How Social Security Benefits Are Calculated

Social Security retirement benefits are based on the following:

  • Lifetime earnings.
  • Age at time of retirement.

Lifetime Earnings

Higher lifetime earnings result in higher benefits. The highest 35 years are used to calculate average monthly earnings. Each year is indexed for inflation to approximate what earnings for that year would be in today’s dollars. Earnings for each year are also capped by the Social Security maximum earnings subject to Social Security tax for that year. After calculating the average indexed monthly earnings, a formula is used to determine the primary insurance amount (PIA).

Full Retirement Age—Social Security

A person reaches full retirement age as follows:

Table Header Table Header
Born prior to 1938
Age 65
Born in 1938
Age 65 and 2 months
Born in 1939
Age 65 and 4 months
Born in 1940
Age 65 and 6 months
Born in 1941
Age 65 and 8 months
Born in 1942
Age 65 and 10 months
Born in 1943 through 1954
Age 66
Born in 1955
Age 66 and 2 months
Born in 1956
Age 66 and 4 months
Born in 1957
Age 66 and 6 months
Born in 1958
Age 66 and 8 months
Born in 1959
Age 66 and 10 months
Born after 1959
Age 67

Age at Time of Retirement

The amount of benefits also depends on the age when you decide to start collecting Social Security. Full retirement age is the age at which retirement benefits equal 100% of PIA. If benefits begin prior to full retirement age, benefits are permanently reduced. If benefits begin after full retirement age, benefits are permanently increased. By delaying the age at which you begin to receive Social Security, benefits may increase. It is not beneficial to wait past age 70.

Early Retirement Reduced Benefits

The earliest age a person can begin receiving Social Security benefits is age 62. The following table illustrates the effect on a primary beneficiary’s benefit, and a spouse’s benefit who normally would receive 50% of the primary beneficiary’s primary insurance amount (PIA) when Social Security benefits begin at age 62:

Year of Birth Primary’s Reduction Percentage Spouse’s Reduction Percentage
Prior to 1938
20.00%
25.00%
1938
20.83%
25.83%
1939
21.67%
26.67%
1940
22.50%
27.50%
1941
23.33%
28.33%
1942
24.17%
29.17%
1943–1954
25.00%
30.00%
1955
25.83%
30.83%
1956
26.67%
31.67%
1957
27.50%
32.50%
1958
28.33%
33.33%
1959
29.17%
34.17%
After 1959
30.00%
35.00%

Taxable Social Security Benefits

A portion of your Social Security benefits may be taxable. Ask your tax preparer for more information.

Pension Income

Pension income paid to you as a retiree is generally taxable. An employee nearing retirement may be offered a choice in how a pension payment will be made. Pension options from a defined benefit retirement plan generally include a lifetime payment with no survivor benefit, a joint and 50% survivor payment, or a joint and 100% survivor payment. The joint and survivor benefits are reduced amounts from the lifetime payment option. Generally, once a pension option is selected, it cannot be changed.

IRA Distributions

Distributions from IRAs and other retirement plans are generally taxable. Roth IRA distributions are generally not taxable. With some exceptions, distributions taken before age 59½ are subject to a 10% additional tax.

Required Minimum Distribution (RMD) Rules

Traditional IRAs

If you participate in a traditional IRA you must begin receiving distributions from the IRA by April 1 of the year following the year you turn age 72.

Roth IRAs

The RMD rules do not apply to Roth IRAs. Distributions are required only after your death.

Required Minimum Distribution

By the required beginning date, you must begin receiving periodic distributions from a traditional IRA in annual amounts calculated to distribute the entire interest in the account over your life expectancy or over the joint life expectancies of you and a designated beneficiary. Minimum distributions must be made by December 31 of each year. If you wait until April 1 of the year following the year you turn age 72, you must take two RMDs in that year; the first by April 1, and a second by December 31 of that same year.

Example: Irene turned 72 on August 20, 2021. She plans to take her 2021 RMD in March 2022. She must also take her 2022 RMD by December 31, 2022.

Required Minimum Distribution Calculation

The RMD for each year equals the IRA account balance as of December 31 of the preceding year, divided by the applicable distribution period, or life expectancy, for your age in the current tax year.

Distributions Greater Than RMD

There is no penalty for taking distributions in excess of RMD. A distribution greater than the RMD cannot be carried over and used to meet the RMD for the following year.

50% Penalty Tax on Excess Accumulations

The RMD rules are designed to make sure you distribute most of your retirement benefits during life, rather than passing them to beneficiaries after death. The penalty for taking less than the RMD out of an IRA or qualified retirement plan is 50% of the part of the RMD that was not distributed.

Early Retirement

Early retirees (individuals who retire before age 59½) are allowed to take distributions from retirement plans and avoid the 10% additional tax. If you are an early retiree, you must follow certain rules.

  • Distributions must be taken at least annually in substantially equal amounts.
  • Distribution amounts are determined by your life expectancy.
  • Distributions must be taken for a minimum of five years beginning with the year of the first distribution. If, at the end of the five years, you have not yet attained the age of 59½, you must continue the distributions until attaining age 59½.