Since monthly payments began in 1940, Social Security has been one of the most essential social programs in the United States. For some of the approximately 53.5 million retired beneficiaries, Social Security is simply supplemental income.
However, for many, it is a vital source of retirement income that covers their basic needs. Regardless of the role Social Security plays in your retirement finances, it’s crucial to have an idea of how much you will receive so you can start planning your retirement budget accordingly.
How Social Security calculates your monthly benefit
If you are still a few years away from retirement, it can be challenging to get an exact estimate, but you can use averages at specific claiming ages to get a rough idea of what to expect. Let’s consider the age of 65 for this example.
Social Security calculates your monthly benefit using your average earnings during the 35 years when your income was the highest.
They adjust your earnings for inflation (called “indexing”) to reflect their value in current dollars, then divide the total number of months in those 35 years to get your average indexed monthly earnings (AIME). If you don’t have 35 years of earnings, Social Security uses zeros for the missing years to calculate your average.
Next, Social Security applies a formula using bend points (which are adjusted annually) to determine your primary insurance amount (PIA), which is the monthly benefit you will receive if you claim at your full retirement age.
The formula involving bend points can be a bit confusing, so an easier way to determine your primary insurance amount is to check your earnings record on the Social Security Administration’s website (SSA.gov) and use their online benefits calculator.
The role of your full retirement age in determining your benefit amount
The final part of determining your monthly benefit is when you claim it in relation to your full retirement age, which is based on birth years as follows:
Although the full retirement age for most new Social Security beneficiaries is 67, you can start claiming benefits as early as age 62 (reducing monthly benefits) or delay them until age 70 (increasing monthly benefits).
If you are 36 months away from your full retirement age, the Social Security Administration reduces your monthly payment by 5/9 of 1% for each month you claim early. Beyond 36 months, the program reduces your benefits by 5/12 of 1% each month. With a full retirement age of 67, someone who claims benefits at 65 will see their payment reduced by approximately 13.33%.
According to the latest data from the Social Security Administration, the average monthly benefit for someone claiming at 65 is $1,505, which amounts to $18,060 annually.
It is also worth mentioning that due to the average lifetime earnings of men and women, the average benefit at 65 can vary. For men, the average benefit at 65 is higher, at $1,671; for women, it is $1,356.
A component of retirement income
With just over $18,000 annually, the average Social Security benefit for a 65-year-old is not enough to fully support many people. This is why, ideally, Social Security should be just one of your sources of retirement income and not the only one.
Of course, not everyone has that privilege due to life circumstances, but for those with jobs that offer a 401(k) or who earn sufficient income, intentionally diversifying your retirement income can provide greater financial security.
A great source is an IRA, which you can open on your own and doesn’t have to be through an employer like a 401(k). By using sources like an IRA, whether Roth, traditional, or both, you can take advantage of their tax benefits and create an additional income stream that brings you closer to financial flexibility in retirement.
There’s no such thing as over-preparing for retirement, so use those years leading up to it to build the largest retirement fund possible. You will likely be thanking yourself during retirement.
