Unraveling the Numbers: A Comprehensive Guide to Social Security Benefit Calculation

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Social Security benefits are one of the cornerstones of anyone looking to retire in the US. A retiree's Social Security benefit provides them with a monthly stream of income that adjusts each year for inflation and lasts for as long as they live. While the actual formula used is complex and beyond the scope of this article, understanding the major components of the calculation will help maximize your Social Security benefits over your lifetime.

Key Ideas

Understanding the Basic Formula

Your Social Security benefit is based on two primary factors – how much you earned and when you claim your benefits.

How much you earn is determined by how much of your income is subject to social security taxes (FICA or SECA). Both wage earnings and self-employment can be subject to social security taxes. It’s important to understand this concept because strategies to reduce income subject to these taxes can also reduce your ultimate social security benefit. Additionally, there are certain individuals whose primary income is not subject to social security at all and would have a notably lower social security benefit. The Social Security Administration (SSA) looks at 35 years of your top earnings to determine your benefits.

The SSA then takes this monthly amount and runs it through a formula called the “Primary Insurance Amount Formula” to generate, you guessed it, your Primary Insurance Amount, which is one of the most important numbers to have.

Finally, when you claim impacts how much your benefit is. In general, the earlier you claim, the lower your social security benefit. The later you claim, the higher your social security benefit.

Here is an illustration:

Now that you know the very basics, let’s dive into the steps in more depth and learn about how each component and calculated.

Step 1 - Calculate your Average Indexed Monthly Earnings (AIME)

Average

As you learned above, the SSA uses the average of your top 35 years of earnings as a start to calculating your benefits. Let’s assume your top 35 years of earnings is equal to $100,000 each year.

What if you worked less than 35 years? If you worked fewer than 35 years, the SSA will still use 35 years for your calculation. However, they will use a zero for years you did not report earnings. For example, if you earned $100,000 for 30 years and then stopped working, your average earnings while working was $100,000, but the average for social security is $85,714 because the formula uses 30 years of $100,000 and 5 years of $0.

What if you worked more than 35 years? In the case of working more than 35 years, the SSA still only uses 35 years in your formula. Any extra years are simply not used. These are called “Drop Out” years as they are just dropped out of the formula. The SSA will still choose the top 35 years out of all 40 years. For example, if you worked 40 years with 20 of those earning $50,000 and 20 of those earning $100,000, your average earnings over your entire career is $75,000, but the average used for your benefits is $78,571. This is because it used 20 years of $100,000 and only 15 years of $50,000.

Indexed

Most people do not make the same amount of money for their whole life. When you start your career, your income is generally lower, but along the way, you hopefully receive pay increases through promotions and cost of living adjustments or inflation adjustments. After all, $50,000 earned in 1980 is different from $50,000 earned today! In fact, if you were making $50,000 in 1980, it was equivalent to making $184,079 in 2023. $50,000 in 1980 → 2023 | Inflation Calculator (officialdata.org)

To equalize this, the SSA indexes (adjusts your past earnings up to current dollars) and chooses your top earnings from the new indexed amounts. For example, if you had earned $50,000 in 1980 and you earned $150,000 in 2023, Social Security would use the $50,000 you earned in 1980 over the amount you earned in 2023. Even though you earned triple the amount in 2023 than you did in 1980, the inflation-adjusted earnings in 1980 are higher.

The actual process of indexing earnings has several nuances, such as what inflation rates are used, when the indexing occurs, and what happens after the indexing year. However, for the purposes of this article, these are not covered.

Monthly

Finally, these average indexed earnings are converted to monthly income to arrive at the Averaged Indexed Monthly Earnings or AIME.

Step 2 - Calculate your Primary Insurance Amount (PIA)

Once you have your AIME, you can calculate your Primary Insurance Amount or PIA. Your PIA is a very important number as it is not only used to calculate your own benefit but also spousal benefits, survivor benefits, and child benefits, if applicable.

At its core, your PIA represents the benefit you would receive if you claimed your benefit at your Full Retirement Age or FRA. The FRA is the age at which you will receive 100% of your PIA as determined by the SSA—no more… no less. The FRA is determined by the year you were born, with most people now being at a FRA of age 67. Click this link to see a table with all of the years and ages: Full Retirement Age Chart by SSA.gov

To calculate the PIA, you run the AIME through the Primary Insurance Amount Formula, which is a formula that applies percentages to income level bend points. It’s easier to understand when you can see it.

The formula uses a concept called Bend Points which is a fancy way to say a different benefit amount applies to different income levels. For 2023, the SSA lists two bend points – the first bend point is 90% of AIME up to $1,115, and the second bend point is 32% of AIME up to $6,721. Anything in excess of this will receive a 15% benefit up to the maximum. For 2023, the maximum allowable income for social security is $160,200, meaning AIME will be capped at $13,350. Benefit Formula Bend Points (ssa.gov)

The below chart shows how different levels of AIME impact your ending PIA. Income under the first bend point increases the PIA at the fastest rate because 90% of the earnings are translated to the PIA amount. After that first bend point, the benefits still increase but at a slower rate.

See the PIA Formula In Action

Let’s compare the PIA for two different average incomes: $72,000 per year or $6,000 per month and $144,000 per year or $12,000 per month.

$72,000 yields a PIA of $2,566 per month while $144,000 yields a PIA of $3,589 per month. At almost double the monthly income, the benefit only increases by about 40%.

It’s notable to point out that a large portion of each of these benefits comes from the first tier of the formula making filling out the first Tier the most important.

Income	Total Benefit	Percent Attributed to First Bend
72,000	2,566	39.1%
144,000	3,589	28.0%

Step 3 - Adjust the PIA for When You Claim

The last step in calculating your Social Security benefits is adjusting them for when you claim. Remember that your Full Retirement Age (FRA) is the age at which you receive 100% of your PIA. For example, let’s assume your PIA is $1,000 per month and your FRA is 67 but you want to claim at a different age. The SSA has another formula available that calculates the benefit if you claim at a period other than age 67.

The reduction formula is broken down into three different periods: two that reduce the benefit and one that increases. These formulas capture the full range of possible claiming ages from the earliest, currently age 62, to the latest, currently age 70.

Claiming Early: If you claim your benefit before your FRA, your benefit will be reduced by the formula but the number of months you claim early. The reduction that applies first is “5/9 of 1%” for each month you claim early up to 36 months. What this means, is that for each month you claim early, your benefit is reduced by .00555555%! Odd, I know. Here is an example, if you claimed 1 month early, your benefit would be reduced by “5/9 of 1%” times 1 month times your PIA ($1,000) which equals $5.55 resulting in an actual benefit of $994.45. If you claimed 20 months early, your benefit would be reduced by “5/9 of 1%” times 20 months times your PIA which equals $111.11 so your benefit would be $888.89. You continue this up to 36 months were the maximum reduction 20%.

Then you proceed to the next reduction formula which is “5/12 of 1%” for up to 60 months! This basically takes you all the way up to the earliest claiming date of Age 62. For example, if you claimed at age 62 or 60 months early, you would multiply “5/9 of 1%” by 36 months to get $200 and then multiply “5/12% of 1%” by 24 months to get $100. Add the two reductions together to get $300 as the maximum reduction to your PIA which results in a benefit of $700 per month.

Delaying: If you delay your benefit after your FRA, you receive a delayed retirement credit up to a maximum age of 70. The delayed retirement credit is expressed in the same way as the reduction formula. For every month you delay past your FRA, your benefit is increased “2/3 of 1%”. For example, if you waited 12 months after your FRA, your benefit would be increased by “2/3 of 1%” times 12 months times your PIA which equals $80 so your new benefit would be $1,080 per month. If you delayed to the maximum of age 70, your benefit would be increased by “2/3 of 1%” times 36 months times your PIA which equals $240. In this case, your maximum benefit would be $1,240 per month.

Summary and Helpful Ideas

Understanding your Social Security benefits helps to make the most of this important pillar of your retirement income picture. This article shows that while calculating your benefit in concept is easy, there are many ways to misstep in practice.

Here are a few Helpful Ideas for making claiming Social Security easier:

Review your annual earnings record to ensure your earnings are reported correctly. This is especially important for those who might have parts of their income exempt from social security taxes or who are self-employed. If there is a mistake, you can correct it early.
Carefully consider how many years of earnings you will have before retiring. If you have any Zero Years, adding a little income to fill them up can increase your benefit substantially.
Consider when you claim and the impact it has on your own benefit and the benefit of others. Delaying your benefits can be an excellent way to increase your guaranteed retirement income for life.
Be aware that various calculators, including SSA’s calculations, make assumptions about the future and your earnings. Make sure you know what those assumptions are and how they impact your plan.

Other Considerations

Social Security has many other factors that are not part of this articles. Spousal Benefits, Earnings Limits, Taxation, Windfall Elimination Provision (WEP), and, Government Pension Offset (GPO), not to mention all of your other sources of income, assets, and spending all factor into your claiming decision. There is no one right answer for everyone but the various factors should weighed against your goals.