Urban InstituteRetirement Policy Center

Benefit Formula Adjustments

By adjusting the Social Security benefit formula, Congress can increase or decrease system payments or target benefit changes to certain workers based on their earnings.

Background

Social Security benefits are based on an average of a worker’s highest 35 years of earnings. To adjust for wage growth, earnings are indexed to the national average wage, generating a measure known as average indexed monthly earnings (AIME).

  • Because initial benefits are tied to wages, which historically have grown faster than prices (figure 1), inflation-adjusted Social Security benefits have increased over time.

Cumulative Relative Growth in Wages and Prices, 1951-2030

Note: Projected values are based on the intermediate assumptions of the 2013 OASDI Trustees Report

  • Once retirees begin collecting benefits, payments adjust each year by the change in the cost of living.

The Social Security benefit formula is progressive, providing higher benefits relative to earnings to low-wage workers than high-wage workers. In 2013, full benefits are based on the following formula (figure 2):

  • 90 percent of the first $791 of AIME;
  • 32 percent of AIME above $791, up to $4,768;
  • and 15 percent of AIME above $4,768.

BendpointGrapg_6_28_2013-01

Note: This formula applies in 2013 to workers who reach age 62, younger workers who become disabled, and workers who die.

  • The earnings thresholds (currently $791 and $4,768), known as bend points, adjust each year by the change in the national average wage.
  • Workers earn benefits on their earnings up to the taxable maximum.

Benefits are reduced for workers who claim before the full retirement age and increased for those who claim later (for details, see retirement age).

How could Benefits Change?

Analysts have proposed several possibilities.

  • Increase benefits and make the formula more progressive, such as by adding another bend point.
    • See Favreault and Steuerle (2007) for the effects of adding a bend point at the poverty level.
  • Increase progressivity by reducing the upper two percentage factors in the formula.
  • Alter the formula gradually over time to reduce benefit costs.
  • Adjust the percentage factors each year so that initial retirement benefits remain constant in inflation-adjusted dollars over time, instead of increasing with wage growth. This approach is known as price indexing.

Why Change the Existing Formula?

By adjusting the benefit formula, lawmakers can change the progressivity of the formula, or reduce (or possibly increase) benefits and program costs.

Why Retain the Existing Formula?

The current formula carefully balances adequate benefit provision with appropriate work incentives.

What Would Be the Impact on Social Security’s Long-Term Fiscal Deficit?

The effect of a benefit formula change depends on the details of the option (size of the adjustment, start date, etc.).

  • For example, gradually reducing the 32 percent factor to about 21 percent and the 15 percent factor to about 10 percent, beginning in 2036 for new eligibles, would reduce the long-term deficit by about 83 percent. (These estimates are from the Social Security Administration (2006), based on 2005 Trustees Report assumptions).
  • More modest reductions would yield smaller savings; larger changes could eliminate the entire long-term deficit.

Who Has Proposed Changing the Benefit Formula?

  • Diamond and Orszag (2004);
  • Liebman, MacGuineas, and Samwick (2005);
  • Price indexing was included in one plan proposed by President George W. Bush’s Commission to Strengthen Social Security (President’s Commission to Strengthen Social Security 2001);
  • The National Commission on Fiscal Responsibility and Reform.

See the Following Report to Learn More:

Favreault, Melissa M. and Nadia S. Karamcheva. 2011. "How Would the President’s Fiscal Commission’s Social Security Proposals Affect Future Beneficiaries?" Washington, DC: The Urban Institute.

Favreault, Melissa M. and C. Eugene Steuerle. 2007. “Minimum Benefits in Social Security.” Washington, DC: The Urban Institute.


Other References:

Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance [OASDI] Trust Funds. 2009. “2009 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds.” Washington, DC.

Diamond, Peter A. and Peter R. Orszag. 2004. Saving Social Security: A Balanced Approach. Washington, DC: Brookings Institution Press. Summary available at: http://www.brookings.edu/views/papers/orszag/200504security.pdf.

Liebman, Jeffrey, Maya MacGuineas, and Andrew Samwick. 2005. “Nonpartisan Social Security Reform Plan.” http://www.ksg.harvard.edu/jeffreyliebman/
lms_nonpartisan_plan_description.pdf.

President’s Commission to Strengthen Social Security. 2001. Strengthening Social Security and Creating Personal Wealth for all Americans: Report of the President’s Commission. Washington, DC: Author. http://csss.gov/reports/Final_report.pdf.

Social Security Administration, Office of the Chief Actuary. 2006. “Provisions Affecting Level of Monthly Benefits.” http://www.ssa.gov/OACT/solvency/provisions/benefitlevel.html.

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