A Complete Guide for Retirees, High-Income Earners, and Business Owners
For millions of Americans, Social Security is the foundation of retirement income. Yet the formula behind your monthly Social Security benefit is far from simple. Many workers ask, how is Social Security benefit calculated, and how can you make the most of it? Understanding this calculation is especially important for high-income professionals, business owners, retirees, and anyone nearing their retirement years.
The Social Security Administration calculates retirement benefits based on your lifetime earnings, adjusted for inflation, and the age at which you claim benefits. In 2025, several key updates such as new bend points, a 2.5% cost of living adjustment, and the repeal of certain offsets now affect how benefit amounts are determined.
This article explains the process in clear, step-by-step terms. We will cover how the Social Security Administration determines your primary insurance amount, how average indexed monthly earnings are calculated, and how your full retirement age impacts your monthly Social Security benefit. Along the way, we will highlight common pitfalls and strategies to maximize your Social Security retirement benefits.
The Step-by-Step Formula for Social Security Benefits
Step 1 – Covered Earnings and Social Security Taxes
The foundation of your retirement benefits is your covered earnings. These are wages or self employment income on which you pay Social Security taxes. In 2025, the wage base limit is $168,600, meaning any wages earned above this amount are not subject to Social Security taxes and will not increase your benefit.
To qualify for Social Security eligibility, you must earn enough Social Security credits. In 2025, one credit is earned for every $1,730 of income, up to four credits per year. A worker typically needs 40 credits, or about 10 years of work, to qualify for retirement benefits.
Step 2 – Index Past Earnings to Today’s Dollars
Next, the Social Security Administration calculates your indexed earnings. Because wages and income levels rise over time, your past earnings are adjusted using the national average wage index. This indexing process brings past earnings into today’s dollars so that a year of work in 1985, for example, is fairly compared to a year of work in 2020.
Indexed earnings reflect the true value of your work history. After age 60, your wages are used at face value with no additional inflation adjustment.
Step 3 – Select Your 35 Highest-Earning Years
The SSA then identifies your 35 years of highest earning years after indexing. These are totaled to form the base of your retirement benefits calculation. If you have fewer than 35 years of covered earnings, the missing years are counted as zeros. This can significantly reduce benefit amounts, especially for workers with gaps in employment or who start paying Social Security taxes later in life.
Clients with fewer than 35 years of earnings may want to continue working to replace zeros with additional wages, potentially leading to larger benefits at retirement.
Step 4 – Calculate Your Average Indexed Monthly Earnings
The total of your 35 years of indexed earnings is divided by 420 months to calculate your average indexed monthly earnings (AIME). This figure is rounded down to the next lowest dime.
For example, suppose your total indexed earnings over 35 years equals $2,310,000. Divided by 420, your average indexed monthly earnings would be $5,500. This number is the foundation for determining your benefit payment.
Step 5 – Apply Bend Points to Find Your Primary Insurance Amount
The Social Security Administration calculates your primary insurance amount, or PIA, using a progressive formula. This formula is based on bend points, which change annually with the national average wage index. In 2025, the bend points are $1,226 and $7,391.
Here is how it works:
- 90% of the first $1,226 of your average indexed monthly earnings
- 32% of earnings between $1,226 and $7,391
- 15% of earnings above $7,391
For example, if your AIME is $5,556:
- 90% of $1,226 = $1,103
- 32% of $4,330 = $1,386
- Total PIA = $2,489
The worker’s PIA is the primary insurance, or base amount, you would receive at your full retirement age. This number is rounded down to the next lowest dime.
Adjustments for Claiming Age
Full Retirement Age vs Early or Delayed Claiming
Your monthly Social Security benefit depends not only on your PIA but also on the age at which you claim benefits. For anyone born in 1960 or later, the full retirement age is 67. Claiming at this age provides your full primary insurance amount.
- If you claim benefits as early as age 62, you will receive a reduced benefit. The reduction can be as much as 30% if you retire early at 62 instead of waiting until full retirement age.
- If you delay beyond full retirement age, you receive delayed retirement credits. Each year you wait until age 70 increases your benefit by about 8%. Claiming at age 70 provides the largest benefits possible.
For example, someone with a worker’s PIA of $2,489 would receive only about $1,742 if they claim at age 62, but approximately $3,100 if they wait until age 70.
Key 2025 Updates That Impact Benefits
Cost of Living Adjustment for 2025
Social Security benefits increase annually through a cost of living adjustment. For 2025, benefits are increasing by 2.5%, based on the consumer price index for urban wage earners and clerical workers. While COLAs help offset inflation, they may not fully cover rising health care costs in retirement years.
Repeal of WEP and GPO
The Social Security Fairness Act of 2025 repealed the Windfall Elimination Provision (WEP) and Government Pension Offset (GPO). This change benefits many public sector workers such as teachers and firefighters who previously faced reductions in retirement benefits. If you were subject to these rules in the past, you may now be eligible for larger benefits.
Other Important Factors in Benefit Calculation
The Earnings Test
If you continue working while collecting benefits before your full retirement age, the earnings test applies. In 2025, $1 of benefits is withheld for every $2 you earn above $22,320. These withheld benefits are recalculated and restored once you reach full retirement age.
Spousal and Survivor Benefits
Spouses may claim benefits up to 50% of the worker’s PIA, while widows and widowers may claim up to 100%. These other benefits provide important income options for couples and families. Divorcees may also qualify if the marriage lasted at least 10 years.
Family Maximum
There is a limit on the total amount of benefits payable to a worker and their dependents, called the family maximum. Typically, it ranges between 150% and 180% of the worker’s PIA.
Disability Benefits
Workers who are unable to work due to disability before retirement age may qualify for disability benefits. These are also based on earnings history and Social Security credits, but the calculation rules differ slightly from retirement benefits.
Common Pitfalls to Avoid
- Relying on outdated estimates: Benefit statements before 2025 may not reflect changes to bend points or the repeal of WEP and GPO.
- Retiring with fewer than 35 years of earnings: Missing years are counted as zeros, reducing your average monthly earnings and your monthly benefit.
- Claiming without a plan: Filing for Social Security retirement benefits too early can lock you into a reduced benefit for life.
- Ignoring taxes: Up to 85% of your Social Security benefits may be subject to income tax depending on your total amount of retirement income.
- Not coordinating with your spouse: Claiming strategies between spouses can impact long-term retirement benefits significantly.
When Should You Claim Benefits?
There is no universal answer. The right decision depends on life expectancy, income needs, retirement age, and your broader retirement plan. Some workers may benefit from claiming at age 62 to support early retirement living expenses, while others gain more by delaying until age 70 to maximize larger benefits.
At Towerpoint Wealth, we analyze client-specific factors, including projected income, tax strategy, and retirement years, to recommend the best approach for claiming Social Security retirement benefits.
FAQs About Social Security Benefit Calculation
How is Social Security benefit calculated?
The Social Security Administration calculates benefits based on indexed earnings, your 35 highest earning years, your average indexed monthly earnings, and bend points that determine your primary insurance amount.
What are bend points?
Bend points are thresholds in the formula used to calculate your PIA. In 2025, they are $1,226 and $7,391.
What is full retirement age?
Full retirement age is the age at which you can claim 100% of your PIA. For anyone born in 1960 or later, FRA is 67.
Can I claim benefits early?
Yes, you can claim benefits as early as age 62, but your monthly benefit will be permanently reduced.
What is the maximum monthly Social Security benefit in 2025?
At full retirement age, the maximum monthly Social Security benefit is about $4,873.
How does the SSA adjust benefits for inflation?
Through an annual cost of living adjustment, calculated based on the consumer price index for urban wage earners and clerical workers.
Can I claim benefits if I continue working?
Yes, but if you claim before full retirement age, the earnings test may reduce your benefit payment temporarily.
Final Thoughts
Social Security is complex, but understanding how the Social Security Administration calculates retirement benefits can help you make more informed decisions. From indexed earnings to bend points to the impact of claiming age, every factor matters.
Your monthly Social Security benefit should be viewed in the context of your overall financial plan. At Towerpoint Wealth, we integrate Social Security retirement benefits with investment planning, tax strategies, and estate considerations to ensure you maximize all your resources in retirement years.
If you want to understand your exact security benefit, when to claim benefits, and how to coordinate Social Security with other benefits and income sources, we encourage you to connect with our fiduciary team. The right strategy can turn a basic Social Security check into a cornerstone of financial independence for your retirement.
