How is Social Security Calculated?

You’ve been working hard all your life and paying diligently into Social Security. But how do you know how much you can count on each month? That, my friend, is the biggest mystery in retirement planning – how is social security calculated?

You need to know how Social Security is calculated so you can make sure you maximize your benefits and make the most of the hard work you’ve put in throughout your career.

This article will help you to understand the basics of Social Security, its rules on eligibility, and how to apply for benefits when you retire.

Social Security & Eligibility

Social Security is a government program designed to provide funds for certain groups of eligible people.

As you work, you pay taxes on your income that go into the government’s Social Security funds. The two funds are the OASI Trust Fund which benefits retirees and the Disability Insurance Trust Fund for people with disabilities.

Money that currently resides in these funds is used to support people in need of it right now while any money that is leftover remains in the funds for future use.

The people eligible for receiving Social Security benefits are those who are currently retired, those with disabilities, and any surviving spouses or children of deceased workers.

In order to receive your Social Security card, you must also be either a U.S. citizen, a permanent resident of the U.S., or a noncitizen who works in the U.S.

Disability benefits are given to anyone affected by a physical or mental disability to the point that they are unable to work for a year or more.

Spouses and children are eligible for survivors’ benefits based on the earnings record of their deceased relative.

However, the most common way to earn Social Security benefits is upon retirement.

As long as you have been contributing to Social Security for at least 10 years, you become eligible for early retirement benefits once you reach 62.

However, if you want to take full advantage of the maximum Social Security benefits available to you, then you should wait until full retirement age to start receiving them.

Full retirement age varies depending on the year you were born. It can get a little bit confusing in the early years, so I’ve laid it all out here:

  • Born in 1954: Full retirement age, 66.
  • Born between 1954 and 1960: Add two months for each year following 1954. For example, the full retirement age for 1955 is 66 and 2 months. For 1956, 66 and 4 months. For 1957, 66 and 6 months, and so on.
  • Born in 1960 onward: Full retirement age, 67.

By waiting until you reach full retirement age to take advantage of Social Security, you become eligible for a higher monthly benefit.

If you are able to wait until age 70 to start receiving benefits, you will be eligible for an even higher monthly benefit than at age 67.

Each additional year that you wait past full retirement age will increase your benefit by a percentage that is based on your birth year.

However, this opportunity maxes out once you hit 70, so you don’t want to wait any longer than that to start receiving your benefits.

Your monthly benefit amount also depends on how much you earned throughout the course of your career.

If you earned more on average during your lifetime, then you will be eligible to receive higher monthly benefits than someone who earned less.

Any gaps in your career where you either didn’t work or your average earnings dropped significantly will most likely result in a lower monthly benefit amount compared to if your earnings had been steadier.

This particularly hits women hard.

I used the Social Security Administration’s Retirement Estimator calculator to see what I can expect in retirement.

how is social security calculated

I’ve been self-employed since 1999 and intentionally pay myself a low W2 salary, so I ran it paying myself $20,000 a year (my current salary) and $40,000 a year to see if I can get any additional benefits by increasing my salary.

I’m not planning to take SSI until age 70, so at the current rate I’ll earn $2,936 a month. Doubling my salary will only get me $87 more a month in SSI so I’ll keep that money in the business.

So, How IS Social Security Calculated?

By going through life working as you normally would, you earn credits that will make you eligible to receive Social Security benefits once you decide to retire.

For each year you work, you can earn up to four credits.

Every year, the amount of money equivalent to one credit changes.

For this year, 2021, one credit is equal to $1,470. To achieve the maximum of four credits for this year, you will need to earn a total sum of at least $5,880.

Generally, the amount of money equivalent to one credit increases each year, so try to be aware of the changes as you progress throughout your career.

As I mentioned, you need at least 10 years of work to be eligible for benefits, meaning you will need to have earned at least 40 credits during your lifetime.

If you are a self-employed worker, you may be wondering how you can earn your credits, since Social Security is normally deducted directly from payroll.

However, there’s no need to fear! Self-employed individuals earn credits in exactly the same way as salaried workers.

You are still eligible for your four credits per year leading up to the ultimate goal of 40 credits throughout your career overall.

How to Claim Your Social Security Benefits

There are three different ways you can apply for Social Security benefits: online at the Social Security Administration website, on the phone at 1-800-772-1213, or by visiting your local Social Security office by appointment.

When you apply, you’ll need to include quite a few documents as well as some important information, which I’ve listed for you here:

  • Your Social Security number.
  • Your birth certificate.
  • Your W-2 forms or self-employment tax return for last year.
  • Your military discharge papers if you performed military service.
  • Proof of U.S. citizenship or lawful alien status if you were not born in the United States.
  • The name of your financial institution, the routing number, and your account number for direct deposit.

It’s a lot to gather together, but don’t sweat it if you don’t have everything you need right off the bat!

The employees in the Social Security office will help you find out where you can retrieve all the necessary documentation.

The documents do need to be originals when you apply, but the Social Security office will also make copies and give the originals back to you.

Try not to delay in applying as soon as you’re eligible so you can be sure to take full advantage of all the monthly benefits you’ve worked hard to earn throughout the course of your career. 

Social security is a right that you’re entitled to as a working individual, but it is also a complex topic.

The rules surrounding Social Security can be fuzzy, especially with ever-changing yearly credit amounts and so much variety in how high your monthly benefit amounts can be.

Learn the basics now so you’re not surprised in the future and ready to take advantage of your benefits while kick-starting the retirement of your dreams.

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