There are a lot of misconceptions about how the Social Security Administration computes an individual’s monthly benefit. This is done by computer by the Administration but it is helpful to understand how your benefits are calculated. With this knowledge, you can insure that your benefits are correct, determine any effect a pension not covered by Social Security has on your benefit, and it will allow you to consider a lot of “what if” scenarios.
To do your own calculation you will need to know several things. First you need to know what your Social Security earnings were in each year you worked. Use all of your earnings no matter how long ago you earned them. Second you will need to know the indexing percentages the Social Security Administration uses to bring your past earnings up to “today’s dollars”. Third you will need to know the bend point figures the Social Security Administration uses to determine your monthly benefit.
Ideally you still have a copy of the last Social Security statement the Social Security Administration sent you (pictured above). They are mailed every 5 years (25, 30, 35, etc.) until age 60 when they are mailed yearly until you file for benefits. They are still available online at www.socialsecurity.gov. Yes, you can get an estimate of your retirement benefits using SSA’s retirement estimator tool. But it does not provide the same information found in the Social Security written statement.
The newly launched My Social Security website gives everyone instant access to their personal Social Security data, including lifetime earnings and potential benefits as they are currently recorded.
“My Social Security Website” can be found at https://secure.ssa.gov/RIL/SiView.do
This new online feature provides a similar service to the paper statements that were once mailed out annually. It is accessible to anyone with a Social Security number who is 18 years of age or older. Registration is done directly through the website and the following information can be found once you are logged in…
– Your Lifetime Social Security Earnings
– Estimated Benefits for Retirement, Disability and Survivors
– Estimated Taxes Paid for Social Security and Medicare
– Additional Planning Information for Retirement and Medicare
A final option, and one that I DO NOT recommend using, is the retirement estimator tool online at https://www.ssa.gov/benefits/retirement/estimator.html
While this tool may appear to be a handy shortcut, it is not very transparent and therefore is not a reliable means for ensuring accuracy. Yes, you can get an estimate of your retirement benefits using SSA’s retirement estimator tool. But it does not provide the same information found in the annual written statement. Omissions include estimates of disability, survivor’s benefits and your complete earnings record. Furthermore, younger Americans who do not have 40 quarters of credits are not even permitted to use the tool. The bottom line is that the statements and the information at “My Social Security” are the two best sources to check for errors on your account.
When reviewing your lifetime earnings, keep in mind that the Social Security Administration measures earnings as wages and/or net earnings from self-employment. Other types of income, such as investment income, are not included. There is also a maximum earnings cap for each year. Any amount you earned over the maximum earnings cap does not get taxed for Social Security. You will see the annual breakdown of the maximum earnings thresholds when I get into the example computations later in this section.
Components of the Social Security Benefits Formula
In addition to your complete earnings record, you also need to know your Indexed Earnings and Bend Points in order to calculate your monthly retirement benefit at full retirement age. Let’s take minute to examine what these numbers are and how they are used in the benefits formula.
Indexed Earnings
Social Security uses your highest 35 years of indexed earnings to determine your average indexed monthly wages. Indexed earnings are a representation of your past earnings in today’s dollars. Using such indexing ensures your future benefits reflect the general rise in the standard of living that occurred during your working lifetime. The Social Security Administration uses the National Average Wage Index (NAWI) to index earnings for benefit applicants.
NAWI indexing depends on the year in which a person is first eligible to receive benefits. For retirement, eligibility is at age 62. If a person reaches age 62 in 2017, then 2017 is the person’s year of eligibility. An individual’s earnings are always indexed to the average wage level two years prior to the year of first eligibility; earnings in the year you obtain age 60 or later will be taken at face value.
For 2019, the indexing factors are:
We will use these indexing factors in a bit when I run through the benefits calculation examples.
Bend Points
A three-tiered benefit formula determines a monthly benefit based on your Averaged Indexed Monthly Earnings (AIME). It is designed to replace a higher percentage of earnings for people at lower levels. At higher levels of earnings the formula provides higher benefits, but the percentage of the benefit relative to AIME declines. The earnings levels where percentages change are called “bend points” because a graph of the benefits would have a bend in the line at those points.
The Bend Points Formula provides 90% of AIME up to the first bend point, 32% from there up to the second bend point, and 15% above the second bend point. Bend points are adjusted each year for inflation. For 2019 these portions are the first $926, the amount between $926 and $5,583, and the amount over $5,583. Note that these are applied to your monthly earnings, so they correspond to annual income 12 times that amount ($11,112 for the first bend point and $66,996 for the second bend point).
Example 1: Your AIME is $3,000. If you retire in 2019 your benefits would be…
.9(926) + .32(3,000 – 926) = $1,497.08 (before rounding)
This is the monthly retirement benefit you receive if you retire at full retirement age.
Example 2: Your AIME is $6,000. If you retire in 2019 your benefits would be…
.9(926) + .32(5,583 – 926) + .15(6,000 – 5,583) = $2,386.19 (before rounding)
*All monthly benefit amounts are rounded down to the next dime.
So what you see here is a worker with lower wages will replace a higher percentage of those wages with their monthly benefits (50%). And even though the worker with higher wages gets a larger monthly benefit, it replaces a lower percentage of wages (39.7%). This disparity in percentages grows wider for workers with even higher AIME than those covered in example 2.
The table below shows the official bend points for the last few years…
Example Benefits Calculations
Okay, so we have discussed the core components you need to calculate your monthly benefits. You have a record of your lifetime earnings. I gave you a chart with the Index Factor for each year of earnings. And we know the Bend Points for 2019. Now it is time to plug this information into the standard benefits formula.
Example 1: Maximum Earnings Worker
A maximum earnings worker is someone who has earnings that exceeded the Maximum Earnings threshold for Social Security taxes. Assume our worker was born in 1957 and became age 62 in 2019.
Step 1: Enter the actual earnings in Total Earnings column but do not enter more than the
Maximum Earnings column.
For example, even though our worker earned $5,000 in 1962 they would only enter $4,800 in the Total Earnings column because that is the maximum amount on which they paid social security tax for that year.
Step 2: Multiply the Total Earnings Column by the Index Factor and enter results in the Indexed Earnings column.
Step 3: Choose the highest 35 years and add these amounts together.
The highlighted years in the table above represent the highest 35 years of indexed earnings. When added together the sum is $4,324,331.46.
Step 4: Divide the total from Step 3 by 420 (35 years times 12) and round down to the next lowest dollar. This will give you the Average Indexed Monthly Earnings (AIME).
$4,324,331.46 / 420 = $10,296.03.
Step 5: Multiply the first $926 of the AIME by 90%. This is the first bend point.
$926 * .90 = $833.40
Step 6: Multiply the amount of the AIME over $926 and less than or equal to $5583 by 32%. This is the second bend point.
($5,583 – $926) * .32 = $1,490.24
Step 7: Multiply the amount of the AIME over $5,583 by 15%.
($10,296 – $5,583) * .15 = $706.95
Step 8: Add the totals from 5, 6, and 7 and round down to the next lowest dollar. This is the monthly retirement benefit at full retirement age.
$833.40 + $1,490.24 + $706.95 = $3,030.59 rounded to $3,030.00.
Not too difficult, right? Now let’s do another example with a different tier of lifetime earnings.
Example 2: Worker with Middle Income Worker
A middle income worker is someone whose earnings that DO NOT exceed the Maximum Earnings threshold for Social Security taxes. Assume our worker was born in 1957 and became age 62 in 2019.
Step 1: Enter the actual earnings in Total Earnings column but do not enter more than the Maximum Earnings column.
In this example we do have to be concerned about Maximum Earnings because all of the workers’ wages fall under the maximum.
Step 2: Multiply the Total Earnings Column by the Index Factor and enter results in the Indexed Earnings column. We will simulate this step.
Step 3: Choose the highest 35 years and add these amounts together.
The highest 35 years in our simulation equal $1,520,356.81.
Step 4: Divide the total from Step 3 by 420 (35 years times 12) and round down to the next lowest dollar. This will give you the Average Indexed Monthly Earnings (AIME).
$1,520,356.81 / 420 = $3,619.19
Step 5: Multiply the first $926 of the AIME by 90%. This is the first bend point.
$926 * .90 = $833.40
Step 6: Multiply the amount of the AIME over $926 and less than or equal to $5,583 by 32%. This is the second bend point.
($3,619.00 – $926) * .32 = $861.76
Step 7: Multiply the amount of the AIME over $5,583 by 15%.
Does Not Apply
Step 8: Add the totals from 5 and 6 then round down to the next lowest dollar. This is the monthly retirement benefit at full retirement age.
$833.40 + $861.76 = $1,695.00
Now you should have a good grasp of how to calculate your monthly benefit at full retirement age (FRA). There are of course other options besides waiting until you reach FRA, and these will be covered in the sections ahead.
The big takeaway of this section is the fact that you can calculate your benefits yourself. Having access to your most recent Annual Social Security Statement will save you considerable time by providing a log of your earnings. All you need to do from there is follow the formula outlined above.
Perhaps the best part of learning the benefits formula is you won’t have to rely on anyone else for answers. The phone lines and walk-in traffic at your local Social Security office will cost you hours of wait time. And through all that waiting you might not even get a direct answer to your question! The government is deflecting the responsibilities to you for getting the information about your case. The rest of my guide will help you become proactive and self-sufficient in these matters.