those who just want a basic idea of how your Social Security retirement benefit will be figured. To summarize, it is a percentage of your average monthly income using your highest 35 years of inflation-adjusted earnings. If this were a college course, it might be called Social Security Benefit Computation 101.

But now I’m going to offer the advanced course for those of you who want to become experts.

I’ll start by introducing this term: the “primary insurance amount,” or PIA. The PIA is your basic retirement benefit upon which all future calculations will be based. The “raw PIA” is actually calculated at age 62. In other words, when the SSA pulls out your highest 35 years of earnings, they only use earnings up to age 62. Then that raw PIA gets “cooked,” or increased, to take into account any earnings you had after age 62 and to include any cost-of-living adjustments (COLAs) that were authorized for Social Security benefits after the year you reached age 62.

But it gets a little tricky when SSA does the re-computation for any earnings you have after age 62. If you worked full time until age 66, for example, you would normally assume that those earnings between age 62 and 66 would definitely increase your PIA. After all, you figure, they are some of your highest earning years, so they will become part of that “high 35.”

But not necessarily. And here is why. For reasons I can’t take the time to explain in this short column, earnings after age 60 are not indexed for inflation. They get calculated at current dollar value only. So, if your “raw PIA” was based on a full 35-year history of high inflation-adjusted earnings, your current earnings may not be high enough to become part of your “high 35,” so they won’t increase your benefit. Or they possibly might bump up the PIA, but not by much.

In fact, I hear from readers all the time who tell me that they are confused because the benefit estimate they are getting from the SSA now (at age 66, let’s say) is not much more than the estimate they got back at age 62. Their current benefit estimate includes the COLA increases, but either little or no bump for their post-62 earnings. The reason why is that lack of inflation indexing after age 60.

As you can see, the Social Security retirement benefit formula is pretty messy. And if you don’t want to be an expert, I say, “don’t worry about it.” Just let the SSA do it for you. Go to www.socialsecurity.gov, and click on the “Retirement Estimator” icon on the homepage. It will walk you through the process of finding out what your Social Security benefit will be.

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