It’s already been a pretty rough year, and if you are turning 60 in 2020, you may want to brace for another blow thanks to COVID-19.
You may face a fairly substantial Social Security cut because of how benefits are calculated, and how down economic years — like what has been triggered by the coronavirus — can affect those calculations.
A lot of factors go into how your Social Security benefits are deduced, and while we mostly focus on what you can do to increase your benefits here on Money & Markets, the Social Security Administration does a lot more math behind the scenes.
Average wages for the U.S. during the year you turn 60 are used in two ways when the SSA calculates your benefits, per The Motley Fool:
- Indexing your wages earned over your career to account for inflation
- Determining what percentage of your average wage you receive in benefits
A Wharton Pension Research Council study may have described how Social Security works best as a program that “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.”
It’s fairly technical, but the SSA uses your 35 highest-earning years (also known as your Average Indexed Monthly Earnings) to determine your benefit. Your AIME is then subjected to “bend points,” or income thresholds, that affect how much of your benefit you’ll receive.
Your Social Security benefits equal 90% of your AIME up to the first bend point, 32% between points one and two, and 15% above the second bend point.
When wages are lower in the year you turn 60, those bend points are lowered and the value of your AIME is reduced, according to the Wharton study.
And the reductions could be substantial if a fix isn’t implemented. The Wharton study found that if wages were reduced by 15% in 2020 due to the wave of unemployment caused by COVID-19, the average worker turning 60 this year would see their annual Social Security cut by 13%. That’s more than $70,000 in benefits over their lifetime, according to the study.
How This Social Security Cut Could Be Fixed
The Wharton School study conducted by American Enterprise Institute scholar Andrew Biggs found a few ways this unintentional Social Security cut could be addressed.
One way is for policymakers to legislate for an ad hoc increase in benefits for those turning 60 this year. A supplement of $125 per month would bring low wage earners up to almost the same level as projected for the same group in 2019, while offsetting around half of the impact to middle-income workers.
He also suggests only using data from the first quarter in the Social Security formula because the effects of COVID-19 had not peaked yet. This isn’t a perfect solution, though, because the cohort turning 60 in 2021 could face a similar predicament if unemployment remains high throughout next year.
While it isn’t a perfect solution, it would give policymakers more time to work on another potential fix if the coronavirus lingers throughout the year.
What You Can Do
If you are turning 60 this year, it may be best to prepare now for an unintentional Social Security cut.
We’ll be watching for any news regarding a fix to this quirk in how Social Security is calculated, but if a fix isn’t implemented it could be a shock if you aren’t prepared. And if changing this policy is met with the same gusto as other Social Security changes (i.e. none at all), it’s better to be prepared for the worst.
Delaying Social Security while working longer could help offset a good portion of the cut, and if a fix is found you’ll just end getting an even larger check when you do retire.
Hopefully someone will propose a fix for this Social Security cut that shields future beneficiaries from the same fate, but this may just be another warning sign to take heed of as you prepare for retirement.