Social Security: The Average Wage Index

Social Security: The Average Wage Index

September 22, 2021
Social Security: The Average Wage Index
Background
for wage-indexed program parameters. All persons eligible
Recent news articles suggest a possible decrease in national
for benefits after 1978 would have their benefits calculated
average wages due to the recent recession caused by the
under this new procedure. (AWIs for earlier years—1951
Coronavirus Disease 2019 (COVID-19) pandemic. Such a
through 1977—were retroactively calculated.)
decrease would have a negative impact on the Social
Security benefits of individuals who reached age 60 in
The 1972 and 1977 amendments and implementation of the
2020. Social Security benefits are tied to a worker’s
current wage reporting system in 1978 caused SSA to adopt
earnings record but are also affected by changes in national
a different computation method for future years. Under the
wage levels, price levels, and claiming age.
new method, the amounts from an earlier year is a base to
which percentage changes from the new raw earnings data
Congressional interest in this issue may be high because of
are applied. Since this change was implemented, the AWI
the large number of potential beneficiaries for whom
value for a given year has usually been greater than the raw
benefits would be affected by a decrease in average wages
earnings data. (In 2019 the average raw earnings were
as measured by the Social Security Administration’s
$51,916.27 per worker, but the AWI was $54,099.99.)
(SSA’s) average wage index (AWI). Many other parameters
used by the SSA are adjusted automatically (typically on an
Calculation of AWI
annual basis) based on changes in national average wages.
Under current law, a given year’s AWI is computed using a
three-step process. The first step uses the SSA raw earnings
Projections for 2020
data. A year’s aggregate net compensation—compensation
In July 2021, the Congressional Budget Office released its
plus contributions to deferred compensation plans less
updated baseline projections, which included several
certain distributions that were included in reported
projections for Social Security parameters. It estimates the
compensation subject to income taxes—is divided by the
2020 AWI will be $54,036.00. This would represent a
number of workers for that year. In the second step, the raw
decrease of about 0.0012% from the 2019 AWI of
earnings data for a given year is compared to the value from
$54,099.99. In August 2021, the Social Security Board of
the prior year to determine the year-over-year percentage
Trustees released its 2020 Annual Report. Under its
change in raw earnings data. In the third step, a given year’s
intermediate assumptions—the best guess of future
AWI is determined by applying the percentage change in
experience—the 2020 AWI will be $55,576.94. This would
the raw earnings data to the prior year’s AWI dollar value.
represent an increase of about 2.73%. In 2009, the only year
in which AWI decreased, the index declined by 1.51%.
For example, in 2019 the aggregate net compensation
($8,790,916,517,299.29) was divided by the number of
Overview of AWI
workers (169,328,746) to produce the per capita value of
Some Social Security parameters are adjusted annually
raw earnings data of $51,916.27. The 2019 raw earnings
using the AWI. This adjustment ensures that the program
data was then divided by the 2018 raw earnings data
parameters reflect changes in the national wage levels.
($50,040.96) to determine the percentage change in raw
earnings: 3.75%. Lastly, this percentage change was applied
The AWI is a dollar amount defined as “the average of the
to the 2018 AWI value of $52,145.80, which yielded the
total wages for such particular calendar year” and is subject
2019 AWI value of $54,099.99.
to regulations as prescribed by SSA’s commissioner (42
U.S.C. §409(k)). Under current law, the commissioner is
SSA annually publishes this calculation in the Federal
required to compute the “average of total wages” based on
Register. Typically, it takes about three quarters for SSA to
the amounts of wages reported by the Secretary of the
collect the wage data and perform the necessary AWI
Treasury, including wages above the contribution and
calculations. The AWI calculations for 2019 were published
benefit base (CBB). Wages above the CBB are not subject
in the Federal Register on October 22, 2020 (85 Federal
to the Social Security payroll tax and are not included in
Register 67413).
Social Security benefit computation. The AWI also includes
certain deferred compensations (20 C.F.R. §404.211(c)(3)).
Typically, overall economy-wide earnings increase over
time. This results in a generally increasing AWI. In its 69-
History of AWI
year history, the AWI has increased in all but one year
Among other things, the Social Security Amendments of
(2009) and exhibited an average annual growth rate of
1972 (P.L. 92-603) and the Social Security Amendments of
4.5%. For newly eligible workers, this leads to year-over-
1977 (P.L. 95-216) amended federal law to provide a wage-
year increases in initial benefits and stable replacement
indexed benefit formula for initial benefits (i.e., benefits
rates (i.e., the portion of earnings that initial benefits
payable at the earliest eligibility age, or 62) and to provide
replace). Program parameters that are indexed to AWI
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Social Security: The Average Wage Index
generally increase as well. For some newly eligible
the Consumer Price Index for Urban Wage Earners and
beneficiaries, a decrease in wage growth, or AWI, would
Clerical Workers (CPI-W) through an annual COLA.
result in lower initial benefits.
In most years, wages and prices increase, resulting in higher
The AWI and Social Security Benefits
initial benefits for new beneficiaries and a COLA for
Initial benefit amounts are based on a worker’s past Social
current beneficiaries. However, if there is a percentage
Security–taxable earnings (i.e., covered earnings at or
decrease in the CPI-W, no COLA is payable, and current
below the CBB) and can be affected by program parameters
benefit amounts are not adjusted. Because Social Security
that are indexed to growth in wages, or AWI. The benefit
COLAs cannot be less than zero, even during periods of
formula is applied in three main steps: (1) computing the
negative price growth, in any given year there could be a
average indexed monthly earnings (AIME), which are
negative change in the AWI but a zero or positive COLA.
earnings that are wage indexed using the AWI, (2)
Maximum Family Benefits
converting these indexed earnings into the primary
The total amount of Social Security benefits payable to a
insurance amount (PIA), using the Social Security benefit
family based on a retired, disabled, or deceased worker’s
computation formula that uses parameters indexed to the
record is capped by a maximum family benefit. The family
AWI, and (3) applying adjustments based on claiming age.
maximum cannot be exceeded regardless of the number of
Averaged Indexed Monthly Earnings (AIME)
beneficiaries entitled to benefits on the worker’s record. In
the case of a retired or deceased worker, the total amount of
In the first step, the benefit formula requires a worker’s
benefits payable to the family is determined by using four
lifetime covered earnings to be indexed using AWI. For
bend points—indexed to the AWI—to section the worker’s
retirement benefits, this is done by increasing each year of a
worker’s
PIA into four brackets, with each bracket replaced by a set
taxable earnings by the growth in average
factor. In the case of a disabled worker, the total amount of
earnings in the economy, as measured by the AWI, from the
benefits payable to the family ranges from 100% to 150%
year of work until two years before eligibility for benefits
of the worker’s PIA. A negative change in the AWI would
(age 60). Given the lag time in computing the AWI,
lead to a lower maximum family amount.
earnings at ages 60 and above are not indexed. Thus,
growth in the AWI during the year in which a worker turns
Additional Program Parameters
60 is an important part of the benefit calculation. Once
Affected by AWI
earnings are indexed, the AIME is obtained by dividing the
total of the highest 35 years of indexed earnings by 420 (the
Quarter of Coverage (QC)
total months in 35 years). A decrease in the AWI in the year
Workers become insured for Social Security by earning
a worker turns 60 would result in a lower AIME than if
quarters of coverage (QC) for work in Social Security–
wage growth were to increase or remain level.
covered employment. The amount needed to earn a QC is
indexed annually to the AWI. In 2021, a worker earns one
Primary Insurance Amounts (PIA)
QC for each $1,470 of earnings, up to four per year; a
Next, the benefit formula process computes a worker’s
worker earning $5,800 in covered employment at any point
PIA—the basic monthly benefit for a retired worker who
in the calendar year would be credited with the maximum
begins to receive benefits at the full retirement age (i.e., 67
number (four) of QCs for that year. Under current law, the
for those born in 1960 and later). Using two bend points,
amount needed to earn a QC cannot decrease. If a decrease
which are also indexed to the AWI, a worker’s AIME is
in the AWI results in a QC amount lower than the previous
sectioned into three brackets of earnings. A fixed PIA
year, then the QC amount remains unchanged.
factor—90%, 32%, and 15%, respectively—is applied to
Contribution and Benefit Base (CBB)
each bracket of an AIME. The PIA factors are set in statute.
The bend points are based on the year an individual is first
The CBB serves as a cap on both contributions and
eligible for Social Security benefits (i.e., age 62). However,
benefits. As a contribution base, it establishes the maximum
amount of a worker’s earnings that are subject to the pay
given the lag time in computing the AWI, the value from
roll
two years prior is used to determine the bend points (i.e.,
tax. As a benefit base, it establishes the maximum amount
when the worker was age 60). A decrease in AWI would
of earnings used to calculate benefits. Under current law,
lead to lower bend points and, in turn, a lower PIA.
the CBB is indexed to the AWI and rounded to the nearest
multiple of $300. If the AWI decreases, resulting in a
Age-Related Adjustments
negative change in the CBB, the CBB from the prior year is
The full retirement age (FRA) for workers born in 1960 or
used. Also, due to the rounding rule, it is possible for the
later is 67. Workers who claim benefits before reaching
CBB to remain unchanged in years of little wage growth.
FRA are subject to a permanent reduction in monthly
Further, increases in the CBB are applied only when
benefits (i.e., actuarial reduction). Workers claiming
COLAs are payable. That is, if there is no COLA, then the
benefits after FRA receive delayed retirement credits,
CBB remains unchanged regardless of wage growth.
resulting in a permanent increase in monthly benefits.
For more information, see CRS Report R46819, Social
Cost-of-Living Adjustments (COLAs)
Security: The Effects of Wage and Price Indexing on
As described, initial Social Security benefit amounts (i.e.,
Benefits and CRS Report R46658, Social Security: Benefit
retired worker benefit amounts that can be collected at the
Calculation.
earliest eligibility age of 62) are indexed to the AWI.
Benefit amounts collected after age 62 are price-indexed to
Barry F. Huston, Analyst in Social Policy
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Social Security: The Average Wage Index

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