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How Social Security Benefits Are Calculated

{ Posted on Nov 15 2010 by Marcus Alston }

A friend and I recently were debating how social security benefits are calculated, so I decided to research the issue.

Social Security benefits are based on earnings earned during your working years. Actual earnings are adjusted or “indexed” to account for changes in average wages from the year the earnings were received.  The Social Security Administration (SSA) then calculates your average indexed monthly earnings during the 35 years in which you earned the most.  The SSA then applies a formula to your earnings and arrives at your basic benefit, also call the “primary insurance amount” or “PIA”. The resulting amount is how much you would receive per month at your full retirement age.

The amount of retirement benefits paid depends on your age when you begin receiving benefits.

The SSA will reduce benefits taken before a person’s normal (or full) retirement age and will increase benefits taken after normal retirement age.

What happens if you work less than 35 years?

The SSA states on its website:

“We use the highest 35 years of earnings to compute an individual’s benefit amount. If the individual does not have 35 years of earnings, we will use all of the earnings on the record. We will factor in an annual total of $0.00 earnings for each of the remaining years.”

Ouch.  If you have worked less than 35 years during your lifetime and you are around retirement age, and you will have less than 35 years of earnings for the calculation and the SSA will use zeros for your earnings for the calculation for each year less than 35!  You may have taken off years to raise the kids or were laid off from work or simply stopped working.  Solution:  Consider working enough additional years so you have a full 35 years of earnings to get rid of the zeros. Consider the below example:

Example:  Bob earned $100,000 for 35 years so his average earnings per year would be $100,000.  Susan also earned $100,000 for 35 years, but for three of those years, she had no income due to staying at home to raise the kids. Her average earnings over 35 years would be $91,428, almost $8,600 less than Bob.  If she works three additional years at $100,000, she will have a full 35 years of earnings, and then her average earnings would rise to $100,000 annually which will help her in the SSA benefit calculation.

Related Article:

Pros and Cons of taking Social Security Early

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