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Policymakers Should Prevent Recession-Related Social Security Benefit Drops

The next COVID-19 relief bill should fix an unintended benefit “notch” under which, due to the pandemic and resulting recession, Social Security benefits will be significantly lower for workers who turn 60 this year and will be eligible for early retirement benefits in 2022. Those becoming eligible for disability or young survivors benefits in 2022 will also see lower benefits.

Here’s why:

Social Security benefits for each new age cohort of retirees are designed to replace about 41 percent of a typical worker’s career-average earnings if one claims benefits at the normal retirement age, which is 67 for those turning 60 in 2020 or later. The benefit formula is progressive: workers with below-average earnings receive a higher replacement rate, and those with above-average earnings receive a lower one. Before computing a worker’s average earnings, Social Security adjusts earnings from years before a worker turns 60 to account for the growth in economy-wide wages, using an “average wage index.”

Normally, average earnings in the economy rise from one year to the next. Due to the sudden, sharp unemployment increase in 2020, however, many workers will suffer a big decrease in their annual earnings. And those decreases will cause the economy-wide average annual wage to fall as well. That, in turn, will reduce the average indexed earnings and Social Security benefits of workers turning 60 in 2020 compared to those with similar earnings who turned 60 in 2019. If the average wage falls by 5 percent in 2020, as now seems likely, the retirement benefit of a 60-year-old worker with average earnings will drop by about $1,200 a year for each and every year of retirement. If the average wage falls more, the decreases will be even larger.

People shouldn’t suffer a large, permanent drop in their Social Security benefits just because they turn 60, become disabled, or experience the loss of a breadwinner around the start of a deep recession. Policymakers should fix this unfair result. One solution would be to specify that the wage-indexing factor couldn’t fall from one year to the next, even when the average wage index declines.

Social Security already includes two provisions that prevent reductions in taxes or benefits in unusual circumstances. The amount of annual earnings subject to the Social Security payroll tax doesn’t decline even if average wages fall. And cost-of-living adjustments don’t reduce benefits when the consumer price index drops. Retired and disabled workers and survivors should have similar protection from lower benefits because of a decline in average wages.