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How social security is calculated?

 

Demystifying Social Security: A Breakdown of Your Retirement Benefit

Social Security, a cornerstone of retirement income for many, can seem like a mystery. How much will you receive? How is that number calculated? Fear not, for behind the scenes lies a clear formula, though it involves a few key steps.

How social security is calculated?
How social security is calculated?

 

The Elusive AIME: Average Indexed Monthly Earnings

The foundation of your Social Security benefit rests on your lifetime earnings. But not all earnings are created equal. Social Security considers your highest 35 years of adjusted earnings after you turn 21. These earnings are then indexed for inflation, meaning they're adjusted to account for the rising cost of living throughout your working years. This ensures a fairer calculation, where someone who earned a high salary in the 1970s isn't penalized when compared to someone earning the same amount today.

The result of this indexing and averaging is your Average Indexed Monthly Earnings (AIME). It essentially represents your average inflation-adjusted monthly income during your peak earning years.

The Formula Unveiled: The Primary Insurance Amount (PIA)

Once you have your AIME, it's plugged into a formula to determine your Primary Insurance Amount (PIA). This PIA is the base benefit you'd receive if you retire at your full retirement age (FRA). The FRA depends on your birth year and ranges from 65 to 67.

The formula itself uses a bend points system. Think of these bend points as income thresholds. A higher percentage of your earnings below a certain point are applied to the formula, while a smaller percentage is applied to earnings above that point. This system ensures that lower earners receive a proportionally larger benefit compared to high earners.

The Finishing Touches: Adjustments for Retirement Age

The PIA you get at your full retirement age is just the base. If you choose to retire before your FRA, your benefit will be permanently reduced to account for receiving payments over a longer period. Conversely, if you delay retirement beyond your FRA, you'll earn delayed retirement credits which increase your monthly benefit.

Putting it All Together

Social Security might seem complex, but it boils down to this: your benefit is based on your highest inflation-adjusted earnings, averaged over your top 35 working years. A formula then considers those earnings to determine your base benefit at your full retirement age. Finally, adjustments are made based on when you actually choose to retire.

By understanding this process, you can get a clearer picture of your future Social Security benefit and make informed decisions about your retirement planning.

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