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Since its inception in 1935, Social Security has been a major source of retirement income for older Americans. Despite the program’s enduring popularity, many potential beneficiaries have no idea how much money they can count on from Social Security once they retire.
Here’s how to find out how much you can earn on Social Security when you retire. We’ll also look at the different factors that come into play when calculating your benefits.
How is social security calculated?
To determine your monthly benefits, the Social Security Administration uses a series of somewhat complicated calculations. Their heart is an inflation-adjusted average of your monthly income from your highest earning years.
This monthly average is performed through an income replacement formula that determines your basic monthly Social Security payment percentage at retirement. This base rate is then adjusted up or down depending on a number of factors, such as your age at which you begin claiming Social Security benefits, your employment status at retirement, your tax bracket, and your Medicare premiums.
If that sounds too complicated, don’t worry. This is how every part of the Social Security calculation breaks down.
How your inflation indexed earnings are calculated
Inflation-adjusted average earnings — officially called your Average Indexed Monthly Earnings (AIME) by the Social Security Administration — adjusts and standardizes your income during your peak earning years.
This inflation-indexed average is calculated by multiplying the income you earned in each of your top 35 earning years by an index factor that normalizes each year’s income for inflation based on the year you turn 60. Social Security uses the National Average Wage Index (NAWI) to determine the indexation factor for each year. The resulting 35 numbers are then added and divided by 420 (12 months x 35 years) to determine your inflation-adjusted monthly average income.
If you have not worked for 35 years, the Social Security Administration uses a zero income for the years you have not earned income when calculating your AIME. You can increase your benefits by continuing to work, shortening your zero earning years and increasing your average.
How your primary insurance amount is calculated
Once you have your AIME, you can calculate your Primary Insurance Amount (PIA), which is the base rate for your Social Security payments. The PIA calculation is based on so-called “inflection points” that determine how much of your income will be replaced by Social Security benefits in retirement.
Think of inflection points as similar to tax brackets in that they determine a percentage of your benefits based on incremental income. There are three inflection buckets: one for 90% of income replacement, one for 32%, and one for 15%.
These inflection buckets help lower income earners have a higher income replacement rate and higher income earners have a lower income replacement rate, says Jim Blankenship, certified financial planner (CFP) and author of “A Social Security Owner’s Manual.
The dollar amounts of inflection points are adjusted for inflation each year, but the percentages of each inflection point are set by law and remain unchanged. AIME amounts are always rounded down to the nearest $0.10. For 2021, the inflection points are:
• 90% of your AIME’s first $996, plus
• 32% of your AIME between $996 and $6,002, plus
• 15% of your AIME above $6.002
For an employee with an AIME of $6,250, the calculation looks like this:
• 90% of $966 = $896.40, plus
• 32% of $5.006 (the difference between $996 and $6.002) = $1,601.92, rounded down to $1,601.90, plus
• 15% of $248 (the difference between $6,002 and $6,250) = $37.20
This employee would earn Social Security benefits of $2,535.50 ($896.40 + $1,601.90 + $37.20) monthly.
When calculating PIA, it’s important to keep a few things in mind. First, there is a maximum PIA. For 2021, that cap is $3,113, meaning that even if your calculated PIA is greater than that, your amount will be set at $3,113. This equates to an AIME of $9,979, which itself is roughly equivalent to an average annual salary of approximately $120,000.
Second, although the dollar limits adjust for inflation each year, this process stops when beneficiaries turn 62, the current federal early retirement age. This basically means that your PIA is set at age 62 unless you have less than 35 years of income or outliers with much lower income than normal. Then your extra earning years can help increase your AIME and by extension your PIA.
And a reminder: your PIA is not the amount you will necessarily receive as your Social Security benefit. It is simply the amount your benefit is based on and can be increased or decreased depending on a number of key factors.
Other Factors Affecting Your Social Security Benefits
While your income history determines your basic Social Security benefit, the amount you actually receive on each monthly check is affected by the following factors:
When you choose to take Social Security benefits
The year — and even the month within that year — you choose to take Social Security benefits affects how much you receive each month. You can start claiming Social Security benefits at age 62, the current early retirement age. But you won’t get your full PIA. It is reduced based on the number of months you have until your full retirement age. This reduction can be quite significant and can be as high as 30% for early claimants in particular.
You can of course avoid these surcharges on your PIA by waiting with payments until you reach full retirement age. This is generally between the ages of 66 and 67, depending on when you were born.
You can even increase your base amount by deferring when you start receiving benefits. After you reach full retirement age, you can increase your benefits by up to 8% of your PIA annually by simply not claiming Social Security. These benefit increases are known as deferred retirement loans and you can accrue them up to age 70.
An important note: these changes in the benefit percentage are done to provide approximately the same cumulative benefit over a lifetime, assuming an approximately average lifespan. In other words, if you start early with Social Security, you’ll likely be able to claim it for longer; someone with the same lifespan who deferred payments would claim them for less time. To give them the same overall benefit, earlier payments must be smaller and later payments must be larger to catch up.
That’s why experts recommend taking your health into consideration when deciding when to call on Social Security. You can get slightly larger benefits by waiting, but if ill health can limit your lifespan, you’d be better off making payments as soon as possible. Conversely, someone in excellent health who expects to live significantly longer than average can earn more by waiting up to 70 years to start Social Security benefits.
Many beneficiaries don’t realize that Social Security benefits can be taxable. The IRS determines this by looking at your provisional income, which is your taxable income (including withdrawals of tax deferred income) plus half of your annual Social Security benefit.
Provisional incomes over $25,000 for singles and over $34,000 for married couples can lead to Social Security benefits taxes. This will not necessarily directly affect your monthly benefit check unless you have withheld taxes.
“If you withheld taxes, your monthly Social Security benefit may be reduced to cover the tax bill when you file your return,” Blankenship says.
Taxes aren’t the only possible deductions from your benefit check. According to Blankenship, “If you’re enrolled in Medicare Part B, Part C, and/or Part D, the premium is deducted from your monthly check.” As of 2021, the standard Share Premium is $148.50 per month. Part C and Part D premiums can vary from insurer to insurer, but you can expect a certain amount of premium cost to be deducted from your Social Security benefit.
If you continue to work, your benefit may also be reduced. “If you are under full retirement age and continue to work while receiving Social Security benefits, there is a limit to the amount you can earn before the rebates are applied,” Blankenship says.
If you earn more than $18,960 in 2021, for every $2 over the limit, $1 will be withheld from your Social Security benefits. In the year you reach full retirement age, this limit changes to $1 in benefits for every $3 you earn over $50,520 until the month of your birthday. Once you reach full retirement age, these limits no longer apply and you can earn as much as you want and receive full benefits. You will also receive all withheld benefits as credits when you reach full retirement age.
Your benefit may even increase from year to year. A cost of living (COLA) adjustment can be made annually to prevent the purchasing power of your benefit from being eroded by inflation. For 2021, the COLA increase is 1.3%. To counter the intense inflation, the COLA could be 6.2% or higher in 2022.
That said, the Social Security Administration is not required to issue a COLA raise every year. Years of low inflation may lead to no increase in COLA.
How to Calculate Social Security Benefits
If you just want an estimate of your benefit, the Social Security Administration provides a quick calculator to give you an idea of your potential benefit. This calculator simply asks for your current annual salary, your date of birth, and your expected retirement date, although you can enter your actual annual income to get a more accurate estimate.
This estimate does not account for early or late claims for benefits, taxes and Medicare, or COLA increases. You will likely need to download the full Social Security Administration calculator or work with a financial advisor to determine your full benefits, taking those factors into account.
Knowing how much you can expect to receive in Social Security will give you an important piece of your retirement income puzzle. With that in hand, you can make the financial plans you need for a safe and satisfying retirement.
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