Your Social Security benefits are determined by a number of factors, but your earned income over the course of your working life is probably the most important.

Key Takeaways

  • Your Social Security benefits will be based on the income you earned during your working years.
  • Only your 35 highest-earning years will be counted.
  • If you take Social Security before full retirement age, your benefits will be permanently reduced.

How Social Security Benefits Are Calculated

The Social Security Administration (SSA) keeps a record of your earned income from year to year, and the portion of your income that is subject to Social Security taxes is used to calculate your benefits in retirement. The more you earned while working (and the more you paid into the Social Security system through tax withholding), the higher your monthly benefit will be, up to a certain maximum. For 2020, that maximum is $3,790 a month.

If you paid into the system for more than 35 years, the Social Security Administration uses only your 35 highest-earning years and does not include any others in its formula. If you did not pay into the system for at least 35 years, a value of $0 is substituted for any missing years. After you apply for benefits, these earnings are adjusted, or "indexed," to account for past wage inflation, and used to calculate your primary insurance amount (PIA). The PIA reflects the benefit you are eligible to receive once you reach what Social Security calls your full retirement age.

Currently, the full retirement age for anyone born between 1943 and 1954 is 66. For people born since 1954, the age gradually rises until it hits 67 for anyone born in 1960 or later.

The age at which you start collecting your Social Security benefits is also an important factor. Currently, you can begin benefits as early as age 62. However, your benefits will be permanently reduced unless you wait until full retirement age. Conversely, you will receive a higher monthly benefit if you postpone collecting past your full retirement age, up to age 70, when benefits max out and there's no further incentive to delay.

Your Social Security benefits may be partially taxable if your income exceeds a certain amount.

Receiving Social Security Income While Working

If you plan to work in "retirement" and also collect Social Security benefits, some of your benefits may be temporarily withheld, based on your income. Until you reach full retirement age, your benefits will be reduced by $1 for every $2 you earn in excess of $18,240 (for 2020).

In the year you reach full retirement age, your benefits will be reduced by $1 for every $3 you earn above $48,600 (for 2020). Starting with the month you attain full retirement age, your benefits will no longer be reduced. Note that these dollars are not lost forever; instead, your Social Security benefit will be increased to account for them after you reach full retirement age.

Your income from Social Security can be partially taxable if your "combined income" exceeds a certain amount. Combined income is your gross income plus any nontaxable interest you earned during the year, plus one-half of your Social Security benefits. For example, if you're married, file a joint tax return with your spouse, and your combined income is between $32,000 and $44,000, you may have to pay tax on up to 50% of your Social Security benefits. If your combined income is greater than $44,000, up to 85% of your benefits may be taxable.