How to Calculate Social Security Benefits

Your Social Security retirement benefits are based on the highest paid 35 years of your working life, capped and adjusted for inflation. Divide the total by 420 to obtain the average monthly income during these 35 years. This amount is then tiered the same way as in a tax return, except that the percentage at each higher tier is lower, not higher. This calculation will give your estimated Social Security benefits.

The details

Average indexed monthly earnings

Each working year is assigned an upper salary cap. Earnings eligible for Social Security benefits are based on the lower of the base annual salary or the salary cap. For example, for the working year 1970, the salary cap is $7,800. Any earnings above that cap do not increase the Social Security allotment.

The inflation index for each working year is also set by the government. It is based on the value of the dollar in that working year, relative to the value of the dollar in the year in which you will retire. For example, if you were born in 1950, your earnings in 1970 (age 20) would be multiplied by an inflation index of 6.74. At the 1970 salary cap of $7,800, your indexed earnings would be $52,572.

After calculating your capped and indexed earnings for every year you worked, choose the highest 35 years and add these together. If you worked for fewer than 35 years, the years you did not work are set at zero income, but they are still added into the total as part of those 35 years.

Divide the total by 420, which is the number of months in 35 years. This will give you your average indexed monthly earnings. If you worked for fewer than 35 years, your average indexed monthly earnings will be lower, because the lack of earnings is included in your average.

Social Security estimated benefits

Your estimated benefits are based on tiered percentages of your average indexed monthly earnings, with the percentages falling steeply in higher tiers. There are three tiers in total. The first tier is calculated at 90 percent of income and the second at 32 percent. Any income over the third cutoff is calculated at 15 percent.

Tier cutoffs vary by retirement year. For example, in 2012, the first tier cutoff was $767 and the second tier cutoff was $5,624.

Calculating Social Security benefits the easy way

You can easily obtain a Social Security retirement income estimate by using the Retirement Estimator on the Social Security website. This calculator uses real-time access to your earnings record to calculate your Social Security benefits, based on local current law. You can even create “what if” retirement scenarios to see how you can adjust your planning to maximize your benefits.

In order to use the Retirement Estimator, you will be required to log in by providing private information, including your name, your Social Security Number, your mother’s maiden name, and your place and date of birth. If you do not want to provide this information online, you cannot obtain exact information based on your earnings record.

Instead, you can use a different calculator which does not access your earnings record. The benefit calculators will show a variety of estimates for all Social Security benefits, based on the amount of information you want to enter. These are also the calculators you should use if you are eligible for a pension but were not doing work that is covered by Social Security.

Early retirement

The amount you have just calculated is the estimated amount you will receive if you wait until your full retirement age of 66. However, you can choose to start receiving Social Security benefits as early as 62. In this case, the amount you can expect to receive will be 75% of your full estimated Social Security benefits.

Credits and qualifying

To qualify for retirement benefits, you will also need a minimum of 40 credits if you were born in 1929 or later. For every year that you were born before 1929, you need one fewer credit.

In every year in which you work and pay Social Security taxes, you can earn up to four credits. In 2012, it takes $1,130 of covered earnings to earn one credit, to a maximum of $4,520 for four credits. The amount required per credit rises slightly from year to year.

It doesn’t matter how long it takes to earn each credit, but it must be earned income. You do not receive credits for investment income.

All calculators other than the Retirement Estimator automatically assume you have the necessary credits for the type of Social Security income you are seeking. Even if you don’t have enough credits to qualify, they will still give you an estimate.

Estimate for another person

If you need a Social Security benefits estimate for another person, you will need to talk to someone at Social Security directly. Contact your local Social Security office or call 1-800-772-1213. For TTY users, call 1-800-325-0778.