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How COVID-19 May Have Infected Your Clients' Retirement Benefits


Workers who were born in 1960 are going to get a reduction in their retirement benefits because of an unintended consequence of how the Social Security Administration calculates retirement benefits. Accountants can help.

Jul 24th 2020
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COVID-19 has hurt the finances of millions of households and will continue to do so for months or even years. However, some of our clients may continue to feel the financial impact of COVID-19 for the rest of their lives.

Accountants are often asked for financial advice, especially when it comes to Social Security benefits and retirement savings. It's common for clients to ask for help in figuring out when they should start drawing their Social Security benefits.

The historically high unemployment levels of 2020 could hurt a lot of people who are close to retirement. So, it's a good idea to brush up on your SSA algorithm knowledge.

How Can COVID-19 Hurt Your Social Security Benefits?

The "reduction" in benefits for people who turn 60 this year is an unintended consequence of the two-step process the SSA uses to calculate retirement benefits. First, the SSA bases retirement benefits on your 35 highest-earning years before you turn 60. It then adjusts those wages by the national average wage index (AWI) of the year you turn 60.

Ironically, the purpose of this is to help out low earners by giving them a higher replacement rate compared to that of high-income earners. However, if you happen to turn 60 in a particularly bad year for the economy, such as 2020, this final adjustment could reduce your retirement benefits.

Nobody knows yet how much the economic downturn will affect workers who turn 60 this year. However, according to estimates by the Wharton Pension Research Council, a 15 percent decline in the average wage index could reduce the retirement benefits of middle-income workers by approximately 13 percent, which could mean $70,000 less in benefits over their retirement period.

What Can Those Born in 1960 do to Offset This?

The only thing people can do to avoid this reduction in benefits is to call their representatives and lobby for a change in the way Social Security calculates benefits this year. However, there is plenty of good advice we can give our clients to help them offset the lower benefits they may receive if they turned 60 this year. For instance, we may want to encourage them to retire later, live more frugally and invest more in their retirement accounts.

When Will We Know for Sure That This Risk is Material?

We will only the full extent of the reduction in benefits when the official average wage index is released, which will probably be late April next year. However, estimates based on the projections of the Congressional Budget Office show a drop of around 7 percent when compared to 2019.

Accountants can help their clients most right now by explaining how the SSA calculates retirement benefits. This is particularly important if you consult for a company that provides retirement benefits to their workers because private retirement funds are a powerful tool to offset changes in Social Security benefits.

If the SSA does not change its formula, people of all ages should take into account the economic conditions of the year they turn 60 when planning for their retirement. As it's impossible to know with any certainty what the economy will be like in the future, we can help our clients minimize the potential damage of a freak bad year by relying more on private savings than government-sponsored savings plans.

Final Thoughts

We often have a better understanding of our clients' spending and investing habits than they do. So, we are in an excellent position to suggest areas where they can reduce expenses or generate a better return on their retirement savings.

An issue I find with many people close to retirement is they can be too conservative with their savings. Although it is smart to change your portfolio when you are about to retire, you risk running out of money in your retirement if you give up on growth investments altogether.

In the case of younger people, increasing their monthly retirement savings by even a modest amount can offset the lower benefits of a low national average wage index. For example, increasing your retirement savings by $255 a month for 20 years would more than offset a "loss" of $70,000 in retirement savings.

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