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The Social Security Benefit Calculation Explained

Very few folks approaching Social Security eligibility have an understanding of how that number conveyed to them from the Social Security Administration is calculated, and as a result there are many rumors about the details. It can appear at first glance to be a bit complex, but here’s a quick explanation:

To determine your benefit amount, Social Security uses the 35 highest earning years in your lifetime work record, but only earnings up to the amount you paid Social Security taxes on. They then adjust (index) each of those year’s earnings for inflation, add them up and divide the total by 420 (the number of months in 35 years) to arrive at something called your Average Indexed Monthly Earnings (AIME).  Note here that if you didn’t have at least 35 years of earnings, they will put zero’s in for the years you didn’t earn, which means that your AIME will be smaller if you didn’t work at least 35 years.  Your AIME isn’t actually the amount of your benefit, but it is used to calculate what Social Security calls your “Primary Insurance Amount” or “PIA” – the amount of benefit you will be entitled to at your “Full Retirement Age” or “FRA” (as you can tell, Social Security loves acronyms!).  In true government fashion, the calculation of your PIA uses a formula which includes something called “bend points”, which are several points at which a different percentage of your AIME is used to figure the amount of benefit you would get if you took benefits at your full Social Security retirement age.  And that’s where it stops – if you start taking you benefit at your full retirement age.  But if you retire earlier your benefit will be reduced, as much as 30% at age 62 depending on your FRA.  And if you retire later your benefit will be increased (8% per year until age 70).

Note: If you earned more than Social Security’s maximum taxable amount in any given year, your earnings for Social Security’s purposes for that year will be the maximum taxable amount – the maximum amount on which Social Security taxes were withheld.

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