social security basics: how credits and benefits are calculated

In short

A friend of mine worked thirty years and never once looked at her Social Security statement. When she finally did, she was surprised by what it showed. You earn credits by working and paying Social Security tax, and you need the current figure, which the official source publishes each year credits to qualify for a retirement benefit. The agency takes your highest 35 years of earnings, adjusts them for wage growth, and averages them into one monthly figure. Your benefit then comes from a formula that pays back a larger share of low earnings than of high earnings. Claiming early shrinks the check for life, and waiting past full retirement age grows it. The best first step is to open your own record at ssa.gov and see what is really there.

The whole of it

What it is

If you are holding a pay stub right now, you have probably noticed a line for Social Security tax. I once watched a young man at a barbershop wonder out loud what that line actually bought him. It is a fair question, and the answer is simple enough to say on a porch.

Social Security is a federal program run by the Social Security Administration. It pays monthly benefits to retired workers, to disabled workers, and to certain family members and survivors. The retirement benefit is the one most people think of first. What you receive depends on your work history, not on how much you saved or what you own.

Work is measured in credits. A credit is a unit of coverage you earn by having taxed earnings. You can earn up to four credits in a year, and the dollar amount that buys one credit is set by law. Most people who work steadily collect their credits without ever thinking about them.

How it works

A story helps here. Think of the program as a ledger kept in your name. Each year you work, an entry goes in. Each entry shows how much you earned that was subject to Social Security tax. Years with no earnings go in as zero.

When you apply for a retirement benefit, the agency reads the ledger. It first adjusts your old earnings upward so a paycheck from 1990 and a paycheck from last year can be compared fairly. It does this with an index of average wages. Then it picks your 35 best years. If you have fewer than 35 years of earnings, the missing years count as zero, and zeros pull the average down.

Next, the agency adds up those 35 indexed years and divides by 420, the number of months in 35 years. The result is your average indexed monthly earnings. This is the number everything else hangs on. Short, but important.

Then comes the formula. The agency applies it to your average indexed monthly earnings to find your primary insurance amount. That amount is what you would get at full retirement age. The formula uses two cutoff points, called bend points, which are set by law and change each year. It pays 90 percent of earnings up to the first bend point. It pays 32 percent of earnings between the first and second bend points. It pays 15 percent of anything above the second bend point. This is why lower earners get back a bigger share of their pay than higher earners do.

Timing then adjusts the result. Full retirement age depends on your birth year, and the agency publishes the schedule. If you claim before that age, the benefit is cut. If you wait past it, up to age 70, the benefit grows through delayed retirement credits. Once you claim, the decision is hard to undo.

The numbers, and where to find yours

Plenty of folks assume these figures are a secret. They are not, and the official pages are free. The dollar amount for one credit is the current figure, which the official source publishes each year. The two bend points for the formula are the current figure, which the official source publishes each year and the current figure, which the official source publishes each year. The cap on earnings that are taxed for Social Security is the current figure, which the official source publishes each year. Your full retirement age is the current figure, which the official source publishes each year, and the earliest age to claim a retirement benefit is the current figure, which the official source publishes each year.

Your own numbers live in your my Social Security account at ssa.gov. Once you sign in, you can see your yearly earnings, your credits, and an estimate of your benefit at different claiming ages. The Social Security Administration also publishes a benefit calculator and a plain explanation of the formula on its site. Check each year of earnings against your old tax returns or pay stubs. A missing or wrong year is worth fixing, and the agency has a process for corrections.

A worked example

Let me tell you about Maria, who is 62 and has worked as a dental office manager for most of her adult life. She is a made up person, and her figures are round so the math is easy to follow. Say her 35 best years, after wage indexing, add up to $2,520,000.

First, divide by 420 months. $2,520,000 divided by 420 is $6,000. That is her average indexed monthly earnings.

Now apply the formula. To keep the sums plain, suppose the first bend point is $1,200 and the second is $7,000. These are example figures only, not the current law figures, which are in the numbers section above.

The first slice is 90 percent of $1,200. That is $1,080.

The second slice covers earnings from $1,200 up to her $6,000. That is $4,800 of earnings. 32 percent of $4,800 is $1,536.

Her earnings do not reach the second bend point, so the third slice is $0.

Add the slices. $1,080 plus $1,536 is $2,616. That is her primary insurance amount at full retirement age in this example, rounded down to the dime in real life.

Now timing. Suppose her full retirement age is 67 and she wants to claim at 62, five years early. Under the agency's published rules, the cut is five ninths of 1 percent for each of the first 36 months, then five twelfths of 1 percent for each month after that. Sixty months early means 36 months at five ninths of 1 percent, which is 36 times 5/9 percent, or 20 percent. Then 24 months at five twelfths of 1 percent, which is 24 times 5/12 percent, or 10 percent. The total cut is 30 percent.

30 percent of $2,616 is $784.80. So her check at 62 would be about $2,616 minus $784.80, or $1,831.20 a month. Waiting to 67 would pay the full $2,616. Her choice depends on her health, her other income, and her plans, and only she can weigh those.

Where it goes wrong

I have seen good people get tripped up by small things, so let me share the common stumbles with kindness. One is never checking the earnings record. A year of missing wages can lower the average for good, and fixing it gets harder as the years pass. Another is assuming that 35 years always exist. Someone with 28 years of work has seven zeros in the average, and that stings.

A third stumble is treating the early claiming age like a free option. The reduction is permanent. The borrower of that early money pays it back through a smaller check every month for life. A fourth is forgetting that benefits can be taxed. Depending on other income, part of a benefit may count as taxable income, and the IRS explains the rules in Publication 915.

Last, some people miss that working while claiming early can trigger an earnings test. Before full retirement age, the agency withholds some benefits if earnings pass a yearly limit, and that limit is the current figure, which the official source publishes each year. Withheld benefits are not lost forever, but the check can look odd for a while.

Questions to answer before you leave this page

Have you opened your my Social Security account and looked at every year of earnings, and do they match your own records? Do you know how many credits you have, and whether you already have the the current figure, which the official source publishes each year that retirement benefits require? How many of your 35 years hold real earnings, and how many would count as zeros? What is your full retirement age, and what does your estimate say at 62, at full retirement age, and at 70? What other income would you have in each of those years, and could part of your benefit be taxed? If you plan to keep working, how would the earnings test affect a check claimed early? And who in your family might depend on your record, such as a spouse or a child, and have you looked up what the agency says they could receive?