If you are a typical U.S. worker nearing retirement, you have been shoveling money into the Social Security system through payroll or self-employment taxes for decades. It's possible that you and your employer together have contributed more than $200,000 into the system on your behalf over time. If you also figure in the time value of money on these contributions, your total contribution to the system could be twice as much. Now the time is approaching to turn the tables and determine what the Social Security Administration (SSA) owes you.

Key Takeaways

  • There are four ways to figure out your Social Security benefits: visit a Social Security office to get an estimate; create an account at the official Social Security website and use its calculators; let the SSA calculate your benefits for you; or calculate your benefits yourself.
  • Doing the calculations for yourself involves understanding what AIME, NAWI, bend points, PIA, and COLA are, and applying them.
  • If you create a model of your future benefits in a spreadsheet, use a financial advisor to check your math and help you decide at what age you should retire.

Anticipating Your Social Security Income

Two facts are known—Social Security benefits are not guaranteed, and some changes will be necessary to keep the system solvent in the future, as millions of baby boomers retire and begin to receive their Social Security benefits.  While these facts add uncertainty, it's also true that the quality of your retirement depends on your planning—and you must start planning somewhere.

A good starting point is to figure out the amount of retirement benefits that all your years of Social Security contributions entitle you to under current law. There are four ways to do this:

  1. You can visit a local Social Security office to get a record of your taxed Social Security earnings and an estimate of retirement benefits (though it won't take into account future earnings or other changes that could impact your monthly payouts).
  2. You can visit the Social Security website and use one of its online benefits calculators to determine your retirement estimate based on your earnings record.
  3. You can wait until you decide to start receiving benefits and let the SSA calculate the amount for you. However, this doesn't help you plan ahead. And while the SSA can usually be counted on to determine benefits accurately, mistakes can be made.
  4. You can calculate your own benefits using the step-by-step process described in this article. Once you understand a few basic concepts, it's not that difficult. One advantage of calculating your own benefits is that you can make decisions and consider trade-offs, such as whether you can afford to retire early or how much you can increase your benefits by continuing to work. 

Step 1: Calculate Your AIME

One important idea behind Social Security is that workers can keep earning benefits for every dollar they pay into the retirement system for as long as they keep working. A non-working spouse qualifies for half of the working spouse's benefits, so each extra dollar a worker earns can actually be worth 1.5 times the benefits.

This idea is embedded in the first step, the calculation of your average indexed monthly earnings (AIME). It begins with the column on your Social Security statement that shows "Your Taxed Social Security Earnings" year by year. Next, you multiply each year's earnings by a factor based on the National Average Wage Index (NAWI) for that year. This effectively adjusts past years' contributions for wage inflation, making them more comparable to recent years.

The Social Security Administration publishes a new table of wage indexing factors each year, based on the current NAWI. The table that matters for your benefit calculation is the one published the year you turn 60. Any wages you earn after age 60 can increase your benefits, but they are assigned a NAWI table factor of 1.0000, which means they are not adjusted for future wage inflation.

The table below helps to explain the AIME calculation for a worker born in 1954 who plans to retire in 2021 at age 66, their full (or normal) retirement age. It assumes the employee has worked from 1980 through 2020.

Earnings before and after indexing
Year Nominal earnings Indexing factor Indexed earnings
2009 106,800 1.1417 121,936
2010 106,800 1.1154 119,121
2011 106,800 1.0815 115,502
2012 110,100 1.0487 115,465
2013 113,700 1.0355 117,736
2014 117,000 1.0000 117,000
2015 118,500 1.0000 118,500
2016 118,500 1.0000 118,500
2017 127,200 1.0000 127,200
2018 128,400 1.0000 128,400
2019 132,900 1.0000 132,900
2020 135,100 1.0000 135,100

Source: Social Security Administration.

Column 1 shows the worker's annual earnings subject to Social Security payroll tax. Column 2 shows the wage index factors, as published in 2020. Column 3 shows annual indexed earnings (Column 1 x Column 2). Notice that the index factor becomes 1.0000 in 2014, the year in which the worker turns 60, and remains 1.0000 without changing for any future years of taxable earnings. If you plan to continue working after age 60, just project your taxable earnings in Column 1 and use 1.0000 in Column 2 for all future years.

The table above shows only a segment of the worker's earnings (2009-2020) out of a work history that spanned 40 years. The Social Security website has a full table. The SSA performs a similar calculation on all past years in which any contributions were paid. Then the average of all indexed earnings from the 35 highest-income years (from Column 3 above) is used. To do this, simply add up the highest 35 years and divide by 35, or to get monthly amounts, take the sum and divide by 420 (35 years x 12 months) to arrive at your AIME. In this case, the previous 35 top-earning years add up to $4,047,132, so the AIME is calculated to be $9,636.

Any wages you earn after age 60 can increase your benefits, but they are not adjusted for future wage inflation.

Step 2: Bend Your Benefits

The next step is to convert your AIME into a primary insurance amount (PIA) by running it through a calculation called "bend points." Social Security is designed as a "progressive" social insurance system, which means it replaces a greater part of average monthly pay for low-income workers than for high-income workers. The bend points implement this skew relative to each worker's AIME.

There are two bend points, and both are adjusted for inflation each year. The relevant bend points for each worker are those published in the year the worker first becomes eligible for benefits (age 62). The calculation below assumes the worker has an AIME of $9,300 and is eligible for retirement in 2015.

Image by Sabrina Jiang © Investopedia 2020

*These multipliers—90%, 32%, and 15%—are set by law and do not change annually. The bend points are inflation-indexed, but only through age 62. PIA is effectively locked in at age 62.

Step 3: Adjustments to PIA

In our example above, the worker's benefits also get increased by cost-of-living adjustments (COLA) for 2016 through 2019. These COLAs are 0.0%, 0.3%, 2.0%, and 2.8% respectively. The resulting PIA is $3,028.13. (The COLA adjustment for 2020 is 1.6% and for 2021 is 1.3%.)

PIA determines the monthly Social Security benefit that will be received in the first year of benefits by a worker who starts benefits at full retirement age. Full retirement age is 66 for individuals born between 1943 and 1954; it increases by two months each year for those born after 1954 and reaches 67 for those born in 1960 and thereafter. A spouse who qualifies for benefits on a worker's record will receive half of the worker's PIA, assuming he or she starts benefits at full retirement age.

But what about a worker who elects to receive benefits before reaching full retirement age? Let's take the case of someone born in 1957, who retires in 2019 at age 62 (their normal retirement age is 66 years and six months.) Retiring at 62, they would receive 72.5% of their normal benefit. Retiring at 63 would give them 77.5% of their benefit, while retiring at 64 would give them 83.3% of their benefit.

There are four ways the starting benefit can be permanently increased or reduced from the PIA calculated at age 62:

  • Starting benefits early. Benefits may begin as soon as age 62, but they are permanently reduced for every month between the onset of benefits and full retirement age.
  • Delaying benefits beyond full retirement age. Delayed retirement credits can permanently increase benefits, and they are awarded for every month between full retirement age and a later onset of benefits.
  • Starting early and continuing to work. If you start benefits before full retirement age and keep working, the SSA may deduct the part of your benefits that exceeds a threshold. However, any such deductions are not permanent. When you reach full retirement age, the SSA recalculates your benefits and credits back any deductions.
  • Continuing to work, period. Even if you don't start benefits early, you can increase your benefits by continuing to work up to any age. Any year in which your indexed earnings are higher than one of your 35 previous highest years will boost your benefits. However, after age 60, you will not receive wage indexing, and after age 62, you will not receive bend point inflation indexing.

All four points are related to your starting Social Security benefits. Keep in mind that once your benefits start, they will be increased annually for the COLA. If you start benefits at age 66, your PIA (determined at age 62) automatically increases with the applicable COLAs from the years in which you turn 63 through 66.

So, What Good Is This Calculation?

If you are in your late 50s and are approaching retirement, you can create a useful model of your future benefits. It works best to do this in a Microsoft Excel spreadsheet, as follows:

  • Using a recent Social Security Statement, list in spreadsheet Column A your taxable Social Security earnings year by year.
  • List in Column B the most recently published NAWI adjustment factors (year by year) as published by the SSA.
  • Multiply Columns A and B and output the result to Column C.
  • Identify in Column D the 35 highest values in Column C. Add these together and divide the sum by 420 (420 months in 35 years). This will approximate your AIME.
  • Use the most recently published bend points to convert your AIME into a PIA.

You also can fill in hypothetical values for estimated taxable Social Security earnings in future years until you plan to stop working. To be conservative, use a NAWI adjustment factor of 1.0 in Column B for all future years.

A financial advisor who fully understands this process can be helpful in verifying your calculations, advising you on when to start Social Security benefits, and estimating the future benefits you can expect to receive.

The Bottom Line

Understanding this process may allow you to have increased confidence that your benefits are fairly secure, regardless of any future actions taken by Congress to deal with Social Security shortfalls. The SSA has invested vast resources in records, systems, and software required to perform these calculations for millions of Americans. As you can see, minimum benefits become "locked-in" based on calculations made between the ages of 60 and 62. So, once you move into that age range, you may be less vulnerable to any changes made to the system in the future.