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Just when you think it’s safe to go back to the beach, the viral predator returns for a second time. If you’re hoping for a quick rebound in the economy following our initial bout with coronavirus, be prepared for the possibility of more bad news, especially if you’re unlucky enough to work in the wrong industry.
Bad luck extends beyond your job. It can also impact your retirement. If you happen to have been born in the wrong year and are depending on Social Security, you may be in for an unsettling surprise.
“The impact of coronavirus on anyone born in 1960 is substantial because it infects the mechanics of the statistics of ‘average wages,’” says Ian Kelly, VP, Operations at NuLeaf Naturals in Denver. “Congress changed Social Security decades ago so that many of the systems in place can function without Congressional intervention. Benefit levels grow, and unfunded liabilities get higher while the tax bases increase. Congress usually stays unaware of what is happening.”
At its foundation, the problem resides in the employment numbers. Although recent numbers may be less severe, the dramatic loss of jobs as a result of the coronavirus shutdown hurts the bottom-line number of Social Security.
“Nobody knows yet how much the economic downturn will affect workers who turn 60 this year,” says Andrew Latham, Managing Editor of SuperMoney in Santa Ana, California. “However, according to estimates by the Wharton Pension Research Council, a 15% decline in the Average Wage Index (“AWI”) could reduce the retirement benefits of middle-income workers by approximately 13%, which could mean $70,000 less in benefits over their retirement period.”
It’s not just the raw numbers, it’s the algorithm Social Security uses once it calculates those numbers. This formula yields the value of your benefit. Normally, the movement is subtle and usually in a positive direction. Thanks to the coronavirus job losses, the year 2020 may produce a quantum leap downward.
“Social Security uses a couple of calculations for your benefit,” says Kyle O’Dell, President of EdgeRock Wealth Management in Denver. “One being your top 35 years of earnings and another being ‘indexing’ your earnings against the national average. Because of all the layoffs, national wage earnings are expected to drop this year by 10-15% according to the Pension Research Council. This could decrease Social Security benefits by $2K-$4K per year.”
How exactly does Social Security calculate your benefit and why is 2020 so important (and bad news) for Baby Boomers born in 1960?
“Social Security calculates your benefit based on your top 35 years of ‘Indexed Earnings,’” says Sally Cholewka, Director of Financial Planning Services at America Group Retirement Strategy Centers in New York City. “In order to account for inflation over time, your ‘Nominal Earnings’ are multiplied by an ‘Indexing Factor’ to arrive at your ‘Indexed Earnings’ for that particular year. Essentially, the ‘Indexing Factor’ is the way we’re turning yesterday’s dollars into today’s dollars. The kicker is how the ‘Indexing Factor’ is determined. This factor uses the Average Wage Index for the year in which the person attains age 60 as the numerator in the equation. Guess what…2020 is that special year for those born in 1960.”
Here’s how this all works.
Cholewka says, “Someone born in 1958 reached age 60 in 2018. The average wage for 2018 ($52,145.80) would be divided by the average wage for 1980 ($12,513.46) for an Indexing Factor of 4.1672. If this person made $10K in 1980, then their Indexed Earnings for 1980 is $41,672. Let’s say the average wage for 2020 plummets to $40,000. A person born in 1960 who earned $10K in 1980 would have Indexed Earnings that year of $31,966. Each and every year in the chart would be lower, thus resulting in a lower Social Security benefit.”
If you’re born in 1960 (or a few years after that and afraid this might affect you, too), is there anything you can do to offset this potential drop in your Social Security benefit?
At the very least, you have some options that don’t require someone else to help you. “Those born in 1960 can try to work more in 2020, delay retirement, and or delay the year they begin taking Social Security benefits,” says Kathleen Owens, Managing Member, Financial Adviser at Aurora Financial Planning & Investment Management LLC in San Francisco.
When it comes to the actual Social Security calculation, your options are extremely limited.
“Nothing can be done by an individual worker to adjust the effect the base year AWI has on their Average Indexed Monthly Earnings (“AIME”) calculation,” says Tim Adams, a National Social Security Advisor in Dayton, Ohio. “However, the worker may want to consider delaying their filing (and earn Delayed Retirement Credits) to help offset the difference.”
You can certainly contact your Congressman, because that’s the only real way to change Social Security. A more manageable strategy would be to rely on what you can do for yourself. “The only thing workers can do to avoid this reduction in benefits is call their representatives and lobby for a change in the way Social Security calculates benefits this year,” says Latham. “Workers can also offset the lower benefits by retiring later, living more frugally, and investing more in their retirement accounts.”
If you really want to make up for the loss, you’ll need to put away more in your retirement account. “The primary thing those born in 1960 can do is to save more money to offset the Social Security benefit loss,” says O’Dell. “If someone from 1960 retires at age 65 based upon a life expectancy of age 95 and assuming a 4% rate of return, the person would have to save an additional $50k heading into retirement to offset the reduction in Social Security benefits.”
But there’s another trick that’s been a proven winner. It’s not without some risk. (How else would you get a greater reward if you didn’t assume some risk?) “Those born in 1960 can, if possible, delay claiming their retirement benefits,” says Sam Abbas, CEO at SimplyWise in New York City. “Every month that you wait to claim results in a larger payout when you do collect—up to an 8% increase per year that you wait.”
Here’s the thing. You won’t know for sure if 2020 will be as bad of a wage year as some fear. It could be worse. It could be less than worse. Right now, all the numbers are speculative. “None of this is official until the actual 2020 Average Wage Index is released,” says Adams. “A new 2020 AWI projection will be made available in the 2021 Social Security Trustees Report which typically comes out in late April.”
To the extent things return to normal, the situation may mute itself. If, on the other hand, we see a second wave of coronavirus, then those born in 1960 may find their Social Security payouts suffer from an unwanted infection.