How Big Will Your Social Security Benefit Be?

Source: Social Security Administration.

As you approach retirement, one number becomes incredibly important. Known as your "primary insurance amount," this figure plays a central role in determining the size of your monthly Social Security checks.

In short, your primary insurance amount represents what you will receive in benefits if you wait until reaching full retirement before applying for Social Security.

Calculating your primary insurance amount
To determine your primary insurance amount, the Social Security Administration uses a three-tiered formula based upon your 35 highest income-earning years, adjusted for inflation.

For instance, if you become eligible for benefits this year, the formula takes 90% of your first $816 in average indexed monthly earnings. It then adds 32% of your average indexed monthly earnings between $816 and $4,917. Finally, it adds in 15% of any earnings above that.

Source: Social Security Administration.

This is a highly progressive formula that seeks to ensure that people with lower lifetime earnings nevertheless have adequate supplemental support in retirement.

The primary insurance amount is not a ceiling
This shouldn't be interpreted to mean your primary insurance amount is the maximum that you can receive in monthly benefits when you retire. Instead, it's a benchmark that the Social Security Administration uses then calculate your exact benefits based on when you apply for them.

Assuming you've accumulated sufficient credits to qualify for Social Security benefits, you can theoretically take them at any time between the ages of 62 and 70. But there's a catch. Namely, if you take benefits before reaching your full retirement age, then they'll be less than your primary insurance amount. And if you wait until after full retirement, your benefits will be larger.

In this sense, your primary insurance amount is like a pivot point around which your true benefits are "actuarially adjusted." Here's how the Social Security Administration explains this point:

Let's say your full retirement age is 66 and your monthly benefit starting at that age is $1,000. If you choose to start getting benefits at age 62, your monthly benefit will be reduced by 25% to $750 to account for the longer period of time you receive benefits. This is generally a permanent reduction in your monthly benefit.

If you choose to not receive benefits until age 70, you would increase your monthly benefit amount to $1,320. This increase is from delayed retirement credits you get for your decision to postpone receiving benefits past your full retirement age. The benefit amount at age 70 in this example is 32% more than you would receive per month if you chose to start getting benefits at full retirement age.

Here's a chart I often share to illustrate this point -- for the record, it assumes a primary insurance amount of $1,000 and a full retirement age of 66:

Can you trust your primary insurance amount?
All of this is fine and dandy, of course, so long as the Social Security system remains solvent. But what happens if, according to current projections, the main trust fund providing retirement benefits runs dry in 2034?

Even assuming this happens, which I think is highly unlikely, this probably won't have much impact on your primary insurance amount. In the past, policymakers have focused instead on increasing the system's revenues by raising taxes and reducing expenditures by lifting the full retirement age (as you can see in the first chart above). 

The takeaway here is twofold. First, the closer you get to retirement, the more important it is for you to know your primary insurance amount, which you estimate by creating an account on the SSA's website. And second, once you've figured this out, you can then get a better idea about how your age at retirement will affect your monthly benefits for the remainder of your life.