The Real Damage To Social Security From COVID-19 Could Be 2 Years Away

The COVID-19 pandemic has had dramatic immediate impacts on people's lives around the world. Those on Social Security have had to batten down the hatches and make the best of what their benefits will let them afford, while many nearing retirement age have faced layoffs, involuntary furloughs, and other adverse events that have affected their income and forced them to think about early retirement.

Social Security's own financial future has also taken a hit from the coronavirus, as lower wages means less payroll tax revenue to fund benefit payments. That could bring the day of reckoning for the trust funds that provide the bulk of the money that goes to recipients several years closer than the current estimated 2035 depletion date.

Yet a large group of benefit recipients could see their Social Security benefits get cut a lot sooner than that. As early as 2022, there could be millions of Social Security recipients who get a lot less on monthly payments than they expected.

How wage levels and unemployment affect your Social Security benefits

There are many figures and calculations that go into determining what your monthly Social Security benefitwill be. In general, the Social Security Administration looks at your wage history throughout your career. It adjusts past-year work income for wage inflation to make the years more comparable, and it then takes an average of the 35 top-earning years in your career. If you haven't worked 35 years, then the SSA fills in the missing years with zeroes to determine the average.

The next step is to take the resulting average indexed monthly earnings and to run it through a formula. This formula determines what your monthly benefit would be if you took Social Security at full retirement age. Take it earlier, and you'll have your payment reduced by a fixed percentage.

None of this might seem to be directly related to the COVID-19 pandemic. However, there are a couple of details that you need to know about these calculations that put the entire process into context:

The SSA adjusts your past-year pay for wage inflation based on averages from two years before you become eligible for Social Security benefits. For those turning 62 in 2020, for example, the SSA looks at 2018 average wage figures to apply its indexing.

The formula for determining your monthly benefit also takes into account average wage levels from two years ago in figuring out how your average monthly earnings translate into monthly Social Security benefits. Technically, the wage index information gets built into what are known as bend points, which are the income levels at which Social Security pays you less in additional benefits for every extra dollar of income you've earned during your career.

Why the hit is two years away

The average wage index that the SSA uses is poised to drop precipitously in 2020 if current conditions persist. That's largely because unemployment levels have risen so sharply. Even with average weekly earnings for workers who still have jobs having risen during the coronavirus pandemic, the zero earnings that those who've gotten laid off and the reduced wages for those who've been temporarily furloughed are likely to have a much greater downward impact. Those 2020 wage numbers won't affect those claiming Social Security at 62 in 2020 or 2021, but they will affect 2022's 62-year-old claimants.

Researchers from the Pension Research Council at the Wharton School projected that a 15% drop in average wages in 2020 would hit benefits by roughly 14%. That would translate into annual benefit cuts of $3,900 for a typical medium-wage worker. Those reductions would be permanent, with future-year cost of living adjustments only providing incremental bumps from those initial low levels.

It's far from certain what average wages will look like by year-end. However, even a smaller decline would still have a marked impact on the monthly checks people get.

Be ready to act

If you're turning 62 in 2022, then now's the time to start lobbying your Congressional representatives to address the potential one-year problem in Social Security's benefit formula. With the potential for wages to take a hit far greater than they did in the 2008-2009 recession, asking for one-time relief is a reasonable strategy -- even if it might be hard to get consensus in a sharply divided Washington.

This article originally appeared in The Motley Fool. The Motley Fool has a disclosure policy.