How Are Social Security Benefits Calculated? Several Points & Factors Affecting The Benefits
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 an important question because it could affect how long you need to work, whether you should continue to work during your retirement years, or any other aspects of your retirement plan.
Firstly, please note that you receive a Social Security retirement benefit estimate every year in the mail, normally around your birth date. There are also several calculators available on the Social Security website to assist you estimate how much your retirement benefits will be, so you do not need to know the ways to calculate the benefit yourself.
It's still helpful to know how Social Security is calculated, however, so here are the basics:
Basically, your highest 35 years of earnings are indexed for inflation, then averaged to figure out the basis 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 have close to 35 years of earnings and you're close to retirement, you'll benefit greatly 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 women who took time off work to raise a family.
The top 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 figure out your primary insurance amount (PIA). We won't go into the details of the formula; the vital thing to note is that your PIA is the full unreduced benefit you would 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 decreased if you take early retirement or increased if you retire after age 66.
The PIA is also the base for other benefits such as spousal benefits, so it's important to understand that your Primary insurance amount is not always the same amount that you will receive. If you're married and your spouse will be collecting benefits based on your earnings instead of her own, then you may want to maximize your own PIA to maximize the total Social Security benefits you & your spouse will receive.
Don't Forget About The Social Security Spousal Benefit
Can a spouse collect on her husband's social security if she reaches retirement age before her husband? No. In order for a wife to collect Social Security benefits on her husband's earnings the following requirements must be met:
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