There's a good chance Social Security will wind up being a substantial income source for you in retirement, so knowing what your benefits will look like ahead of time can help you better plan for your golden years. To help in this regard, the Social Security Administration (SSA) issues annual earnings statements that not only summarize your annual income for Social Security purposes, but provide an estimate of your benefits in the future. If you're 60 or older, these come to you directly in the mail. If you're younger, you can access them online.
But just how reliable are those statements? If you're on the younger side, it may be too soon to get a solid handle on what your benefits will actually look like.
How your Social Security benefits are calculated
Your Social Security benefits are calculated based on your average indexed monthly earnings (AIME) during your 35 highest-paid years of wages. Once your AIME is established, a formula is applied that determines what your monthly retirement benefits will look like.
Now if you're in the later stages of your career, and you already have most of your working years under your belt, then it's pretty easy to arrive at a solid estimate of what your future benefits will be. But the more years you have between now and retirement, the harder it becomes to nail down that number, since your future earnings, or lack thereof, could impact the amount you ultimately get to collect.
Imagine you're 45 years old with a projected monthly benefit of $1,700 at full retirement age. If your earnings continue to rise over the next 20 years or so, there's a good change you'll end up with a much higher benefit down the line. But because the SSA can only base its numbers on your earnings history coupled with projections, you can't really rely on the number it gives you when you have so many more working years ahead.
Your filing age will be a factor, too
Another thing to keep in mind about Social Security is that while your monthly benefits are determined based on your earnings history, the age you first claim benefits at could cause that number to change. If you claim Social Security at your precise full retirement age (which is either 66, 67, or somewhere in between, depending on your year of birth), you'll get the exact monthly benefit your wage history allows for. However, you're allowed to start taking benefits as early as age 62. Go that route, and you'll get your money sooner, but you'll also reduce your benefits substantially in the process (if your full retirement age is 67, filing at 62 will cause your monthly benefits to go down by 30%).
You also have the option to delay benefits past full retirement age. For each year you do, you'll snag an 8% boost, up until age 70, at which point that incentive runs out.
Now if you're already in your early 60s, you might manage to predict when you'll claim benefits. But if you're in your 40s, it's too soon to know when you'll end up filing. And that's why the younger you are, the harder it is to figure out what Social Security will ultimately pay you.
Social Security's role in your retirement
Though you may have a hard time determining what your Social Security benefits will be well in advance of retirement, one thing you should know is that generally speaking, they'll replace about 40% of your previous income if you were an average earner. Most retirees, however, need roughly 70% to 80% of their former earnings to live comfortably, so no matter what Social Security ends up paying you, be sure to save for your golden years independently along the way. This way, if your benefits do come in lower than expected, you'll have a cushion to compensate.