Quirk in Social Security Benefit Formula Provides New Retirees Lower Benefits

For the first time since automatic adjustments were adopted in 1975, Social Security benefits received no Cost-of-Living Adjustment (COLA) this year. Current beneficiaries were compensated by receiving a higher-than-average 5.8 percent COLA payment in 2009, though they still perceive themselves to be harmed by this year’s lack of payment. New retirees, however, will produce lower benefits, thanks to an oddity in Social Security’s benefit formula.

COLAs are granted by a Social Security formula, and when combined with a spike in inflation during 2008, benefits may be reduced for those born in the year 1947. These individuals may see a decrease of 2.6 percent in comparison to the average benefits received by those born between 1930 to 1946, which could result in a loss of over $12,000 for a typical couple, over the course of their retirement. Many are dubbing this group a new Social Security “notch.”

“Notch” is a term derived from a series of changes made to Social Security benefit rules in the 1970s. These changes put individuals born from 1917 to 1921 at a disadvantage – or so they thought. A bipartisan congressional commission did not agree, however, and concluded the notch was small and justified enough on policy grounds that there was no warrant for compensation. Since 1981, more than 100 pieces of legislation have been proposed to compensate the notch associates and numerous seniors groups hunted for assistance, claiming they could aid notch allies in receiving better benefits. Essentially, no one wants to deal with that type of circus again.

So, due to a quirk in the Social Security benefit formula, individuals who turned 62-years old in 2009 will likely have lower benefits than the older and younger recipients around them. The short-term solution to this new “notch” is to increase benefits for individuals in the 1947 birth group, making them comparable to the 1946 birth group. However, that would require an increase of around 3.5 percent, which would be hard to work out. But making the 1947 birth group’s benefits comparable to the average received by cohorts from 1930 to 1946 would be a more modest 2.7 percent increase, which may be doable.

Unfortunately, a solution such as this is only a quick fix for a bigger problem. There needs to be a permanent solution to minimize benefit discontinuities. Though, as part of any reform, Social Security benefits may need to be reduced, but focusing cuts on a small group of near-retirees, regardless of socioeconomic status, does seem unjust. The Center for Retirement Research concludes, “While a congressional ad hoc COLA for current beneficiaries is not justified, given that the real purchasing power of today’s benefits has increased, an argument can be made that individuals age 62 in 2009 deserve some adjustment. Their reduced benefits stem from an unintended quirk in the Social Security benefit formula. […]Unlike the previous notch, Congress will now have a politically popular and economically sensible option upon which to act.”

Written by Kelly Mellott

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