Social Security is the largest source of retirement income for many Americans, and the rules that decide the size of a monthly check are both more formulaic and more flexible than most people expect. The amount depends on a worker’s earnings record, which is fixed by history, and on a claiming decision, which is up to the worker. This article explains the standard steps the Social Security Administration uses for a retirement benefit. It is general information, not advice, and the agency’s own tools should be used for a personal estimate.
Where does the calculation begin?
The starting point is a worker’s record of earnings subject to Social Security payroll tax. Every year of covered work is recorded, and each year’s earnings count only up to a maximum amount, the annual taxable maximum, which is adjusted over time. Earnings above that cap are not taxed for Social Security and do not raise the benefit.
To qualify for a retirement benefit at all, a worker needs 40 credits, which usually means about ten years of covered work. The agency awards credits based on annual earnings, up to four a year.
What is indexing?
A dollar earned in 1990 is not worth the same as a dollar earned today, so the agency adjusts earlier years to reflect the growth in average wages across the economy. This step is called indexing. Earnings in the years before age 60 are multiplied by an index factor that brings them up to roughly the wage level of the year the worker turns 60. Earnings from age 60 on are counted at their actual value.
Indexing is the reason the calculation does not simply penalize workers whose careers began decades ago, when wages were lower. It places old and new earnings on a comparable footing.
Why 35 years?
The agency takes the worker’s 35 highest years of indexed earnings, adds them up and divides by 420, the number of months in 35 years. The result is the Average Indexed Monthly Earnings, or AIME. If a worker has fewer than 35 years of earnings, the missing years count as zeros, which pulls the average down. Working more years, even at modest pay, can replace a zero year and raise the benefit. Likewise, a high-earning year later in a career can replace an earlier low one.
How does the formula turn the average into a benefit?
The AIME is converted to a Primary Insurance Amount, or PIA, using a progressive formula with two “bend points.” The formula pays:
- 90 percent of the AIME up to the first bend point,
- 32 percent of the AIME between the first and second bend points, and
- 15 percent of the AIME above the second bend point.
The bend points are dollar amounts that change each year with average wages, and they are fixed for each worker based on the year the worker turns 62. Because the formula replaces a higher share of low earnings than of high earnings, Social Security is progressive: lower-wage workers receive a larger percentage of their past earnings than higher-wage workers do, though higher earners still receive larger checks in dollars.
The PIA is the benefit a worker would receive at full retirement age. Cost-of-living adjustments are added later, as discussed below, and they apply from the year a worker turns 62 even before claiming.
What is full retirement age?
Full retirement age, sometimes called normal retirement age, depends on the year of birth. It was 65 for people born in 1937 or earlier and rose gradually. For anyone born in 1960 or later, it is 67. A person who claims at exactly that age receives 100 percent of the PIA.
How does claiming age change the amount?
The claiming decision is where most of the flexibility lies. Retirement benefits can begin as early as age 62, and the longer a person waits, the larger the monthly amount.
- Claiming early. Benefits claimed before full retirement age are permanently reduced. For someone whose full retirement age is 67, claiming at 62 results in a reduction of about 30 percent. The reduction is computed month by month.
- Claiming at full retirement age. The worker receives the PIA with no reduction.
- Delaying. For each year a worker waits beyond full retirement age, up to age 70, the benefit grows by 8 percent through delayed retirement credits. For a person with a full retirement age of 67, claiming at 70 raises the benefit by 24 percent above the PIA. There is no further increase after 70.
None of these choices is right for everyone. A longer life favors waiting, because the larger payments are received for more years, while health concerns, the need for income or the ability of a spouse to claim on a record can change the math. The agency does not give personal advice on timing, and the decision may be worth discussing with a qualified, fee-only adviser.
What about working while collecting?
A worker who claims before full retirement age and continues to work faces the retirement earnings test. If earnings exceed an annual threshold, the agency withholds some benefits, though the withheld amounts are credited back in higher payments after full retirement age. After reaching full retirement age, there is no limit on earnings. Because the rules and thresholds change each year, the current figures should be checked on the agency’s website.
How do cost-of-living adjustments and taxes work?
Benefits are adjusted each year by a cost-of-living adjustment, or COLA, based on the change in the Consumer Price Index for urban wage earners and clerical workers. The adjustment is announced in the fall and takes effect in January. Depending on a recipient’s other income, a portion of Social Security benefits may be subject to federal income tax. Whether California taxes the benefits is a separate question, and California does not tax Social Security income at the state level, though federal taxation can still apply.
Does other retirement income change the picture?
Spouses, former spouses and survivors can be eligible for benefits based on a worker’s record, which adds another layer: a spouse can receive up to half of the worker’s PIA at full retirement age, and a surviving spouse can receive up to the amount the worker was receiving or entitled to. Social Security is only one source. Military retirees, a large group in San Diego County, as described in the guide to the region’s military presence, receive retirement pay through a separate system, and they may also earn Social Security benefits from civilian work. Public employees in some California systems may be covered by their own pensions instead of, or in addition to, Social Security, which can trigger special provisions. Pension and savings income can also affect how much of a benefit is taxed, so a complete picture requires looking at every source together.
How can someone check their own record?
The agency offers a free online account where workers can view their earnings history, see estimates of future benefits and check for errors. Errors in the earnings record can reduce a benefit, so reviewing it periodically is worthwhile. Health coverage decisions often come at the same time as retirement decisions, and Medicare enrollment periods are tied to age 65 in ways that interact with when someone chooses to claim.
Changes to benefit rules come from Congress, and agency procedures change through rulemaking that is open to public comment, as explained in how to comment on federal regulations. Social Security’s formula is public and the pieces are straightforward. Knowing how the 35-year average, the bend points and the claiming age fit together makes official estimates easier to understand and helps workers ask better questions of the agency or an adviser.
Sources: Social Security Administration; U.S. Department of the Treasury; California Franchise Tax Board
