Ever wonder how Social Security determines the benefit amount you will receive once you’ve applied for benefits? You may already know that benefits are based upon a variety of factors. Social Security considers the amount of income earned subject to Social Security taxes, the total number of years those earnings took place, and the age at which you begin taking benefits. Beyond this important, but basic, information is where confusion often sets in.

To begin to zero in on a benefit amount, Social Security uses your highest 35 earnings years, not your most recent 35 years of earnings (a common misconception). If you do not have a 35-year work history, any years with no earnings will count as zero in the calculation. Social Security indexes your earnings for inflation through age 60 and simply records them as earned thereafter. Social Security then calculates the average amount you earned per month over your highest 35 earnings years to establish your Average Indexed Monthly Earnings (AIME).

Once your AIME is established, Social Security applies the amount to the current benefit formula to determine the benefit amount to be paid to you at your full retirement age (FRA). This amount at your full retirement age is known as the Primary Insurance Amount (PIA). If you apply for benefits prior to your FRA, the benefit is discounted for early retirement. When you apply for benefits after your FRA, the benefit is enhanced due to the addition of delayed retirement credits. Social Security’s benefit formula changes slightly every year and can easily be found with a quick online search.

When you view your Social Security benefit statement, it is important to understand that the amounts displayed are estimates of future benefits, which are derived from certain assumptions. For example, your benefit statement assumes you will continue to work – at your current wage level – until you begin to collect benefits at the age for which a benefits estimate is provided. These earnings may or may not materialize, as it is not out of the question for you to retire at one age and start collecting Social Security benefits at another. Therefore, it is important to understand that you may never really know exactly what your benefit might be until you actually apply and your benefit is calculated based on your final earnings information. Remember also that benefits are prorated monthly. Therefore, you will receive a larger benefit if you begin receiving benefits at age 62 and 1 month versus age 62 and 0 months.

Finally, if you have reached your FRA, earning income while collecting Social Security can only benefit you due to the fact that when you add to your highest 35 earnings years, your benefit will be recalculated and increased due to the addition of a new amount to your highest 35 earnings years. This increase will be above and beyond what might be applied in the form of an annual cost of living adjustment, should one occur. If you are collecting benefits and earning income, but your income is not enough to break into your highest 35 earnings years, your benefit will only increase due to a potential cost of living adjustment, should one occur. Consequently, you could be 80 years of age while collecting benefits for a decade or longer, working and adding to your highest 35 earnings years. In this case, you would be notified that your benefit is increasing not only due to the current cost of living adjustment, should one occur, but also because of this important new addition to your highest 35 earning years.