Planning is a central component for a happy retirement, and Social Security is a part of that plan for most seniors. But few people understand exactly how these benefits are calculated. The formula tends to favor lower-income seniors, but higher-income retirees can still expect a pretty nice check in the mail every month. To show you what I mean, let’s consider someone with an average annual income of $100,000.

How Social Security Benefits Are Calculated

Your Social Security benefits are based on your average indexed monthly earnings (AIME) during your 35 highest-earning years.

The Social Security Administration calculates your AIME by taking your reported earnings for every year you worked and multiplying them by the index factor next to that year in this worksheet. Then, it adds up the 35 years with the highest indexed earnings and divides that by 420 (the number of months in 35 years).

There are a few things worth calling out. First, if you haven’t earned at least 40 credits, you won’t be eligible for Social Security at all.

The definition of a credit varies from year to year. In 2019, you earn one credit for every $1,360 in earnings, and you’re allowed to get a maximum of four credits per year. So to qualify for Social Security, you must have worked for at least 10 years, though the years don’t have to be consecutive.

If you’ve worked for more than 10 years but less than 35, you’re eligible for Social Security but you’ll have zeros factored into your AIME calculation, dragging down your benefit considerably.

Because of the way your AIME is calculated, a single high-earning year won’t make as much of a difference as you might have hoped because it won’t drastically raise your average. Earning more than the Social Security wage base limit also won’t help you increase your benefits because of taxes.

For 2019, this limit is $132,900. Because earned income above this threshold isn’t subject to Social Security tax, the government doesn’t consider it when calculating your benefits. But since our example involves an individual earning $100,000 per year, we don’t have to worry about this for the purpose of the example.

Once you have your AIME, simply plug it into the following formula:

  1. Take 90% of the first $926.
  2. Take 32% of any amount over $926 but less than or equal to $5,583.
  3. Take 15% of any amount over $5,583.
  4. Add up the amounts you get from the three steps above and round down to the nearest dollar.

So to return to our example, retirees with an average annual salary of $100,000 adjusted for inflation over their 35 highest-earning years would have an AIME of $8,333. We take 90% of the first $926 and get $833.40. Then, we take 32% of the next $4,657 ($5,583 minus $926 = $4,657) and get $1,490.24. Finally, we take 15% of the remaining $2,750 and get $412.50. When we add those three numbers and round down, we end up with $2,736 per month, or $32,832 per year.

The Age at Which You Retire Matters

The above calculations assume the individual is retiring at their full retirement age (FRA), which is somewhere between 66 and 67 for most workers today, depending on birth year. You can start Social Security benefits as early as 62, but you’ll receive a reduced amount to reflect the extra months you receive benefits.

If you have an FRA of 66 and you begin benefits at 62, you’ll only get 75% of your scheduled benefit per month, which comes out to $2,052 for the person in the example above. If you have an FRA of 67, you’ll only receive 70% of your scheduled benefit per month, or $1,915 for our example worker.

You can also delay benefits past your FRA and your checks will increase until you hit the maximum benefit at 70. This is 124% of your scheduled benefit per check for an FRA of 67 or 132% for an FRA of 66. If the $100,000 earner chose to delay benefits, that would yield $3,392 per month with an FRA of 67 or $3,611 with an FRA of 66. Those add up to $40,704 and $43,332 per year, respectively.

The Uncertain Future

All of the above information is based on today’s Social Security benefit formula and today’s definition of full retirement age. But it’s possible these could change in the future. The latest Social Security Trustees Report says the program’s trust funds will be depleted by 2035 and it will only be able to pay out 80% of scheduled benefits after that unless the government makes adjustments to the program.

We don’t know what these adjustments will look like, but it seems possible — even likely — that Social Security won’t stretch as far into the future as it does today, at least in its present formula. So it’s essential to prioritize retirement saving on your own to ensure you don’t run out of money.

Social Security isn’t going away entirely, so you will still be able to count on it to cover some of your living expenses in retirement. You can use the above formula to estimate your benefits or create a my Social Security account with the SSA. Use this as your baseline to help you plan how much to save on your own.

— Kailey Fralick

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