How Are Social Security Benefits Calculated?

How Are Social Security Benefits Calculated

Social Security benefits are a crucial element of retirement planning. For those without investments or pension plans, it may be their sole source of income. The government website has made it easy to access your personal retirement benefits online. Once you create an account, you are able to see how much you qualify for. You can also adjust the calculations in different age scenarios. However, you may still be asking yourself, “How are Social Security benefits calculated?” Several factors discussed below affect the formula for your personal benefits.

The Social Security Formula to Calculate Benefits                                                 

Your lifetime earnings determine your personal Social Security benefits. First, the formula indexes your actual earnings. This is to account for any fluctuations in average wages from your first year of receiving wages. Then, they find your average monthly earnings for the 35 years with the highest earnings. Your average indexed monthly earnings, or AIME, only counts income within the maximum table earnings. For 2020, this amount is $137,700.

The Social Security benefits formula applies to this figure. The new total gives you a “primary insurance amount” or PIA. Your PIA is the basic benefit you will receive once you reach full retirement age. The sliding scale helps low earners who depend more upon these benefits. The current year’s breakdown separates wages into three categories:

  • 90% of intial $960 of AIME
  • 32% of any amount between $960 – $5,785
  • 15% for any amount above $5,785

Lastly, you enter your age when you begin claiming benefits. If this seems complicated, you can also use their Retirement Calculator to estimate your individual benefits.

Factors that Affect Social Security Benefits

If you want to check the math yourself, there are a few factors that could change the final total. First and foremost, you will receive less if you claim Social Security benefits before full retirement age.  You can claim them beginning at the age of 62. Although, you will lose a significant amount of money if you do.

Secondly, your benefits get recalculated every year. This is to adjust payments based on inflation. It also includes any income from the previous year. You can qualify for an annual cost of living increase until you reach 70. Should you delay your retirement, you will also receive incremental monthly increases.

Finally, certain people will use a different formula. This is usually the case for government workers, or people who receive retirement/disability pensions from a job that didn’t pay Social Security taxes. The website provides a second calculator if the Windfall Elimination Provision (WEP) will affect your Social Security benefits.

Future Funding for Social Security

The future of Social Security has become a hot topic of debate. In particular, many people are questioning the sustainability of retirement benefits. Will the current generation of workers receive the same benefits? Should we count on receiving Social Security benefits after retirement? The answer is unclear. We must remember the future is unpredictable and these ideas are not well understood.

The Social Security Board of Trustees predicts that program costs will rise by 2035. At this point, taxes will only cover 75% of scheduled benefits. The reduced benefits are a result of an aging population and a lower birth rate. Experts believe there will be greater public debt since more people will be claiming their trust fund assets and redeeming Treasury debt securities. Although it appears there will be funding available, it is always best to diversify your retirement plan. Most importantly, be certain how your Social Security benefits are calculated.

Read More