How is Social Security calculated?

Whether you're approaching retirement or you have years to go, you probably wonder how much you can expect to receive in Social Security benefits. If you know how Social Security is calculated, you can feel more confident about planning to live out your retirement years the way you want to.

Let's take a look at the Social Security formula, so you can determine how much income you can expect and how it will fit into your overall retirement strategy.

In this article we will cover:

• How you earn credits for Social Security
  
• Factors that affect your benefit amount
  
• Example: Calculate your Social Security benefit
  
• Optimizing Social Security for you
  

Before getting into the dollars and cents of your monthly benefit, you need to know a bit about how Social Security works. Your eligibility for the Social Security program's retirement and other benefits depends on how much you've worked and paid Social Security taxes.

You earn credits based on the amount of your wages and self-employment income, and you become eligible for the Social Security retirement program once you've accrued 40 credits. You can get a maximum of four credits per year, so it takes everyone at least 10 years of working to become eligible.

In 2024, you get one credit for every $1,730 of employment income earned during the year. To get the maximum of four credits, you have to have made at least $6,920 in employment income.

Credits only determine eligibility—not your benefit amount.

The core idea of Social Security is that the taxes collected from you and other workers contribute to a funding system that provides you with a payout to help support you during your post-career retirement years.

Your benefit amount, however, isn't a simple percentage of your monthly paycheck when you were working. It's based on how much you earned from working, how long you worked and at what age you opt to take Social Security benefits.

Using records of the Social Security tax payments you've made over the years, the Social Security Administration calculates your lifetime earnings. This number helps determine a key figure of the Social Security calculation: your average indexed monthly earnings.

Social Security benefits are set up to give you a percentage of what you earned on average in a month during your working years. This number is your average indexed monthly earnings.

The "indexed" part involves adjusting your total income based on the year it was earned so inflation isn't as much of a factor.

For this calculation, your indexed lifetime earnings (for your highest-earning 35 years, if you worked longer than that) are divided by the number of months you worked—35 years (420 months). This yields a monthly amount that's the average you earned: your AIME.

Next, your average indexed monthly earnings are divided into portions, called bend points, that are adjusted each year for inflation and the costs of living. In 2024, the bend points at full retirement age are:

• 90% of the first $1,174 of your AIME
• 32% of AIME between $1,174 and $7,078
• 15% of AIME over $7,078

These portions are then added together to determine your primary insurance amount (PIA). This is the amount you would receive at your full retirement age.

You can start Social Security benefit payments as early as age 62. However, the government incentivizes waiting to take Social Security benefits by giving you a higher payment if you wait until your full retirement age (FRA) or later.

Your FRA depends on the year you were born. For those born in 1960 or later, the FRA is currently 67.

At your FRA, you get 100% of your benefit. This amount changes if you claim Social Security before or after that.

• If you take benefits before FRA, your payment is permanently reduced based on your age. For example, claiming at the youngest possible age—62—means you'll get just 70% of what you would get at FRA. That reduction becomes smaller each month that you wait to claim. A 64-year-old retiree, for instance, would have their benefit reduced to 80%.
• If you take benefits after reaching FRA, your benefit will be permanently higher. The benefit amounts steadily increase until you reach age 70, where it tops out at 124% of what you'd get at FRA.

Many people opt not to take Social Security until later so their long-term payment is higher. Delaying the start of your payments, to age 70 if you can, is one way to try to get the most out of your Social Security benefits. However, what's best for you depends on your individual circumstances, factoring in your finances, health, life expectancy, etc.

Let's put all the calculations together. Let's say that Cameron has worked for 35 years, averaging $96,000 a year when adjusted for inflation and wage growth based on his retirement year. The Social Security Administration would divide his lifetime earnings by 420 months to yield his average monthly indexed earnings of $8,000 per month.

For the first $1,174 of Cameron's monthly earnings, he gets 90% in monthly Social Security benefits, or $1,056 in benefits.

For his earnings between $1,174 and $7,078, Cameron will get 32% in monthly Social Security benefits. This bucket of earnings is $5,904, so 32% of that will be $1,889.28 in benefits.

For his earnings above $7,078, Cameron receives 15% in monthly Social Security benefits. He earned $922 in this portion, and 15% of that amount yields an additional $138.30 in benefits.

To calculate his primary insurance amount (PIA), Cameron adds $1,056, $1,889.60 and $138.30 to yield a retirement Social Security benefit of $3,083.90 per month. The final step is to decide at what age he'll retire.

For example, Cameron might opt to retire at age 64. Then his benefit would be reduced by 20% to $2,467.12. Or Cameron could opt to retire at age 69.5, yielding a 20% bonus and giving him $3,700.68 per month.

Choosing when to claim your Social Security benefits—at age 62, 67, 70 or somewhere in between—is a personal decision. You'll need to factor in your other retirement savings accounts, any pension or annuities you have, your health, whether you plan to continue working and other factors. Using financial planning tools, you can examine what your benefit would be at various ages and make an informed decision from there.

A Thrivent financial advisor can help you weigh your options, whether you want to boost your benefits by working a few more years or you're happy with getting a smaller benefit in return for additional time in retirement. Together, you can assess your credits, work to understand how the Social Security formula applies to you, and make thoughtful projections about how your overall retirement strategy should look.