How Social Security Retirement Benefits Are Calculated in 2018

The Social Security retirement benefit calculation formula is based on a few variables. It takes your 35 highest-earning years into account, as well as your full retirement age and the age at which you choose to start collecting your retirement benefit. Here's how this calculation method works for 2018, and how early or late retirement could affect your benefits.

Primary insurance amount

First of all, if you're already collecting Social Security benefits, your 2018 benefit will not be recalculated using the method I'm about to describe. Your current monthly benefit will simply be adjusted according to the 2018 cost-of-living adjustment, or COLA.

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For new beneficiaries, the first step in calculating Social Security benefits is to determine your primary insurance amount, or PIA. This is the amount of your monthly Social Security retirement benefit if you choose to start collecting your benefits at your full, or normal retirement age.

The calculation is done as follows: 

• The Social Security Administration maintains a list of your annual earnings, up to each year's Social Security maximum taxable wages.
• Each year is indexed for inflation, and the top 35 years are averaged together and divided by 12. This figure is your average indexed monthly earnings.
• This average is then applied to a formula to calculate your PIA. For 2018, this formula is 90% of the first $896 in averaged indexed monthly earnings, 32% of the amount between $896 and $5,399, and 15% of the amount in excess of $5,399.

What is your full retirement age?

Depending on what year you were born, your full retirement age is between 66 and 67 years of age, and in 2018, people who first become eligible for Social Security benefits (born in 1956) have a full retirement age of 66 years and four months.

Here's a quick guide to determine your full Social Security retirement age:

Data source: Social Security Administration.

If you choose to start your benefits before or after your full retirement age, it will affect your monthly benefit, which I'll get into in the next section.

Early or late retirement

Americans who qualify for Social Security retirement benefits can choose to start collecting their monthly benefits at any time between ages 62 and 70. However, starting before or after full retirement age has a permanent effect on your benefits.

If you choose to start Social Security early, your benefit is reduced by certain percentages, depending on how long before full retirement age you chose to claim your benefit. For the first 36 months before full retirement age, your PIA is reduced at an annual rate of 6 2/3%, or five-ninths of 1% per month. Beyond 36 months early, the PIA is further reduced by 5% per year, or five-twelfths of 1% per month.

For example, if you claim Social Security four years before you'll reach full retirement age, your PIA will be reduced by a total of 25%. That's 6 2/3% for each of the first three years (for a total of 20%) and an additional 5% for the fourth year.

On the other hand, starting Social Security retirement benefits after you reach full retirement age will result in an increase of your PIA. Specifically, for every year you choose to delay your retirement benefits, you'll be given a permanent 8% boost, until as late as age 70. If your full retirement age is 66, that translates to a 32% increase in monthly benefits.

A real-world example

Let's say you were born in 1955 and earned an inflation-adjusted average of $50,000 per year throughout your career, which translates to $4,167 per month. Based on the PIA formula listed earlier, you would be entitled to a monthly benefit of $1,853 at full retirement age.

Since your full retirement age is 66 years and two months, you would have to start your benefit at exactly this age to receive that monthly amount.

If you wanted to claim your benefit in 2018 when you turn 63, you would have three years and two months before reaching full retirement age. Based on the reduction rule, you'd have a total reduction of about 20.83%, which would reduce your monthly retirement benefit to $1,467.

In the future

The Social Security formula's structure has remained constant for some time, but the thresholds in the benefit calculation formula, known as the "bend points," change annually to keep up with inflation. In addition, since Social Security is not in the best long-term financial shape, it's possible that the calculation formula itself could change significantly in the future.