Among the most popular Social Security questions that I hear from baby boomers getting ready to retire is "how are Social Security benefits calculated?" This is a vital question because it could affect how long you require to work, whether you need to continue to work during your retirement years, or any other aspects of your retirement plan.
First, please note that you get a Social Security retirement benefit estimate every year in the mail, usually around your birth date. There are also a few calculators available on the Social Security site to assist you estimate how much your retirement benefits will be, so you don't require to know the ways to calculate the benefit yourself.
It's still useful to know how Social Security is calculated, however, so here are the principles:
Generally, your highest 35 years of earnings are indexed for inflation, then averaged to determine the base for your per month benefit. If you worked less than 35 years, the missing years will be calculated as zero for purposes of determining your benefit amount.
Planning tip: If you've near 35 years of earnings and you're close to retirement, you will benefit significantly by continuing to work until you've 35 full years of earnings to include in your benefit calculation. The majority of people this will affect are females who took time off work to raise a family.
The highest 35 years of earnings are then divided by 35 to get your average indexed monthly earnings (AIME). A formula is applied to your AIME to determine your primary insurance amount (PIA). We will not go into the details of the formula; the important thing to note is that your PIA is the completely unreduced benefit you'd receive if you retired at your full retirement age (at the age of 66 for people born between 1943 and 1954). This amount will be reduced if you take early retirement or increased if you retire after age 66.
The Primary insurance amount is also the base for other benefits such as spousal benefits, so it is vital to understand that your Primary insurance amount is not necessarily the same amount that you'll receive. If you're married and your spouse will be collecting benefits based on your earnings instead of her own, then you may need to maximize your own Primary insurance amount to maximize the total Social Security benefits you & your spouse will receive.
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