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,