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In order to calculate your Social Security benefit you need to know what your PIA (Primary Insurance Amount) is. In order to calculate the PIA, you need to know what your Average Indexed Monthly Earnings (AIME) factor is. So how is your AIME determined?
During your working career, your Social Security-covered earnings were reported to the Social Security Administration. When you reach age 60, an index factor is applied to each year of your earnings in order to adjust each year’s earnings for inflation. After the index factor is applied, the top 35 years of earnings are totaled and then divided by 420 (the number of months in 35 years). This produces an average… indexed… monthly… earnings… factor.
If you haven’t had a full 35 years of Social Security-covered earnings, the AIME is still calculated using 35 years as the divisor. This can result in a much lower benefit as compared to your average earnings in the years that are in your record. For example, if you earned the “average” wage during at least 35 years of your working life, your AIME would work out to $3,582. However, if you only had 30 years of reported earnings during your working life, having taken time off for college or to raise your family, your AIME would only work out to $3,070.
And this makes a real difference – the PIA that results from the first example (with 35 years of earnings) is $1,605 per month, versus $1,441 per month when you have only 30 years of the exact same earnings. That’s a difference of nearly $2,000 per year.
The index factor that I mentioned earlier is determined in your 60th year, and it’s based on the national average wage during that year, compared with the average wage in prior years. This is known as the Average Wage Index (AWI), and you can learn more about it in detail on the Social Security website.