The average Social Security benefit for a retired worker is $1,404.15, as of December 2017. Do you know how much you'll get?

Several variables go in to determining your Social Security benefit, including how old you are when you apply, what year you were born in, how many years you worked for, how much you earned, and whether you're still working. Sound confusing? Here's a rundown of all you need to know about how your Social Security benefit is calculated, so you can make a smart decision about when to apply.

Social Security card inserted between U.S. currency.

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How your Social Security benefit is calculated in 2018

If you qualify for Social Security, which generally means you've worked for 10 years or more in covered employment, here's how the Social Security Administration (SSA) determined your Social Security benefit at full retirement age -- also known as your primary insurance amount.

First, for every year of your career, your Social Security-taxed earnings are indexed for inflation. Next, the 35 highest-earning years are considered. If you have fewer than 35 years of covered employment, zeros are entered for the remaining years.

Your indexed earnings are then averaged together, and divided by 12 to produce your average indexed monthly earnings (AIME). Finally, this average is applied to a formula to determine your initial monthly Social Security benefit. For 2018, the formula is:

  • 90% of the first $896 in AIME.
  • 32% of the amount greater than $896 but less than $5,399.
  • 15% of the amount in excess of $5,399.

If you claim Social Security before or after you reach full retirement age, your benefit will be permanently adjusted to compensate, as we'll outline in the next section.

If you don't qualify for Social Security based on your own work record but are married to or divorced from someone who does, you may qualify for a spousal benefit based on your spouse's work record. This can be as much as half of the spouse's full retirement benefit, if you wait until your own full retirement age to claim.

For the best estimate of how much you can expect to receive at full retirement age, you can view your most recent Social Security statement by creating an account at www.ssa.gov if you haven't already done so.

Full retirement age has started to increase -- know what yours is

I mentioned in the previous section that Americans have a full retirement age of 66-67 years old. Your full retirement age depends on the year you were born. Here's a quick guide to help determine your full retirement age:

If You Were Born In...

Your Full Retirement Age Is...

1954 or earlier

66 years

1955

66 years, 2 months

1956

66 years, 4 months

1957

66 years, 6 months

1958

66 years, 8 months

1959

66 years, 10 months

1960 or later

67 years

Data source: Social Security Administration.

Here's why this is especially important now. People turning 62 in 2018 were born in 1956, so they have a full retirement age of 66 years and four months. People who will turn 62 in 2019 have a full retirement age of 66 years and six months. In other words, the phase-in of the higher full retirement age has started, and newly eligible Americans need to be aware of it, as it can significantly affect your benefits if you claim early.

Know how your claiming age affects your benefits

Americans who are eligible for Social Security can choose to claim their benefit as early as age 62, as late as age 70, or anywhere in between. All Americans have a "full retirement age" of 66-67 years old, which serves as a baseline on which monthly benefits are based, which we'll discuss in the next section.

If you choose to claim Social Security before you reach your full retirement age, your monthly benefit will be permanently reduced. Your calculated benefit at full retirement age is reduced at a monthly rate of 0.56% per month (6.67% per year) for up to 36 months early, and at a rate of 0.42% per month (5% per year) for any months or partial months beyond 36 months early.

On the other hand, if you choose to wait beyond your full retirement age to claim Social Security, your benefit will be permanently increased at a rate of 0.67% per month (8% per year) until as late as age 70. For example, if your full retirement age is 66 and you wait until age 70 to claim your Social Security retirement benefit, your monthly check will be 32% higher -- not including those four years' worth of cost-of-living adjustments.

What happens if you claim Social Security while you're still working?

If you're planning to claim Social Security benefits and you haven't retired from your job yet, there's something you need to be aware of. Your monthly checks could be reduced or could even disappear entirely because of how much you make.

This is known as the Social Security earnings test. And how much you might be affected depends on your age and how much you earn from your job.

In the eyes of the SSA, there are three categories of beneficiaries for the purposes of the earnings test:

  1. Those who will reach full retirement age after 2018. If you fall into this category, $1 of your Social Security benefits will be withheld for every $2 you earn in excess of $17,040 in 2018 ($1,420 per month). If the calculated reduction is more than your Social Security check, the entire amount of your benefit will be withheld.
  2. Those who will reach full retirement age during 2018. Only the months before your birthday month are considered, and every $3 of earnings in excess of $3,780 per month will cause $1 of benefits to be withheld.
  3. Those who have already reached full retirement age. The earnings test does not apply in this category.

Any benefits that are withheld under the earnings test can be used to permanently increase your benefit once you reach full retirement age, so it's not necessarily lost money.

How do you claim Social Security benefits?

As a final point, one of the obvious things you need to know before you take Social Security is how to claim your benefits.

By far, the most efficient way to claim Social Security is to apply online at www.ssa.gov. This takes about 15 minutes, and there are usually no further documentation requirements or forms to sign. You can also apply over the phone or in person at your local Social Security office. However, wait times can get rather long, so I highly recommend calling and making an appointment if you prefer to apply face-to-face.

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