How Your Social Security Benefit Is Calculated

Stephen C. Goss

Stephen C. Goss

If you’ve checked your annual Social Security statement lately, you probably know the size of the benefit you’re projected to receive in retirement. But do you know how that number is calculated?

Social Security determines your initial benefit at full retirement age (FRA) using a complex formula that takes into account your earning history, wage inflation, and a present-value calculation. If you want to understand how the math in those formulas works, there’s no better person to ask than Stephen C. Goss, chief actuary of the Social Security Administration (SSA).

A widely respected expert on Social Security, Goss has been with the SSA for more than 30 years, working in areas related to health insurance and long-term care insurance as well as pension, disability, and survivor protection. He’s been involved in every discussion of Social Security policy reform over the past three decades and has a strong command of the under-the-hood aspects of the program.

I sat down with Goss recently to get a tutorial on Social Security’s benefit formulas; an edited transcript follows. You can also listen to the full interview here.

Q: How does the Social Security benefit formula actually work? That is, aside from the timing of my claim, how will my benefit be determined?

A: The 5,000-foot view is that we have a formula called the Primary Insurance Amount (PIA). It is a weighted formula that gives a higher benefit relative to career earnings for a lower earner than for a high earner. If you and your employer have been paying taxes, you have to work enough time to become insured–either for retirement benefits when you are 62 or older, or if you become disabled at an earlier age, or should you die [leaving a benefit for your survivors].


Q: How much time is required to qualify for a benefit?

A: For a retirement benefit at 62, you need to have earned one quarter of coverage for every year that has passed since age 22–40 quarters of coverage. So, if you have at least 10 years of work with a significant amount of earnings, you will be insured.

For disability insurance at a younger age–say, at age 42–to be fully insured you only have to earn half as many quarters of coverage. But there is another test called the recency test. You must have worked five out of the last 10 years to qualify.

We have a straightforward formula for determining the PIA. First, we calculate your average indexed monthly earnings (AIME). That involves taking any years of earnings that you had before you reached age 60 and indexing them to put them on more of a proper comparative basis with the earnings level in our society as of the year you turned 60. That is done using the average wage indexing series that the Social Security Administration (SSA) computes every year.

Q: So, AIME is a sort of inflation adjustment, but one that uses wages, not consumer prices?

A: Exactly–it reflects the average wage in the U.S. economy. That usually rises about 1% faster than consumer prices. It is just a way of making all your years of earnings comparable relative to what the average earnings level in the economy was in those years.

Q: And then you use only the highest 35 years of earnings to compute the PIA?

A: For a retirement at 62 or older, you’d take your highest 35, and on that wage-indexed basis, we simply average those. If you only had 30 years of earnings, we still take the highest 35 and will include five zeros. So, it is your best 35, including zeros if necessary. We average that out and express it as a monthly amount. That becomes your average indexed monthly earnings (AIME).

That is the first component. Next, we take the AIME and apply it to the PIA formula. It’s a bit like the income tax structure, where for AGI in the first segment bracket of your earnings, you might pay a low tax rate, and for AGI in higher brackets, you pay higher tax rates. With the PIA formula, you get 90% of AIME for the first segment, which we call “bend points.” This year, that covers the first $826 of monthly AIME. For the next segment, between $826 and $4,980, you get 32% of AIME. For any AIME amount above $4,980, if you are a relatively high earner, you get 15% of AIME.

Q: That is one of the most important ways that we have built progressivity into the system. There are others, such as the special minimum benefit provision or auxiliary benefits.

A: Exactly. For a person who is a very low earner, that first PIA bend point is at about the 10th percentile of all of our retiring workers. So, very few people are getting that full 90% return of their AIME. Most people are up into that middle segment. And the average is somewhere around 45% of the ratio of PIA to AIME.

Q: How does the timing of my benefit claim figure into all this?

A: The age at which you decide to start receiving benefits matters. We use an actuarial reduction factor that many people are familiar with. If you wait until the full or normal retirement age–which currently is 66–your monthly benefit level will be exactly that PIA.

Now, let’s say you want to start receiving retirement benefits at 62, which is the earliest you can claim. Then, you will get a reduced benefit for the rest of your life. The PIA would be reduced by 25%–you’ll get 75 cents per dollar of PIA paid to you on a monthly basis at 62, and you’ll continue to have that reduction for the rest of your life.

If you wait until after normal retirement age to start benefits, you get something called the “delayed retirement credit,” which works out to 8% for each 12-month period you delay. If you wait one extra year beyond normal retirement age, you get 108% of your PIA. If you wait a second extra year–until 68–you’ll get 116%, and so on. You can do this up until the year you turn 70.

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  1. It was gradual up until the last change that was signed at 3:00 AM with no public discussion to eliminate the file and suspend option for couples. That will cost my wife and I $50,000 not including 4 years worth of COLA’s and there’s nothing we can do about it because our birthdays don’t fall into the magic 6-month window. The whole narrative that changes will be gradual and wouldn’t affect people who are retired or near retirement went out the window. Based on that, a lot of people are going to say grab the money as soon as you can because they might take it away.

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