Your Social Security: 35 Years of Work

This blog is for a part-time Macy’s saleswoman and immigrant whom I met in a hospital waiting room – she’d never heard of Social Security.

It is also for a 22-year-old contingent worker I know who lacks steady employment and isn’t regularly accruing credit toward the Social Security pension he will probably need when he retires.

And it is for a 62-year-old eager to claim his benefit right away, possibly short-changing his retirement.

A substantial share of retirees would fall into poverty were it not for the Social Security program passed during the Great Depression.  It’s especially important for two groups of people to understand how Social Security calculates their pension benefits: young adults making employment decisions that will impact them decades from now and older people figuring out when to retire.

Yet research shows that many people do not know the basic workings of a program that is crucial to their financial security.

Steve Richardson, a Social Security official in Boston, holds regular seminars to explain the pension program to the public. “The first thing I ask is – before I say my name – ‘How many people in this room know how many years Social Security looks at to determine your pension payment?’

“Not many of them know it’s your high 35 years of earnings.”

To qualify for a pension benefit at all, a person must work full- or part-time for 40 quarters – a total of 10 years. That’s not a difficult hurdle for most to clear during decades in the labor force. What’s central is the size of your future benefit check, which is determined by your highest 35 years of indexed earnings, Richardson said – and that brings us to the math thing.

The first step in the U.S. Social Security Administration (SSA) calculation of pension benefits is to adjust your past earnings to reflect the growth in average U.S. wages over time. Social Security indexes each year of your wages by the general growth in wages up until age 60. For example, the $13,000 that a baby boomer earned in her first year of work in 1975 would be increased to reflect the growth in average wages over the years.

SSA then uses your highest 35 years of these indexed earnings to calculate your average indexed monthly earnings, or AIME. For example, if you worked 43 years, then the eight lowest years of your indexed earnings drop out of the AIME calculation. On the other hand, if you’ve had an inconsistent employment history and worked only 30 years, your pension amount would be pulled down by the “zeroes” entered into the AIME calculation for the remaining five years required to determine your benefit.

Finally, a complicated formula is applied to each worker’s AIME to determine the size of his or her Primary Insurance Amount, which is the monthly benefit at his or her full retirement age under the Social Security program (66 for boomers).

A few specific situations demonstrate why this math matters:

• Take workers who’ve just entered the labor force. Realize that the earlier you start earning wages and contributing to Social Security, the sooner you will have the full 35 years of earnings to put into the formula for your future pension benefit.

• Another situation is older workers who have not yet contributed to the program for 35 years. If you continue to work and replace those zero-earning years with actual earnings, the additional years will increase your pension benefit by increasing your AIME.

• If you have put in 35 years and continue to work, you could replace low-earning early years in the AIME calculation with higher pay levels at the end of your career. However, doing so won’t necessarily have a large impact on benefits, Richardson said.

He used the example of a 61-year-old executive who finally landed the corner suite he’d been hoping for and now brings in well over $120,000 per year. This new job might not increase his Social Security check by very much – or at all – for two reasons. First, higher pay for a couple years is unlikely to affect an AIME calculated over 35 years. More important, Social Security covers (and taxes) earnings only up to a preset level – $118,500 in 2016.

The most effective way for older workers to increase their pensions substantially is to delay when they start collecting their benefits.  Benefits are adjusted based on when you sign up. Each year of delay increases a monthly Social Security check by 7 percent to 8 percent – so a boomer would get 76 percent more by delaying claiming the pension from age 62 to age 70.

For more information, see the “Social Security Claiming Guide,” published by the Center for Retirement Research, which sponsors this blog. You can get a concrete estimate of how your pension benefit would be affected by another year of work or a higher-paying job by using the Social Security calculator.

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