How Are Social Security Retirement Benefits Calculated

The Maximum Social Security Benefit Is Going Up Next Year But Very Few People Will Qualify

The Social Security Administration adjusts retirement benefits on an annual basis to account for rising prices and changes in general wage levels. As a result, the maximum Social Security benefit for retired workers increases each year. For individuals that claim benefits in 2023, that sum will climb to $4,555 per month, up from $4,194 per month in 2022.

After battling runaway inflation for the past year, anyone planning to start Social Security next year is probably hoping for the maximum benefit. But only a small percentage of retired workers will actually qualify.

Here is what it will take to get the biggest Social Security check.

Image source: Getty Images.

How Much Money Do You Need For Retirement

Arriving at an answer to this question may not be immediately obvious because it depends on several variables related to your retirement objectives. Do you envision your retirement lifestyle costing more or less than what you spend now? If you want to increase the amount of domestic or international travel you enjoy during retirement, you will likely need additional money for these adventures. However, if you want to move into a smaller house or condo to simplify your life after you retire, you may not need as much money on an annual basis as you do now.

It can be helpful to imagine what your expected expenses in retirement might be and develop a retirement budget to estimate the level of income you think youll need. Remember to include unexpected costs like taking care of elderly parents, special destination weddings, inflation and potential investment losses. After you have a rough estimate of your retirement budget, you can more accurately determine the percentage of income replacement at retirement, one of the assumptions in our Retirement Savings Calculator. Depending on your situation, a scaled-down lifestyle may need only 80% of your current income, whereas opening an antique store as a brand new business venture could bump that up to 150%.

Fact #: Social Security Provides A Guaranteed Progressive Benefit That Keeps Up With Increases In The Cost Of Living

Social Security benefits are based on the earnings on which people pay Social Security payroll taxes. The higher their earnings , the higher their benefit.

Social Security benefits are progressive: they represent a higher proportion of a workers previous earnings for workers at lower earnings levels. For example, benefits for a low earner retiring at age 65 in 2021 replace about half of their prior earnings. But benefits for a high earner replace about 30 percent of prior earnings, though they are larger in dollar terms than those for the low-wage worker.

Many employers have shifted from offering traditional defined-benefit pension plans, which guarantee a certain benefit level upon retirement, toward defined-contribution plans s), which pay a benefit based on a workers contributions and the rate of return they earn. Social Security, therefore, will be most workers only source of guaranteed retirement income that is not subject to investment risk or financial market fluctuations.

Once someone starts receiving Social Security, their benefits increase to keep pace with inflation, helping to ensure that people do not fall into poverty as they age. In contrast, most private pensions and annuities are not adjusted for inflation.

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Tell Social Security About Your Return To Work

If you plan to return to work, you should notify the SSA right away, Elsasser advised. That way, the agency can start to reduce your checks now.

If you don’t, you could be in for an unwelcome surprise early the next year when the IRS reports your earnings to the SSA.

If that happens, you may get an unexpected letter from the SSA notifying you that they are stopping your benefit right away until any earnings penalty from the prior year is made up.

That may disrupt your cash flow, which you may not be expecting.

Effect Of Delaying Retirement Benefits

1Represents Full Retirement Age based on DOB January 2, 1960

2PIA = The primary insurance amount is the basis for benefits that are paid to an individual

That higher baseline would last for the rest of your retirement and serve as the basis for future increases linked to inflation. While it’s important to consider your personal circumstancesâit’s not always possible to wait, particularly if you are in poor health or can’t afford to delayâthe benefits of waiting can be significant.

Be aware that if you decide to wait past age 65, you may still need to sign up for Medicare. In some circumstances your Medicare coverage may be delayed and cost more if you don’t sign up at age 65. If you start Social Security benefits early, you’ll automatically be enrolled into Medicare Parts A and B when you turn age 65.

Your annual Social Security statement will list your projected benefits between age 62 to 70, assuming you continue to work and earn about the same amount through those ages. If you need a copy of your annual statement, you can request one or view it online on the Social Security Administration portal.

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Why Retiring At 62 Is A Good Idea

Probably the biggest indicator that its really ok to retire early is that your debts are paid off, or theyre very close to it. Debt-free living, financial freedom, or whichever way you choose to refer it, means youve fulfilled all or most of your obligations, and youll be under much less strain in the years ahead.

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Your Benefits May Be Reduced Temporarily

If you are over your full retirement age, there is no earnings penalty if you return to work.

“They can make as much as they want and be able to collect Social Security checks,” Elsasser said.

Full retirement age is 66 to 67, depending on your year of birth. The Social Security Administration’s retirement age calculator can help you find out the age at which you will reach eligibility for full benefits.

“In the calendar year you reach full retirement age, you really have a lot more flexibility for working and having earned income, and the penalty is less, too,” Elsasser said.

Even though benefits are reduced for the earnings penalty, those who return to work still stand to make more in the short term, as well as later on when their benefits are increased.

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Myth #: Your Benefits Are Based Only On Wages You’ve Earned Before Age 65

How your Social Security benefit is calculated can seem mysterious. However, it’s important to know a few essential facts to aid your claiming strategy. You can use the tools on SSA.gov to do the calculations.

• Your benefit is calculated based on your highest 35 years of earnings they don’t have to be consecutive years or before age 65.
• If you work past age 65, those earning years will be included, so long as they are high enough to be part of your highest 35 years.
• Even working part-time after turning 65 may be part of your highest 35 years of earnings.
• To be eligible for Social Security, you must have a minimum of 10 years of covered employment , which equates to 40 credits in the Social Security system.
• If you don’t have 35 years with earnings, zeros will be included in the calculation.

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There Are Social Security Survivor Benefits For Spouses And Children

If your spouse dies before you, you can take a Social Security survivor benefit. However, that wont be in addition to your own benefit. You must choose one or the other. If you are at full retirement age, that benefit is worth 100% of what your spouse was receiving at the time of his or her death .

A widow or widower can start taking a survivor benefit at age 60. However, the payment will be reduced because its taken before full retirement age. Theres a twist available assuming the survivor has benefits of their own available and hasnt already filed for them: Take the survivor benefits as early as possible, which is age 60, and switch to your own retirement benefits at age 70. Your survivor benefits will be reduced because you will have filed for them before your full retirement age, but your own benefits will grow, garnering delayed-retirement increases, until age 70. Online programs such as the one offered by Social Security Solutions can help you compare the cumulative benefits for each strategy to determine which one provides the highest payout.

Remarriage has implications here. If you remarry before age 60, you are not eligible for a survivor benefit. If you remarry after age 60, you may be eligible for a survivor benefit based on your former spouses earnings.

Eligible children who are under age 18 or were disabled before age 22 can also receive a Social Security survivor benefit. It would be worth up to 75% of the deceased’s benefit.

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How Is Social Security Calculated

There is a three-step process used to calculate the amount of Social Security benefits you will receive.

Step 1: Use your earnings history to calculate your Average Indexed Monthly Earnings .Step 2: Use your AIME to calculate your primary insurance amount .Step 3: Use your PIA, and adjust it for the age when you will begin receiving benefits.

You can use a copy of your Social Security statement that provides your earnings history to plug your own numbers into the formulas below.

Can I Collect My Retirementbenefits Early

You can start collecting Social Security as early as age 62 but theres a catch. If you collect before you reach your full retirement age , youll receive a lower monthly payment permanently. For example, if your FRA is 67, but you begin to claim benefits at 62, youre signing up to get 30% less. However, this reduction will decrease for each month you wait after age 62, up until your FRA. Think of your FRA as your break-even point.

Age to receive full Social Security benefits2

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Your Social Security Money Is Based On Your Income

The amount of money you make during your career plays an important role in determining how much money youll receive from Social Security. If you work a total of 45 years, only the highest 35 years of earnings would count toward your benefit amount. For example: If you earned $35,000 for the first 10 years of your employment history and $55,000 for 35 years, only the $55,000 income would count .

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Four Ways Benefits Can Be Increased Or Decreased

There are four ways the starting benefit can be permanently increased or reduced from the PIA calculated at age 62:

• Starting benefits earlyBenefits may begin as soon as age 62, but they are permanently reduced for every month between the onset of benefits and FRA.
• Delaying benefits beyond full retirement ageDelayed retirement credits can permanently increase benefits, and they are awarded for every month between FRA and a later onset of benefits.
• Starting early and continuing to workIf you start benefits before your FRA and keep working, the SSA may deduct the part of your benefits that exceeds a threshold. However, any such deductions are not permanent. When you reach your FRA, the SSA recalculates your benefits and credits back any deductions.
• Continuing to work, periodEven if you dont start benefits early, you can increase your benefits by continuing to work up to any age. Any year in which your indexed earnings are higher than one of your 35 previous highest years will boost your benefits. However, after age 60, you will not receive wage indexing, and after age 62, you will not receive bend point inflation indexing.

All four points are related to your starting Social Security benefits. Keep in mind that when your benefits start, the COLA will increase them annually. If you start benefits at age 66, your PIA automatically increases with the applicable COLAs from the years in which you turn 63 through 66.

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How To Calculate Social Security Benefits In Excel

If you are in your late 50s and approaching retirement, you can create a useful model of your future benefits. It works best to do this in a Microsoft Excel spreadsheet, as follows:

• Using a recent Social Security statement, list in spreadsheet column A your taxable Social Security earnings year by year.
• List in column B the most recently published NAWI adjustment factors as published by the SSA.
• Multiply columns A and B and output the result to column C.
• Identify in column D the 35 highest values in column C. Add these together and divide the sum by 420 . This will approximate your AIME.
• Use the most recently published bend points to convert your AIME into a PIA.

You also can fill in hypothetical values for estimated taxable Social Security earnings in future years until you plan to stop working. To be conservative, use a NAWI adjustment factor of 1.0000 in column B for all future years.

A financial advisor who fully understands this process can help verify your calculations, advise you on when to start Social Security benefits, and estimate the future benefits you can expect to receive.

Who Is Eligible For Social Security Benefits

Anyone who pays into Social Security for at least 40 calendar quarters is eligible for retirement benefits based on their earnings record. You are eligible for your full benefits once you reach full retirement age, which is either 66 and 67, depending on when you were born. But if you claim later than that – you can put it off as late as age 70 – youâll get a credit for doing so, with larger monthly benefits. Conversely, you can claim as early as age 62, but taking benefits before your full retirement age will result in the Social Security Administration docking your monthly benefits.

The bottom line: Youâre eligible for Social Security Benefits if youâve paid into the system for at least a decade, but your actual benefits will depend on what age â between 62 and 70 â you begin to claim them.

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Defining The Social Security Break

Your Social Security break-even age represents, in theory, the ideal point in time to apply for benefits in order to maximize them. Remember, you can begin taking your benefits at age 62 at a reduced amount. But by taking your benefits at this earlier age, youll receive more Social Security checks over your lifetime assuming you reach your desired life expectancy.

On the other hand, delaying your benefits past full retirement age increases them year over year until you reach age 70. Currently, the full retirement age for most people is either 66 or 67 years old, based on Social Security Administration guidelines. If you wait until age 70 to start claiming your benefits, youd receive 132% of your regular monthly benefit amount. So the trade-off is receiving fewer checks from Social Security but the ones you do get would be larger.

Your break-even age is the point at which youd come out ahead by delaying Social Security benefits. Your actual Social Security break-even age can depend on the number of benefits youre eligible to receive, your tax situation and things like how inflation might affect the purchasing power of your benefits.

Other Sources Of Retirement Income

Home Equity and Real Estate

For some people in certain scenarios, preexisting mortgages and ownership of real estate can be liquidated for disposable income during retirement through a reverse mortgage. A reverse mortgage is just as it is aptly named â a reversing of a mortgage where at the end , ownership of the house is transferred to whoever bought the reverse mortgage. In other words, retirees are paid to live in their homes until a fixed point in the future, where ownership of the home is finally transferred.

Annuities

A common way to receive income in retirement is through the use of an annuity, which is a fixed sum of periodic cash flows typically distributed for the rest of an annuitants life. There are two types of annuities: immediate and deferred. Immediate annuities are upfront premiums paid which release payments from the principal starting as early as the next month. Deferred annuities are annuities with two phases. The first phase is the accumulation or deferral phase, during which a person contributes money to the account . The second phase is the distribution, or annuitization phase, during which a person will receive periodic payments until death. For more information, it may be worth checking out our Annuity Calculator or Annuity Payout Calculatorto determine whether annuities could be a viable option for your retirement.

Passive Income

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Social Security Information You Can See Online

When you sign in to your online account, youll be able to view your Social Security statements. If you dont yet receive benefits, youll see an estimate of the amount you could receive when you do retire.

Theres a table that shows your monthly benefit amounts if you retire for instance, if you were born in 1960 or later, your chart may show retirement at 62 years old , 67 years old and 70 years old . Note that these retirement ages may change in the future. The longer you wait to retire, the more money you could receive per month.

You can also see your eligibility and earnings information. If youve worked at least 10 years, youll have enough work credits you need 40 to receive benefits. If you click on Review your Earnings Record, youll see your taxed Social Security and Medicare earnings for each year you worked.

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