Background

A co-worker sent me an article I can’t seem to link to properly – https://www.morningstar.com/news/marketwatch/20200912157/a-drop-in-social-securitys-average-wage-index-could-hurt-four-million-people The article purports that the affect of COVID-19 in 2020 will permanently reduce their Social Security benefits by 9.1% because of the Adjusted Wage Index. I read the article and found that while a good portion of it was sound, the conclusions were misleading. I am posting here for two reasons:

I am hoping the community can help substantiate and/or refute the article and my interpretation of it
I assume most still working FIRE folks don’t give much weight to social security (nice to have) and I also assume that they are aiming for pre-60 retirement. On the other hand, Social Security is a complicated beast to understand so by sharing why I think this article is misleading, I am also helping to educate for those who want to understand.

How Social Security Is Calculated

I actually found this article and the ssa.tools results easier to understand than what was on the SSA website.

Step 1 – Determine Your Wages For Each Year

This can be done using the Social Security website and going to your earnings history. A couple of things to note:

If you are a high wage earner, you may find that the amount reflected in a given year is less than you actually earned – this is because there is a maximum each year after which income is no longer considered for social security purposes
These are starting values – they get adjusted in the next step

Step 2 – Adjust The Wages For Inflation

This is the step the article is saying will result in a permanent 9.1% drop in benefits but I believe is misleading. This is done using the Average Wage Index. Things I think the article got right

The year that matters is the year you turn 60 (2 years prior to being first eligible)
2020 will very likely be lower than originally predicted. The article says: The 2020 Trustees Report projected that the AWI, which equals total wages in the year divided by the number of wage earners, would increase by 3.5% from 2019 to 2020. It later goes on to say: experience so far in 2020 suggests that total wages will be about 10% lower than projected in the 2020 Trustees Report and the number of workers will be about 1% lower than projected. (The number of workers doesn’t decline very much because AWI includes all wage earners even if they only worked for the month of January.) If these percentage declines play out, then the average wage index will be 9.1% (1 — 90/99) lower than projected for 2020
The affect will be permanent for those turning 60 this year without legislation (the article mentions 2 bills already created to address)

What I disagree with in the article is: Assuming these declines come to pass, about four million people will receive benefits that are 9.1% less than expected

Instead, I think it should read: Assuming these declines come to pass, about four million people will receive benefits that are based on earnings 9.1% less than expected.

I have already made this section long enough because this is the crux of the issue but suffice it to say, the AWI is used to adjust the earnings history from step 1

Step 3 – Calculate Your Average Indexed Monthly Earnings (AIME)

Identify the highest 35 earning years from step 1 after applying step 2
Divide the sum by 35 and then again by 12

This is what you made on-average per month through your 35 highest earning years and will be what your SS benefit will be based on

Step 4 – Identify Your Primary Insurance Amount (PIA)

You can think of the next step almost like reverse tax brackets. Essentially a progressively smaller portion of your AIME contributes to your benefit amount. There are only 3 brackets – called bend points. Here is a table of them as they change each year. I will use 2021 for the purposes of the example applying the PIA formula:

90% of the first $996
32% of any amount between $998 and $6002
15% of any amount above $6002

Step 5 Adjust for Cost Of Living & Age Of Starting Benefits

Cost Of Living Adjustments apply but aren’t really germane to the conversation. Additionally, the amount of your PIA (monthly benefit) is adjusted based on the age you retire. For most everyone, the PIA in the previous step is based on starting benefits at age 67. You can take benefits as early as 62. The benefits can even increase beyond the PIA in the previous step if you delay taking the benefits past 67 but it maxes out at age 70.

Conclusion

Because of the way the bend points work, I don’t believe the impact of the AWI in 2020 can have the impact the article suggests. Social Security is intentionally capped in two ways

There is a maximum amount you can earn in any given year that counts towards social security
The last bend point is set to 15% meaning you only get 15 cents for every dollar earned above that bend point.

I did one calculation based off a AIME of 8333 (100K annually) and the difference was a hair under 4% – still substantial and worth fighting over but less than half of the number claimed by the article.