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Who Does Social Security Help the Most?

By Dan Caplinger - May 1, 2016 at 6:02AM

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The way that Social Security benefits get calculated gives some people an advantage. Find out about it.

Image source: FDR Presidential Library & Museum via Flickr.

Tens of millions of retirees rely on Social Security to make ends meet in retirement. Yet what many people have never realized is that what you get out of Social Security doesn't necessarily match up to what you put in. In fact, when you consider what different people pay in payroll taxes over the course of their careers, some people get a lot more help from Social Security than others. Yet because of the policy goal behind the Social Security program, most of those who do know about this provision don't have a huge problem with it. Let's take a closer look at how Social Security helps people differently and whether you're in line to benefit from the program's quirks.

How Social Security pays you
One way to measure how much Social Security helps you is to look at the percentage of your average earnings that the program replaces in retirement through benefit payments. In many private pension plans, benefits are calculated as a percentage of your salary in the latter years of your career. Therefore, for two workers who are the same age and have worked the same number of years for the employer, the higher-income worker will get a larger pension than the lower-income worker, and their monthly pension payments will typically be proportional to their respective pay. If one person makes twice as much as another, then the higher earner will generally get twice as big a pension payment.

Social Security doesn't work that way. Instead, because it is intended to serve as a social insurance program that provides at least enough money for low-income retirees to make ends meet, the Social Security Administration uses three tiers in determining how much it pays in benefits.

Bend points and income replacement
Specifically, the SSA's system has what are called "bend points." For those who become eligible for benefits in 2016, the SSA pays out 90% of the first $856 in average indexed monthly earnings that recipients have made over the 35 top-earning years of their career. Therefore, for truly low-income retirees, Social Security can pay back as much as 90% of their average career income if they claim benefits at their full retirement age.

Above $856, however, lower income-replacement rates apply, creating the bend point that you can see on the graph below. Between $856 and $5,157, every dollar of additional average indexed monthly earnings boosts the primary insurance amount by $0.32, effectively replacing less than a third of that income. Social Security replaces just 15% of any average indexed monthly earnings beyond $5,157, producing a second bend point.

Image: Author, based on SSA formula.

The net effect of the two bend points is that the percentage of income replaced under Social Security falls dramatically as your earnings rise. For those who made $20,000 per year adjusted for inflation throughout a 35-year career, monthly Social Security benefits of about $1,030 will replace more than 60% of pre-retirement earnings. With an average salary of $30,000, the benefit rises to almost $1,300, but the income replacement falls to just over 50%. Meanwhile, if you make $60,000 a year on average, then benefits of $2,100 per month will replace just over 40% of your pre-retirement income, and earners with $100,000 in income get about $2,625 monthly, working out to less than a third of what they made before they retired.

Is Social Security fair?
Whether you agree with Social Security's method of helping low-income workers replace more of their pre-retirement income depends on whether you believe in its policy goals. Opponents argue that higher-income workers pay more in taxes into the system, and thus the redistributive impact of the bend points in the benefit formula works against them. Proponents would respond that Social Security's progressive benefit calculation is consistent with certain other federal government provisions, including our progressive federal income tax system, which levies higher tax rates against higher-income Americans. Indeed, recent proposals have recommended boosting Social Security benefits at the lower end of the income spectrum, further boosting the program's social insurance aspects.

Regardless of what you believe, Social Security's benefit formula is designed to grant more assistance to lower-income workers when you measure payments as a percentage of work income. Knowing that can help you plan for your own retirement more effectively and take into account what other sources of income you might need in order to retire in the manner you want.

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