When considering your retirement income plan, Social Security will be one of the sources you rely on. For some, this may be all their income, while for others, it will be just part of what they will live on in retirement. While much consideration is placed on when the optimal age to claim is, have you ever wondered how your Social Security benefit is calculated?
There are two main criteria for determining your eligibility and calculating your Social Security benefit amount, which we explore below.
Criteria #1: Social Security Credits
To be eligible to claim Social Security on your own earnings record, you must have accrued 40 credits during your working years. You can earn up to 4 credits per year, meaning you must have earned the minimum wage in at least 10 years, though they do not need to be consecutive.
For 2024, to earn one credit, you must earn $1,730. This amount is adjusted for inflation annually. To earn the maximum four credits this year, you must earn at least $6,920. This can come in the form of W2 earnings or self-employment income. Note that this does not include portfolio income such as interest, dividends, and capital gains or other income such as IRA distributions.
Once you have earned 40 credits, you will become eligible to claim Social Security on your retirement record.
Criteria #2: Earnings Record
The formula for calculating your primary insurance amount, or PIA, is determined by your average indexed monthly earnings (AIME) over your highest-earning 35 years of working after age 21. The earnings factored into this calculation are capped annually. For 2024, this is limited to the first $168,600 you earn, which is also known as the Social Security wage base.
If you have an earnings history of less than 35 years, zeroes will be included. If greater, only the highest 35 years will be considered. From there, your earnings will be recorded and indexed for inflation on your Social Security record and will be used to determine your AIME.
The Social Security Administration then divides your AIME into three sections, or ‘bend points’ to calculate your PIA.
For 2024, the bend points are:
90% of your first $1,174 of AIME
32% of your AIME between $1,174 and $7,078
15% of your AIME above $7,078
As an example, let’s assume that your highest 35-year indexed earnings total $3,000,000. Dividing this by 420 (35 years x 12 months) equals $7,143. This is your AIME, which is then applied to the three bend points above:
90% x $1,174 = $1,056.60
32% x $5,904 ($7,078 minus $1,174) = $1,189.20
15% x $65 ($7,143 minus $7,078) = $9.75
These total $2,255.50, which is your primary insurance amount in this example – or, said another way, is your gross monthly Social Security benefit at your Full Retirement Age (FRA – age 67 for most).
Other Factors to Consider
Once your PIA is calculated, several factors may impact the benefit amount you eventually receive.
Claiming before your FRA: If drawn early, your benefit amount will be reduced. If claimed at age 62 when first eligible, your PIA will be reduced by ~30%.
Delaying your benefit beyond your FRA: If delayed, your benefit will increase annually by ~8% up to age 70. Your benefit will no longer increase if delayed past age 70.
Cost of Living Adjustments: Each year, benefits are adjusted for inflation based on the Consumer Price Index. Note that even if you delay claiming your benefit, your benefit will receive the cost-of-living adjustment.
Covered Pension: If you were covered by a pension plan from work on which you did not pay Social Security taxes, your benefit may be reduced. This is generally for government jobs or a job in a foreign country and is known as the Windfall Elimination Provision.
You continue to earn income: As the end of your career approaches, you may very well be earning your highest salary. Given your benefit is determined by your highest 35 years of earnings, should this year be one of those, it would replace the lowest earning year in the calculation.
Unsure of how Social Security will factor into your retirement income plan? Reach out to us today to set up a time to discuss.
Grayson Blazek
Grayson is a CFP® who helps clients plan for retirement, make wise investment decisions, and identify advantageous tax strategies. As a fee-only advisor, Grayson believes in offering comprehensive financial advice that is always in his clients’ best interest.
