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It can be rightly said that without Social Security income, many of our nation's seniors could be in financial trouble during their golden years.
The program pays out benefits to more than 60 million people, two-thirds of whom are retired workers, and the majority of those retirees need their benefits to make ends meet. Data from the Social Security Administration shows that 61% of Social Security beneficiaries count on their benefits to account for at least half of their monthly income. This figure was even higher for unmarried elderly individuals.
How your Social Security benefit is calculated
However, the intricacies of Social Security are mostly a mystery to the average American. This is because most of them don't keep up on the Social Security statements mailed to them every five years, which detail their earnings history and estimated monthly retirement benefit. Most workers rightly believe they'll receive a Social Security paycheck once they retire, but they haven't the slightest clue how much it will be or how it's calculated in the first place.
To calculate your estimated benefit, the SSA begins by restating your previous years' earnings in today's wages to reflect wage growth over the many decades you've likely worked. Second, the SSA takes your 35 highest-earning years and divides the total earnings by 420 (the number of months in 35 years) to arrive at the Averaged Indexed Monthly Earnings (AIME). Lastly, the SSA benefit formula is applied to the AIME to calculate your Primary Insurance Amount (PIA), which is the amount you'd be entitled to receive each month if you claim benefits at your full retirement age, or FRA. Your FRA is a dynamic number that shifts based on your birth year.
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As you might have imagined, there are other factors that can alter your estimated benefit. For example, the age at which you file for benefits can have a substantial impact on what you'll receive each month. The longer you wait, beginning at age 62 and continuing until age 70, the higher your benefit will be.
Your FRA represents the point at which you're due 100% of your PIA, which means claiming benefits prior to reaching your FRA will result in a reduction from your estimated benefit. Though it all depends on your birth year, some retirees could see a 25% to 30% haircut in their monthly benefits if they sign up as soon as they turn 62. Conversely, waiting until age 70 to claim benefits could result in a payout that's 24% to 32% higher than your benefit would be at full retirement age. Based on data from the SSA, about 60% of recipients enrolled for benefits prior to hitting their FRA, nearly a third did so right around their FRA, and about 10% enrolled after hitting their FRA.
Estimating your average benefit based on your earnings history
Your earnings history also matters. To begin with, if you don't work for at least 35 years, then the SSA will enter $0 for each year below 35 that you worked, and those zeroes will be factored into your average earnings. Additionally, earning more in wages throughout your career will help net you a larger benefit come retirement. Thus working later in life can help to raise your benefits, as you'll have acquired the skills and experience needed to net a good wage.
What might your benefit look like in today's dollars based on your average annual income? For this answer, we'll employ a fairly simple Social Security retirement benefits calculator from Bankrate and assume our fictitious individual has an FRA of 66 years (and chooses to retire at age 66). We'll also assume he or she has worked a full 35 years and is unmarried.
Here's what seniors' estimated benefits would be based on the listed average annual income levels:
Chart by author using Bankrate's Social Security retirement benefits calculator. Monthly benefits estimated in today's dollars and assuming a full retirement age of 66.
Again, keep in mind these are estimates based on a quick calculation using Bankrate's benefits calculator. Married individuals, survivors, and those who are disabled and covered by Social Security could receive markedly different monthly checks than what's laid out above. Likewise, these benefit estimations assume an FRA of 66. The FRA will actually begin moving higher from age 66 to age 67 beginning in 2017 for brand-new retirees born in 1955 who qualify for benefits. This could skew the benefits you see above lower as time passes.
If you want the most accurate estimator of your monthly benefits and don't want to wait for the SSA to send you a statement, then you can visit its website, which has a number of quick or detailed estimators at your disposal. In many cases, you'll just need to know how much you made last year in order to get a pretty good estimate of what your monthly benefit will be at your full retirement age.
