This year — 2020 -- will always be remembered as the year of historic unemployment caused by the COVID-19 pandemic. More than 4 million people who turn 60 this year may suffer an added loss because a decline in this year’s average wage index could reduce their future Social Security benefits for the rest of their lives. It would take an act of Congress to fix it.
The potential drop in future Social Security benefits for this group of near retirees is the result of a complicated formula that adjusts a worker’s average career earnings to changes in the average wage index up through age 60.
A percentage change in the average wage index in the year a worker turns 60 has a nearly one-on-one impact on the Social Security benefit formula calculation of average career earnings that determine retirement benefits, former Social Security Administration official Andrew Biggs explained in a recent paper for the Pension Research Council published by the Wharton School of the University of Pennsylvania.
Biggs, now a resident scholar at the conservative American Enterprise Institute, initially forecast a 15% drop in this year’s average wage index. For Americans born in 1960 who turn 60 in 2020, that would reduce career average earnings by about 13%. For workers earning the median wage of about $50,000 a year, that drop in average earnings would translate into a Social Security benefit reduction of about $3,900 a year and about $70,000 over their lifetimes.
Biggs recently updated his forecast. Based on new employment and wage data from the Congressional Budget Office, he now projects a 9.8% decline in average wages in 2020, which would translate into a future Social Security benefit cut of 8.8% for workers who turn 60 this year. That would result in an annual benefit reduction of $2,500 for median-wage workers and a loss of about $49,000 in Social Security benefits over their lifetime. But that could change again before the end of the year.
“The specific level of benefit cuts will be determined by the actual change in average wages in 2020, which we won’t know until the end of the year,” Biggs told me. “After that, there’s maybe a year to fix the problem.”
There has been only one other time that the national average wage index declined since 1951 -- in 2009, as a result of the Great Recession. But the drop was much smaller than the one projected for this year and Congress did nothing.
“COVID was much more sudden than the Great Recession,” Biggs said. “The 2020 situation was a perfect storm where employment was at a 60-year high in the first quarter of 2020 and by the second quarter, unemployment had risen to an 80-year high.”
As a possible remedy, Biggs has proposed a major change in the way Social Security calculates benefits that involves abandoning the wage-index earnings formula and replacing it with an inflation-indexed average of pre-retirement earnings. But that’s not a quick fix and would be better left as part of a major Social Security reform package that Congress will have to tackle sometime during the next 15 years before the Social Security trust fund reserves are depleted.
In the meantime, Paul Van de Water of the Center on Budget and Policy Priorities has proposed a simpler solution: Have Congress mandate that changes in the wage index can never result in lower benefits than the year before. That is similar to the way Social Security handles annual cost-of-living adjustments and the maximum amount of earnings that are subject to payroll taxes. Neither measure can fall below the previous year’s level.
Biggs agreed that a solution that keeps the average wage value used by the Social Security Administration from declining from one year to the next “would smooth out the changes so over several years no single cohort of American workers receive a large benefit cut relative to other people who might be only a year older.”
Congress would have to act by the end of 2021 to fix the wage index formula before people who were born in 1960 become eligible to claim Social Security benefits when they turn 62 in 2022.
“We’re talking to people on both sides of the aisle about possible solutions,” Van de Water told me in a telephone interview.
“Our main objective is to keep the issue front and center,” he said. “If it doesn’t get fixed before next fall, it would be more complicated.”
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