Social Security and You: The COVID-19 Virus and Social Security
Q: I keep hearing all this talk about how the COVID-19 virus is going to reduce future Social Security benefits. But I can't figure out why. Can you explain it to me?
A: I'll give it a shot. But before I do, let me make a couple of important points. First, if the virus affects anyone's Social Security, it probably will be just a small cohort of people -- essentially, anyone turning 60 this year. No one else. And second, it really isn't clear yet if even that small group of people will be affected. So, now let me explain.
It all has to do with the Social Security benefit formula. When the Social Security Administration figures your retirement benefit, they look at your entire earnings history, pull out the highest 35 years, add them up and then divide by 420 (the number of months in 35 years) to come up with your average monthly wage. Then they use a formula that gets to the "social" part of Social Security to figure your retirement benefit.
That formula is slightly different depending on the year you were born. Here is a quick example. If you were born in 1954, they take the first $856 of your average monthly wage and multiply it by 90%. Then they take the next $4,301 of your average monthly wage and multiply it by 32%. And finally, they take whatever is left over of your average monthly wage and multiply it by 15%.
Can you see the "social" angle I alluded to above? The lower your average monthly wage, the higher your Social Security benefit "rate of return" will be. If you are poor, you don't get more money. But you get a better deal out of the system than your higher-paid counterparts.
OK, I can hear some of you saying, "Thanks a lot for the 'Social' Security lesson, but how does the virus play into all of this?" Well, let me get into that.
I left out one very important part of the benefit formula. I said that the SSA adds up your highest 35 years of earnings. But what I didn't mention is that each year of those earnings are indexed for inflation. And just like the benefit computation formula changes for each year of birth, so, too, do the indexing factors.
For example, let's go back to that guy who was born in 1954. And let's say that 1985 was one of his highest 35 years of earnings -- and that he made $35,000 that year. Before they add that into the computation of his average monthly wage, they multiply it by an indexing factor of 2.76. So, instead of $35,000, they use an inflation-adjusted amount of $96,600. And there is a different indexing factor for each year of his earnings. For example, for folks born in 1954, the indexing factor for their 1995 earnings is 1.89. And for 2005 earnings, it's 1.26. Again, there are slightly different factors for each year of earnings.
So, where do those indexing factors come from? For reasons way too complicated to explain in the limited space of this column, all I can tell you for now is that they are based on the year you turn 60. In a nutshell, they take the average national wage for the whole country from the year you turned 60 and use that as a base to figure the indexing factors for each year of earnings that are in your Social Security account.
And over the years, as the average national wage for the country has gone steadily up, the indexing factors have also crept up for each year of birth. Let's say Joe was the guy born in 1954. And, to repeat, he made $35,000 in 1985, but with the 2.76 indexing factor, they actually used $96,600 in his Social Security benefit computation.