Social Security has grown from its humble origin in the Great Depression to become a key source of income for millions of retirees today. But how are these benefits calculated on a per-person basis? There are several factors that come into play when it comes to calculating Social Security benefits. Here is a breakdown of those factors and how they are used to determine the monthly benefit of a given retiree.
There are four key factors that determine the monthly benefit amount for a retiree. They include: These four factors are the variables that go into the Social Security benefit calculation. But to even be eligible to receive benefits, the worker must have been gainfully employed for at least 40 three-month quarters of time. And in each quarter, the employee must have earned at least a certain amount (that is indexed for inflation each year) in order for that quarter to count towards receiving benefits. And in all 40 of those quarters, the worker must have paid either the 6.2% Social Security tax if he or she was a W-2 employee or 12.4% if he or she was self-employed. The purpose of the calculation is to adjust your career earnings to reflect the changes in general wage levels that took place during the years of your career. The job that paid a worker a $300 monthly income 40 years ago, would yield quite a bit more today. Social Security says that the adjustments "ensure that a worker's future benefits reflect the general rise in the standard of living that occurred during his or her working lifetime." Calculating Social Security benefits is a three-step process, broken down as follows:Calculating Social Security Benefits
Factors That Determine Social Security Benefits
How to Calculate Social Security Benefits
That means that if the worker worked for 40 years, Social Security would use the worker's highest-paid 35 years in its calculations and ignore the other five.
The worker's highest 35 years of earnings are used to calculate a monthly average. This amount is called the Average Indexed Monthly Earnings (AIME).
With this formula, the first amount of the worker's earnings are multiplied by 90%, the next amount is multiplied by 32% and any amount above this is multiplied by 15%. The amounts themselves are indexed annually for inflation.
If the worker wants to begin collecting benefits at age 70, the PIA is increased by 32%.
How Are Social Security Benefits Calculated? FAQs
Social Security benefits are based on a calculation that takes into account an individual's earnings history, age of retirement, and other factors such as whether or not the individual was married.
The Social Security Administration looks at your highest 35 years of earnings when calculating your benefits. Your average indexed monthly earnings (AIME) are then used to determine the number of your benefits.
Your age affects when you are eligible for Social Security benefits. Additionally, benefits are higher for those who wait to claim them until their full retirement age or beyond.
Other sources of income can affect the amount you receive in Social Security benefits if they exceed certain thresholds. In addition, there are special rules that apply to certain types of earned income.
Yes, the maximum amount that an individual can receive in Social Security benefits is determined by the law and is adjusted for inflation each year. For 2021, the maximum benefit for someone retiring at full retirement age is $3,148 per month.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
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