Social Security and You: How Your Retirement Benefit Is Calculated

Q. Even though I'm not on Social Security, I've been reading your column for years. A while back, I had clipped out a column you wrote explaining how benefits are figured. And now that I'm getting ready to file for benefits, I can't find that column. Can you please reprint it? And I also have a question. I do recall that you said a benefit is based on your highest 35 years of earnings. But I saw something on the Social Security Administration website that said it's a 40-year base. Have the rules changed?

A. I checked my past columns, and it's been about a year since I explained how Social Security retirement benefits are figured. So, I guess it's about time I do it again. And I'll also explain why I'm right when I say it's a 35-year base of earnings, and how the SSA website also is right when they say a 40-year base!

In a nutshell, a Social Security retirement benefit is a percentage of your average monthly income using your highest 35 years of inflation-adjusted earnings.

So, what's this 40-year base all about? Well, when you file for retirement benefits, the Social Security Administration will look at your earnings history and pull out your highest 40 years. They don't have to be consecutive. But from that 40-year base, they drop out your five lowest years. So they end up using your highest 35 years of earnings to figure your benefit. If you don't have 35 years of earnings, the SSA must plug in an annual salary of $0 for every year you did not work, until the 35-year base is reached.

However, before they add up those "high 35," they index each year of past earnings for inflation. And this is where the formula starts to get messy. That's because there is a different adjustment factor for each year of earnings, and each year's adjustment factor is different based on your year of birth.

Here is a quick example. If you were born in 1962 and earned $20,000 in 1991, they would multiply those earnings by an inflation adjustment factor of 2.9, meaning they would actually use $58,000 as your 1991 earnings. But if you were born in 1960 and earned that same $20,000 in 1991, they would use an inflation factor of 2.5, resulting in $50,000 as the 1991 earnings used in your Social Security computation.

You can find a complete breakdown of those inflation adjustment factors for each year of birth at the Social Security Administration's website: www.socialsecurity.gov. If you have a hard time negotiating that website, just Google "Social Security indexing factors" and it will lead you to the right place.

The next step in the retirement computation formula is to add up your highest 35 years of inflation-adjusted earnings. Then you divide by 420 -- that's the number of months in 35 years -- to get your average inflation-adjusted monthly income.

The final step brings us to the "social" part of Social Security. The percentage of your average monthly income that comes back to you in the form of a Social Security benefit depends on your income. In a nutshell, the lower your average wage, the higher percentage rate of return you get. Once again, the actual formula is messy and varies depending on your year of birth. As an example, here is the formula for someone born in 1960. You take the first $1,024 of average monthly income and multiply it by 90%. You take the next $5,148 of your average monthly income and multiply that by 32%. And you take any remainder and multiply it by 15%.

You can find a complete breakdown of those computation "bend points" at www.socialsecurity.gov. Or just Google "Social Security bend points" to find several sites that should help you.

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