Behind The Curtain: How They Calculate Social Security Benefits

A Step by Step Guide

It’s important for you to have a clear understanding of the process used to calculate your Social Security benefits.  Knowledge is power. If you understand this calculation, you may be able to spot mistakes and fix them before it’s too late.

calculate social security benefits

Like anything with Social Security, the rules can seem complex. Before I understood these rules, I struggled to understand how the Social Security Administration determined who would get what benefit amount.  But once I distilled the several pages of calculation rules, I realized that there are only four easy-to-understand steps.

Step #1: Inflation Adjustment

At age 60, all of your prior earnings are adjusted for inflation.  This adjustment is simply meant to ensure your Social Security benefit reflects today’s cost of living. If your benefit was based on your actual non-inflation adjusted earnings, it would be much lower.

For example, if you earned $10,000 in 1980, they multiply it by 3.5871901 to get the inflation adjusted earnings of $35,871.90. If you want to see all the numbers for yourself, there is a tool on the Social Security website.

The money you earn beyond age 60 is not adjusted for inflation, but added to your earnings history at face value.

Below is a chart from the Social Security Administration showing the historical inflation adjustments.

Social Security Wage Index Chart

Step #2: AIME Calculation

Once they inflate your historical earnings to represent today’s cost of living, they pick out the highest 35 years. (If you have less than 35 years of earnings, they will still use 35, but will substitute zeros where there should be earnings.) Once they have chosen the highest 35 years, they simply add them up. Since the goal is to obtain a monthly number, they divide the sum by 420 (the number of months in 35 years). The result is the average amount of inflation adjusted earnings during each month of your highest 35 years of earnings. The Social Security Administration refers to this number as “Average Indexed Monthly Earnings” or more commonly by by its acronym, “AIME.”

Step #3: AIME applied to bend points = PIA

Before we get too deep into step #3, it should be noted that the Social Security Administration uses the term “PIA” fairly often when referring to your benefit amount. They will also call it by its full name, the Primary Insurance Amount. This should not cause confusion. The PIA is simply your Full Retirement Age benefit.

On to step #3…

Once the monthly amount of indexed earnings have been calculated (AIME), the Social Security Administration will apply it to their formula to produce your PIA.

Social Security Bend Points

The result is simply the sum of everything in the last column. The formula to calculate this changes every year, but you can find the current numbers on their website.

Chart showing Social Security AIME example


You may notice that the lower earnings are credited to your benefit amount (PIA) at a higher percentage. This formula is set so that a worker with lower wages might expect to receive a Social Security benefit that replaces about half of his historical earnings, assuming the worker retires at full retirement age. A worker with much higher earnings will receive a larger Social Security benefit, but it may replace only around 25% of wages.

Step #4: Filing Age Reduction/Increase

The last step is not necessarily considered to be a part of the calculation, but it does have a direct impact on your benefit amount. It’s the reductions or increases for filing ages and it is pretty simple. If you file earlier than your full retirement age, you will receive less than your full retirement age benefit. If you file after your full retirement age, you’ll receive more than your full retirement age benefit.

Let’s examine the increase first.  If you wait to file, you’ll receive a credit of 8% for every year you delay up until age 70.  The Social Security Administration refers to these increases as “delayed retirement credits.”

On the other side, if you file early, your full retirement age benefit will be reduced.  How much it’s reduced all depends on your age when you file.  If you file at 65-one year early-your benefit will be reduced by almost 7%.  Those reductions continue to age 62.  At this point your benefit would be at least 25% lower than what you would receive at your full retirement age.

Social Security Full Retirement Age


While this formula is how they generally calculate Social Security benefits, there are some circumstances where it does not apply. For example, if you are eligible for a pension from work where you did not pay Social Security, they could use an alternate formula for the PIA calculation.

You may not ever want to calculate your own benefit amount, but now you’ll know how. If you need more help with any Social Security or financial planning topics, don’t hesitate to visit this page and schedule a FREE 15 minute consultation.

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