In 2023, a low earner with an income equal to 45% of the average wage received $14,824 in Social Security benefits, according to the Center on Budget and Policy Priorities. A high earner, on the other hand, got a much larger benefit. Someone who earned 160% of the average wage would end up with an annual Social Security benefit of $32,345.
The higher earner here ends up with $17,521 more each year from Social Security. On paper, it looks like the higher earner is getting a way better deal. But is that really the case?
Image source: Getty Images.
Lower earners replace more of their pre-retirement income
Although the higher earner is getting more money in their check each month, they are actually replacing less of the income they were earning before stopping work.
Specifically, those who made 160% of the average wage end up replacing around 30% of the income that had been coming into the house before leaving the workforce. Those whose income was 45% of the average wage, on the other hand, end up with benefits that replace about half of their prior earnings.
There's a very simple reason why people who make less money end up getting more out of Social Security, in terms of income replacement, than people who make more of it. It has to do with the way the benefits formula determines how much Social Security pays each month in retirement benefits.
Social Security's benefits formula is a progressive one
Lower earners replace more of their income with their Social Security benefit because the formula is designed that way. It's progressive. Here's how it works.
First, your average wage is determined using inflation-adjusted data from the 35 years when you earned the most. This is called your Average Indexed Monthly Earnings (AIME).
Then, your standard benefit equals a percentage of AIME. But the percentage differs depending on earnings. Specifically, you'll get benefits equal to:
- 90% of your AIME up to a first "bend point"
- 32% of your AIME between the first and second bend point
- 15% of any income above the second bend point
The "bend points" that apply are the ones in effect in the year you turn 62, or in the year before you die or become disabled if either of those things happened before age 62. For 2024, the bend points are $1,174 and $7,078. But they get inflation adjustments each year.
High earners will have a lot of income above the first, and perhaps even above the second, bend point. So they will replace a smaller percentage of all that income. Those who earn less will have all of their income below the second bend point and in some cases nearly all of it under the first, so they'll replace a larger percentage of it. That's why the lowest-earning Americans get to replace about 50% of pre-retirement earnings, compared with less than a third for the highest earners.
There's another factor to consider. There's a limit on how much of your yearly income is subject to Social Security tax and counted in calculating your benefits. It's called the wage base limit, and it's $168,600 for 2024. So, anyone who makes more than that amount gets none of that additional income counted in their AIME calculation or replaced in retirement.
All this means that even those who get a higher Social Security benefit on paper need plenty of supplementary savings, since they aren't getting benefits replacing much of that money they were earning.
It's important to realize this early on and save accordingly so you don't struggle to try to live on Social Security alone. Everyone, no matter their income, should aim to have plenty of money invested to provide for a much more comfortable future than retirement benefits alone could offer.
