How is Social Security Calculated?

Social Security Benefits Calculation Overview

The Social Security benefits for retirees are determined based on several factors, including their 35 highest-earning years after adjustment for inflation. This adjusted average is known as AIME (Average Indexed Monthly Earnings). The PIA (Primary Insurance Amount) is calculated using a formula applied to this average earning. (1) This gives the actual Social Security benefits the person is eligible for. However, the PIA is not the final benefit amount; it’s the base figure from which actual benefits are calculated, considering factors such as retirement age.

As of the latest data from the Social Security Administration, the average monthly Social Security benefit for retired workers is approximately USD 1,833. This figure is subject to change annually with cost-of-living adjustments. Retired dependent spouses are entitled to an average of USD 898, while disabled workers receive around USD 1,483 monthly. Additionally, a widow gets around USD 1,711, while a surviving child dependent receives up to USD 1,070 monthly as Social Security benefits.

Social Security benefits are among the significant sources of income for the growing retired population in the United States. Almost every American contributes to the Social Security Administration, which assures a string of benefits on retirement from active employment.

If you wonder how social security is calculated, this article will help. Here, we have detailed the simple formula to calculate your Social Security benefits after retirement.

Formula to Calculate Social Security Benefits

The formula to calculate Social Security benefits involves percentages applied to different portions of the AIME, but the specific dollar amounts (bend points) and percentages can change annually. This is the latest formula that the federal government used to calculate Social Security benefits for people born after 1960:

Take the first USD 1,115 of the AIME and multiply it by 90%
Choose any amount between USD 1,115 and USD 6,721 and multiply it by 32%
Select any amount over USD 6,721 and multiply it by 15%
Take the total from the above three steps and round it to the nearest USD 0.10

Steps to Calculate Social Security Benefits

A simple way to know how much your Social Security checks will be worth at a certain age is to use the information from your Social Security account on the SSA website.

However, if you want to learn how exactly the SSA calculates Social Security benefits, you need to follow these steps:

1 – Find your wages during employment

The SSA monitors the income you have earned and the portion from it you contribute towards Social Security taxes each year. My Social Security account on the SSA website will give you this amount.

The actual income and the Social Security taxes paid on it are usually the same. However, this might change with higher-earning individuals.

For instance, in 2022, you only needed to pay Social Security taxes on the first USD 147,000 earned. But in 2023, the maximum taxable income was raised to USD 160,200. So, don’t be surprised if your 2022 earnings show your income as USD 147,000, even if you earned more.

2 – Adjust wages for inflation

The AWI (Average Wage Index) corrects wages according to inflation. This allows the government to calculate the years you earn more income accurately. The SSA website lists AWI for all years, with data available from 1951 onwards.

The Average Wage Index (AWI) used to adjust your earnings is based on the AWI two years before the year of your 62nd birthday, not when you turn 60. This adjustment ensures that your earnings are considered in the context of national wage trends at a significant point in your career. You need to divide this AWI by the AWI for the year in question. This gives your index factor. Now, multiply this index factor by your income, and you will get accurate index-adjusted wages.

If this seems difficult, you can simply use the AWI calculator provided at the SSA website here https://www.ssa.gov/OACT/COLA/awifactors.html and find your adjusted wages as per inflation.

3 – Figure out your AIME

Once you have adjusted income for inflation, you can calculate the total income from the past 35 years of earnings. If you have not worked for 35 years, the SSA calculates your AIME by adding zeros for each year short of 35 to ensure the calculation is based on 35 years. This total income is then divided by 420 (the number of months in 35 years) to calculate the AIME, regardless of whether those were consecutive years or years with no earnings.

Though the AIME may seem lower than expected, you may have to factor in the durations when you have no income.

4 – Use the formula for Social Security benefits

The next step after getting your AIME is to use the Social Security benefits formula described earlier. Just make sure to use the formula prescribed for your age. To do this, it is generally correct to be aware of the formula in effect the year you turn 62. However, it’s more accurate to say that your benefits are calculated based on the rules and formulas in effect in the year you claim them. This is applicable even if you did not sign up for benefits at that age.

The total from this formula gives your PIA. You will also receive this benefit if you sign up at your FRA. On the other hand, if you sign up after or before your FRA (Full Retirement Age), you need to follow the additional steps to calculate your Social Security benefits on retirement.

5 – Adjust PIA as required

The Full Retirement Age (FRA) varies by birth year:

For those born between 1943 and 1954, the FRA is 66 years.
For those born from 1955 to 1959, the FRA increases gradually from 66 and 2 months to 66 and 10 months.
The FRA is 67 years for those born in 1960 and later. However, it increments by months for those born from 1955 to 1959.

So, if you claim your Social Security benefits early, then your benefits will be reduced by:

5/9^th of 1% per month for a maximum of 36 months
5/12^th of 1% for extra months (if claimed before 36 months)

6 – Calculate the exact Social Security benefits amount

The last step is to round your total to the nearest dollar. This gives you the exact take-home benefits from your Social Security plan.

Conclusion

The Social Security Administration (SSA) calculates total benefits using a special formula. This involves entering your total earnings, the age you apply for benefits, taxes paid towards Social Security, etc. You can find your wages during the employment period, adjust for inflation, and use the formula to calculate how much of your benefits you will receive from your Social Security account upon retirement.

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