For most American retirees, Social Security is a huge part of the retirement equation. In fact, a recent New York Times article notes that even retirees with a $1 million nest egg rely heavily on Social Security income during retirement.

Even though Social Security is so important, most of us still don’t understand exactly how the benefit works. What do you need to do to get it? And how do you calculate your future benefit?

Here’s the low-down on how you earn Social Security benefits and how you figure how much is coming to you.

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It Doesn’t Take Much to Qualify

Many factors influenced the government to adopt Social Security during and after the Great Depression. (You can read more about that here.) But at its heart, Social Security was always directed toward lower-income workers who don’t necessarily have the means to invest for their own retirement years.

Therefore, the bar to qualify for Social Security is pretty low. To qualify for Social Security, you have to earn credits. You can earn up to four credits each year you work, and you need to earn 40 credits to qualify for benefits.

You need to earn $1,000 for one credit. So if you earn at least $4,000 per year over 10 years of work, you can get at least some Social Security benefits.

But There’s a Caveat

Even though it doesn’t take much to qualify for some Social Security benefits, the more you put into the system, the more you can take out. While even billionaires won’t get six-figure Social Security checks, those who worked longer or earned more will qualify for a bigger benefit.

That’s because a big portion of your Social Security benefit is calculated based on your lifetime income average, up to a certain ceiling.

In 2013, the maximum taxable earnings ceiling is $113,700. That means that you don’t have to pay FICA (Federal Insurance Contribution Act) taxes on any income above that ceiling. It also means that when the SSA calculates your benefit, they’ll only count the first $113,700 in your 35-year average.

To calculate benefits, the Social Security Administration averages your annual income for 35 years of work.

If you work more than 35 years, the SSA will factor in your highest-paying years, pulling up your average. If you work less than 35 years, you’ll get some zeros added into your calculation, pulling your average down. (So it’s a really good idea to keep working until you have at least 35 years of decent-paying work under your belt.)

Other Factors

Index Factor

Of course, the government doesn’t keep things simple by averaging youractual35-year earnings. Instead, for each year, your earnings are given an index factor, which helps put your earnings from various years into today’s dollars.

For instance, the index factor for 1952 is 14.46. So if you earned $2,000 in 1952 (the maximum is $3,600 in 1952 dollars), your indexed earnings will be $28,920.

The index factor takes inflation into account, so by the time you get to the current year, the factor is 1 because your earnings from this year are in current dollars. This means that for each year from 1952 on up, the index factor is a bit smaller. Also, it changes each year as inflation goes up. The current year will always have a factor of one, but the index factor for 1965, for example, will go up a little bit each year.

Percentage of Income

And don’t think that you can average your indexed earnings each year and pull your Social Security benefit amount from that. Your earnings information is put into a formula that determines what percentage of your average income Social Security will replace.

As of 2013, Social Security will replace about 40 percent of an average earner’s income, according to a Social Security pamphlet. That percentage will be lower for high-income earners and higher for low-income earners.

Because the goal is to ensure that retirees can cover at least their bare minimum expenses after retirement, the system is set up to level the playing field a bit.

Retirement Age

Another major factor in determining your Social Security benefit is when you choose to begin taking benefits. Today’s retirees are eligible for Social Security starting at age 62, but those who take the benefit this early will get less money each month.

If you wait until your full retirement age — somewhere between 65 and 67, depending on when you were born — you’ll get a bigger Social Security benefit. And if you delay your retirement further, up to 70, you’ll get an even larger benefit.

According to the Social Security Administration, if your full retirement age is 67, but you take benefits starting at 62, your monthly check will be reduced by about 30 percent. If you take benefits starting at 65, your check will take a 13.3 percent hit, and if you take benefits at 66, you’ll take a 6.7 percent cut.

On the flip side, retiring after you’re eligible for full Social Security benefits can put more money into that monthly check. Those born after 1943, for instance, can get an 8 percent benefits increase for each year they delay retirement between 67 (full retirement age) and 70 (the age at which benefits stop increasing). This chart from the SSA outlines yearly and monthly rates of increase for individuals in various age brackets.

The goal here isn’t necessarily to encourage people to stay in the workforce longer. Instead, the goal is to try to even out how much money, in total, individuals get from Social Security.

Based on average life expectancy, which is calculated by the SSA each year, a man who takes benefits starting at 62 will likely draw on those benefits for 22 years. If he waits until 70 to take benefits, he’d be likely to need them for closer to 14 years.

Social Security Administration actuaries try to calculate benefits so that no matter when this man retired, he’d get around the same lifetime amount from the Social Security system.

Of course, average life expectancy has very little to do with how long an individual lives. That’s one reason that deciding when to take your Social Security benefits is so difficult.

Cost of Living Increases

One final issue when calculating Social Security benefits is the cost of living increases. The Social Security Administration is careful to include inflation in all its calculations. And once you start taking benefits, this is no different.

Each year, the SSA looks at the Consumer Price Index, the calculation that shows how much purchasing power our money has, compared with the year before. To ensure that your Social Security checks have the same purchasing power from year to year, they’re automatically increased every year by a percentage based on the Consumer Price Index.

Adding it All Together

All of these various factors come together to make up your monthly Social Security benefit. Confused? You’re not alone. Social Security calculations are complex, and they get more so for younger workers, who are affected by the tenuous future of the Social Security program.

Luckily, the government offers some excellent Social Security benefits calculators that can help you determine your likely Social Security earnings, even if you don’t understand how the numbers work.

First, check out your Social Security account here, where you can get the administration’s records for your annual earnings. Then, explore these calculators and worksheets to help you figure out your Social Security benefits:

  • SSA Online Calculator: This simplified calculator will give you a rough estimate of your possible Social Security benefits.
  • SSA Detailed Calculator: This calculator asks for more detail, so it gives you a better estimate of your Social Security benefits.
  • SSA Retirement Estimator: If you have enough credits to receive Social Security, you haven’t applied for benefits, and you aren’t receiving benefits, you can use this calculator. It automatically inputs your earnings and other information using your Social Security records.
  • Retirement Benefit Sheet: This fact sheet from the SSA includes a worksheet that you can fill out to estimate your benefit on your own. If you want to do the math on your own so you’re more familiar with how the formula works, this is the place to do it.

For Younger Workers

These calculations should hold true for those nearing retirement age now. But if you’re a younger worker interested in calculating future Social Security benefits, keep in mind that we aren’t sure what the future of the program looks like. Right now, the SSA estimates that the Social Security program will be able to pay out about 75 percent of scheduled benefit amounts by 2035.

Tip: Empower is a free Retirement Planner. If you’ve never signed up for the dashboard, you can do so for free with this link.

So take that into account if you’re counting on Social Security as part of your overall retirement plan.

(Personal Capital is now Empower)

Empower Personal Wealth, LLC (“EPW”) compensates Webpals Systems S. C LTD for new leads. Webpals Systems S. C LTD is not an investment client of Personal Capital Advisors Corporation or Empower Advisory Group, LLC


  • Abby Hayes

    Abby is a freelance journalist who writes on everything from personal finance to health and wellness. She spends her spare time bargain hunting and meal planning for her family of three. She has a B.A. in English Literature from Indiana University Purdue University Indianapolis, and lives with her husband and children in Indianapolis.