There are two kinds of people in the world. Those who just want to know the time and those who want to take the clock apart to see how it works. I’m sure most of us fall into the first category. I sure do. But of course, there are always those who need to disassemble that clock, examine it, and then try to put it back together.
And when it comes to Social Security retirement benefits, there also are two kinds of people: those who just want to know what their benefit is going to be and those who want to know exactly how the government comes up with their retirement benefit calculation.
But as I think about it, there is probably a third category of Social Security retirement benefit calculators. It is those people who want a general idea of how their benefit will be figured. They just don’t need all the nitty-gritty details. I think most seniors fall into that category.
For years now, I’ve been providing a relatively simple explanation for those folks. In a nutshell, a Social Security retirement benefit is a percentage of your average monthly income using your highest 35 years of inflation-adjusted earnings.
So, when you file for retirement benefits, the Social Security Administration will look at your earnings history and pull out your highest 35 years. They don’t have to be consecutive. If you don’t have 35 years of earnings, the SSA must plug in an annual salary of “zero” for every year you did not work, until the 35-year base is reached.
However, before they add up those “high 35,” they index each year of past earnings for inflation. And this is where the formula starts to get messy. That’s because there is a different adjustment factor for each year of earnings, AND each year’s adjustment factor is different based on your year of birth.
Here is a quick example. If you were born in 1949 and earned $20,000 in 1980, they would multiply those earnings by an inflation adjustment factor of 3.25, meaning they would actually use $65,000 as your 1980 earnings. But if you were born in 1950 and earned that same $20,000 in 1980, they would use an inflation factor of 3.33, resulting in $66,600 as the 1980 earnings used in your Social Security computation.
You can find a complete breakdown of those inflation adjustment factors for each year of birth (for folks nearing retirement age) at the Social Security Administration’s website: SocialSecurity.gov.
The next step in the retirement computation formula is to add up your highest 35 years of inflation-adjusted earnings. Then you divide by 420—that’s the number of months in 35 years—to get your average inflation-adjusted monthly income.
The final step brings us to the “social” part of Social Security. The percentage of your average monthly income that comes back to you in the form of a Social Security benefit depends on your income. In a nutshell, the lower your average wage, the higher percentage rate of return you get. Once again, the actual formula is messy and varies depending on your year of birth. As an example, here is the formula for someone born in 1949: You take the first $749 of average monthly income and multiply it by 90 percent. You take the next $3,768 of your average monthly income and multiply that by 32 percent. And you take any remainder and multiply it by 15 percent.
You can find a complete breakdown of those computation “bend points” on the Social Security website.
Believe it or not, that was the “simple” explanation for those who just want some idea of how their Social Security retirement benefit will be figured. To summarize, it is a percentage of your average monthly income using your highest 35 years of inflation-adjusted earnings. If this was a college course, think of it as Social Security Benefit Computation 101.
But now I’m going to offer the advanced course. This is the one for the bean counters and clockmakers out there.
I’ll start by introducing the term “primary insurance amount,” or PIA. The PIA is your basic retirement benefit upon which all future calculations will be based. The “raw PIA” is actually calculated at age 62. In other words, when the SSA pulls out your highest 35 years of earnings, they only use earnings up to age 62. Then that raw PIA gets “cooked,” or increased, to take into account any earnings you had after age 62 and to include any cost-of-living adjustments, or COLAs, that were authorized for Social Security benefits after the year you reached age 62.
But it gets a little tricky when the SSA does the re-computation for any earnings you have after age 62. If you worked full time until age 66, for example, you would normally assume that those earnings between age 62 and 66 would definitely increase your PIA. After all, you figure, they are some of your highest earning years, so they will become part of that “high 35.”
But not necessarily. And here is why. For reasons I can’t take the time to explain in this short column, earnings after age 60 are not indexed for inflation. They get calculated at current dollar value only. So, if your “raw PIA” was based on a full 35-year history of high inflation-adjusted earnings, your current earnings may not be high enough to become part of your “high 35,” so they won’t increase your benefit. Or they possibly might bump up the PIA, but not by much.
In fact, I hear from readers all the time (the bean counters and clockmakers) who tell me that they are confused because the benefit estimate they are getting from the SSA now (at age 66, let’s say) is not much more than the estimate they got back at age 62. Their current benefit estimate includes the COLA increases but either little or no bump for their post-62 earnings. The reason why is that lack of inflation indexing after age 60.
As you can see, the Social Security retirement benefit formula is pretty messy. And if you’re not a clockmaker, I say, “Don’t worry about it.” Just let the SSA do it for you. Go to the Social Security website, and click on the “Retirement Estimator” icon on the homepage. It will walk you through the process of finding out what your Social Security benefit will be.
Tom Margenau worked for 32 years in a variety of positions for the Social Security Administration before retiring in 2005. He has served as the director of SSA’s public information office, the chief editor of more than 100 SSA publications, a deputy press officer and spokesman, and a speechwriter for the commissioner of Social Security. For 12 years, he also wrote Social Security columns for local newspapers, and recently published the book “Social Security: Simple and Smart.” If you have a Social Security question, contact him at email@example.com.