How the Coronavirus Could Permanently Cut Near-Retirees’ Social Security Benefits

Apr 17, 2020 / Amanda Chase, Horsesmouth Assistant Editor

As a group, retirees are more financially insulated from the economic effects of the COVID-19 pandemic than are most other demographic groups in the United States. Yet due to how the Social Security benefit formula interacts with the sharp economic downturn due to the Coronavirus, some groups of near-retirees are likely to suffer substantial permanent reductions to their Social Security retirement benefits. Assuming a 15 percent decline in the Social Security Administration’s measure of economywide average wages in 2020, a middle-income worker born in 1960 could have his annual Social Security benefits in retirement reduced by around 13 percent, with losses over the retirement period in excess of $70,000.

In simplest terms, the Social Security program replaces a progressive percentage of a retiring worker’s career-average earnings, with low earners receiving a higher replacement rate of pre-retirement earnings compared to high earners. Yet how the Social Security benefit formula measures a person’s career-average earnings, and how Social Security’s progressive replacement rates are implemented, depend on the growth of average earnings in the economy. A sharp decline in economywide wages can have unanticipated negative effects on the Social Security benefits of workers nearing retirement age.

To compute an individual’s Social Security benefit, one must first calculate a measure of each worker’s career-average salary, referred to as the Average Indexed Monthly Earnings (AIME). The worker’s annual nominal earnings each year are indexed to economywide earnings as of the year the worker turns age 60, which is accomplished by multiplying the annual nominal earnings by the ratio of the national Average Wage Index (AWI) in the year the worker turns 60 to the AWI in the year the nominal earnings were paid.

After past earnings are indexed for wage growth to age 60, the Social Security benefit formula selects the highest 35 years of earnings (including any nominal earnings taking place after age 60). The average of those highest 35 years of earnings is then divided by 12 to produce a monthly figure referred to Average Indexed Monthly Earnings (AIME). Next, Social Security calculates the worker’s Primary Insurance Amount (PIA) based upon his AIME.

For 2018, the most recent year for which data are available, the AWI was $52,146. The Social Security Trustees Report (2019) projected that the nominal AWI for 2020 would be $56,396, or 8 percent higher. This is highly likely to be overstated due to the Coronavirus-related economic downturn. How big a decline there will be in the Average Wage Index is uncertain, but it could be substantial due to the manner in which changes in the AWI are calculated. Earnings are dropping sharply as layoffs and furloughs take effect. This implies that that the aggregate payroll total for 2020 will be substantially below what the Trustees projected.

You can find the full Wharton Pension Research Council study, including suggestions for how the government can mitigate these effects, here.



A client, born in 1960, sent me the WSJ article that summarized this Whitepaper. On page 6 of the piece could you please clarify the second half of the following statement, "For a medium wage earner, lifetime benefits will fall by $70,193 in present value. Lifetime losses to a very low wage worker are $24,647; and the maximum wage earner loses $148,030. If uniform post-retirement mortality were assumed, the dollar value of benefit losses to lower earning workers would increase and for higher-earning workers the losses would be less." Thanks, Pete

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