Why some retirees could face reduced Social Security benefits unless Congress acts

Washington lawmakers are deciding the financial fates of millions of American families with the next coronavirus stimulus package.

But there’s one unintended consequence of the Covid-19 pandemic they have yet to fix: potential reductions to Social Security benefits for one particular cohort of Americans.

The people affected would include those who were born in 1960 or who become disabled or die in 2022, thus prompting lower benefits for their survivors.

The reason why people who were born in 1960 are affected is because in 2022 they will turn 62, the age at which they first become eligible to claim Social Security retirement benefits.

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This year, the year they turn 60, is when the Social Security Administration uses the average wages of all workers to determine their benefit calculation.

Aggregate wages have fallen sharply from 2019 to 2020 due to the economic downturn, thereby potentially reducing their benefits.

About 5 million Americans could be affected by this so-called notch, or drop in retirement benefit levels, according to estimates from Rep. John Larson, D-Conn., who has introduced legislation to address this problem.

The cuts to the affected people’s retirement benefit checks could be significant. According to Larson’s estimates, someone who was born in 1960 earning medium wages could receive $1,400 to $2,000 less per year for the rest of their lives compared to individuals born one year earlier.

“Congress must step in to prevent this,” Larson wrote in an op-ed published this week.

The national Average Wage Index measures wage growth among Americans. The Social Security Administration uses the index to adjust benefits, which are tied to inflation.

The AWI increased every single year from 1951 to 2008, Stephen Goss, chief actuary at the Social Security Administration, said at a recent Congressional hearing.

In 2009, the AWI declined for the first time by 1.5%, prompted by the Financial Crisis. That resulted in lower benefits for those people who became eligible to collect benefits in 2011, Goss noted, though nothing was done to fix the issue at the time.

This year’s economic downturn could be much more dramatic.

“It is likely that a much larger decline in the AWI will occur in 2020,” Goss said.

This year, for example, the AWI could be 5.9% lower than it was in 2019, Goss said. That would reduce the monthly retirement benefit for a median earner born in 1960 by about $119 per month, he said.

Meanwhile, all workers who earn wages in 2020 could see reduced benefit growth when this year is factored into those calculations.

“This is not just something hitting people who are turning 60,” said Larry Kotlikoff, a Social Security expert and president of Economic Security Planning, a provider of financial planning tools. “It’s everybody who’s younger than 60 right now.

“You could be 20 and hit by this,” he added.

Because 2020 isn’t over, the scope of the problem is still unknown.

The Average Wage Index for 2020 will not be confirmed until late 2021, Goss said, once the Social Security Administration has received all W-2s for this year from the IRS and processed them.

“Whatever it turns out to be, it will not have a real effect on benefits until we get into 2022,” Goss said.

Politicians have proposed a couple of bills aimed at a fix.

That includes Larson’s bill, which would make it so that the AWI never goes below the previous year’s level and also prevents other benefit cuts.

The proposal, called the Social Security COVID Correction and Equity Act, would also put in place measures to expand the overall program, including boosting benefits by 2% on average.

In addition, Sens. Tim Caine, D-Va., and Bill Cassidy, R-La., have introduced a bill that would fix it so that the AWI can never go negative.

Experts agree a change will likely happen, even if Washington lawmakers have not included it in their latest package. A fix for Medicare, however, was included in the stimulus legislation.

“If you’re fixing one, you should fix them both,” said Nancy Altman, president of Social Security Works, an advocacy organization.

Social Security Works has backed Larson’s bill.

“Everyone who has earnings in 2020 will see a benefit cut unless the correction is not overbroad,” Altman said. “The Larson bill fixes it correctly.” 

Experts generally agree that a fix will eventually happen. But for those born in 1960, retirement is still approaching.

People in that cohort also face lower interest rates in addition to the notch, said Dr. William Reichenstein, head of research at Social Security Solutions Inc., a provider of Social Security claiming software.

But the benefit increase you get for delaying your retirement benefits one year — up to 8% — hasn’t changed, Reichenstein noted.

“That nice rate of return for delaying a year, that looks awfully good in today’s low-interest-rate environment,” Reichenstein said.

During times like these, more people tend to be tempted to claim Social Security benefits early. But because benefit increases are guaranteed for each year you delay claiming up to age 70, it can make more sense to tap your retirement accounts first while letting your future Social Security checks grow, Reichenstein said.

To identify the best claiming strategy for you, it helps to work with a financial advisor or a Social Security software tool.

“Run your numbers,” said Bill Meyer, CEO of Social Security Solutions. “Don’t underestimate that this is a gigantic decision.”