Searching through the internet, I’ve noticed a lot of confusion regarding the way retirement benefits are calculated by the Social Security Administration (SSA). I’ve read articles online that claim the SSA uses your highest 5 or 10 years of earnings. This is not the case, and basing your own calculations on this misinformation will lead to inaccurately high results.
Official calculations of your monthly benefits are based on your highest 35 years of indexed earnings. Even if you have not accumulated 35 years earnings the SSA still uses the 35 year average to compute your monthly payment. Here is how it works…
First, an index factor (also called an inflation factor) is used to determine today’s value for each year of your past wages. This index factor is applied to all annual earnings through the year you turned 59. Earnings after age 59 are taken at face value and therefore not applied to the index factor.
Next, your highest 35 years of earnings are added together and divided by 420 months to calculate your average MONTHLY indexed wage. From there, the average monthly indexed wage is broken into a maximum of 3 bend points. These bend points were created to limit the amount of benefits the highest earners could receive. Bend points also insure that low wage earners receive a larger percentage of their average monthly income during retirement.
The first bend point is $885 for 2017. You receive 90% or a maximum of $796.50 toward your full retirement age benefit in this earnings bracket. The second bend point is calculated between $885 and $5,336 for 2017. In this bracket you receive 32% or a maximum of $1,424.32 toward your full retirement benefit. The third and final bend point includes average wages over $5,336. You get 15% of earnings in this bracket, and there is no maximum since it is based on your lifetime average wage.
The final step in calculating your monthly retirement benefit is to add all of your bend points together, which will equal your monthly benefit amount. A simple example would be someone who averaged a monthly income of $5,336 over their highest 35 years of earnings. This person would receive about $2220 every month for the rest of their lives, assuming they waited until full retirement age to apply for benefits.
The downside of not having 35 years of indexed earnings is that it adds zeros to your average annual income calculation. This can significantly reduce your retirement benefits if you have several years of no earnings. Most people in this situation would likely rely on spousal benefits, or opt to keep working as long as possible to replace some or all of the zero-earning years.
Keep in mind that the SSA will review your benefits calculation every year to check for increases. Thus, it is possible to positively influence your averages if you are making full time wages. However, if you are continuing to work for this reason then you should wait until full retirement age in to avoid the earnings cap.