Annual PIAs

To calculate an individual’s retirement benefits, the Social Security Administration first considers a beneficiary’s 35 highest-earning years (with each year adjusted for wage growth) to determine their average indexed monthly earnings (AIME). SSA then runs this AIME through a progressive replacement rate formula to determine a beneficiary’s primary insurance amount (PIA), the monthly benefit that a worker receives if they elect to start receiving benefits at their full retirement age (currently age 67 for those born after 1959).

What’s Wrong with the Current Formula?

Applying the PIA formula to a worker’s average earnings across 35 years presents two key issues:

• Equal benefits to drastically different claimants. The formula does not appropriately distinguish between higher earners who work fewer years and lower earners who work more years: Both receive the same replacement rate from Social Security, even though the progressive benefit formula is intended to advantage those who are most likely to need additional income in retirement. Claimants who had brief careers with relatively high earnings records are likely either mid-career migrants, married to a higher-income spouse, or wealthy through inheritance or other means. The current benefit formula, however, redistributes income toward such beneficiaries on the often-mistaken presumption that they are low- or moderate-income individuals.

• Limited work incentives to Americans as they age. The formula only counts a worker’s 35 highest-earning years. Thus, once an individual has worked for 35 years, any additional years of earnings can at best replace lower-earning years from earlier in the person’s working life. In practice, because each year of earnings is adjusted for national average wage growth, the difference is typically small. Additionally, because the formula averages earnings before applying the PIA factors, most workers earn the maximum that can be replaced at the 90% rate earlier in their career and therefore receive a much lower replacement rate on all additional earnings. Despite these diminishing returns to work, workers continue to face the same payroll-tax rate throughout their working life. This dynamic strongly encourages earlier retirement—a sub-optimal choice for the majority of retirees, and one with significant impacts on financial security in retirement.

An Alternative Benefit Structure: Annual PIAs

The Bipartisan Policy Center’s Commission on Retirement Security and Personal Savings previously proposed addressing these issues by transitioning to an annual-PIA benefit formula, whereby SSA would apply the PIA replacement rates to each year of earnings and then average those “mini PIAs” to determine a beneficiary’s total PIA. Specifically, because lifespans and working lives have lengthened since Social Security was created, the commission recommended allowing beneficiaries to sum up to 40 (of their highest-earning) years and using 37 years as a denominator in the formula.

Figure 1: The Current Benefit Calculation vs. Benefit Calculation Using Annual PIAs 

Switching to annual PIAs would: 

• End the current preferential treatment for high earners with short careers. By distinguishing between workers with similar total lifetime earnings but different tenures in the workforce, annual PIAs would, in many cases, better target Social Security retirement benefits to those most in need of financial support. For example, using an annual PIA, a worker who earned $100,000 in a given year but who had a shorter career would have the progressive benefit formula applied to that individual year. Consequently, that year’s PIA would replace only 35% of those earnings. By contrast, under current law, Social Security retirement benefits would replace a much higher share of those earnings.
• Bolster the solvency of the Social Security trust funds. The SSA Office of the Chief Actuary has estimated this reform would close around 7% of Social Security’s long-range shortfall.
• Reduce the need for overly complex, often-unfair current provisions. Some types of employees, including certain federal, state, and local government workers, are not covered by Social Security and do not contribute payroll taxes on their earnings. The windfall elimination provision (WEP) and government pension offset (GPO) limit inadvertent Social Security benefits for these workers, but WEP and GPO are complicated and often unfair. The annual-PIA structure would eliminate the need for WEP and GPO by individually crediting each year of covered earnings.
• Strengthen incentives to continue working for those who are able. This reform would reward individuals who spend more years in the workforce. By 2045, roughly 6 in 10 Americans over age 62 will have worked more than 40 years (according to the Urban Institute’s DYNASIM). The proposed change would both recognize this reality and provide an incentive to continue working, especially for individuals who are nearing typical retirement age. In effect, the accrual of Social Security benefits would look more like the accrual of benefits under a traditional defined-benefit pension plan. Instead of the current formula, in which each added year of work after a certain point only slightly affects an individual’s Social Security benefit, using annual PIAs would increase benefits proportionally with each year of work, up to 40 years.

Complementary Reform Options

Although the annual-PIA reform described above would have many advantages, it would also reduce benefits for beneficiaries with fewer than 37 years of work, many of whom were low earners. Therefore, it is paramount to consider complementary policies that could be packaged together to ensure that Social Security retirement benefits continue to provide adequate financial security for those in need. These could include:

• Establishing a new basic minimum benefit (BMB). Supplementing standard Social Security payments for low-income beneficiaries above the full retirement age with a BMB could help offset the annual PIA reform’s impact on beneficiaries with low and intermittent lifetime earnings. The specific BMB amount would be scaled so that those with the lowest Social Security benefits would receive the largest BMB add-on payments. Total benefits, however, would always increase with additional covered earnings, preserving the incentive for lower earners to continue working.
• Increasing the progressivity of the benefit formula. While the current formula is progressive—with earnings at lower levels replaced at higher rates—increasing its progressivity would help offset the regressive impact of an annual-PIA structure.
• Implementing a supplemental longevity benefit. Poverty rates are higher for the oldest Americans than they are for younger cohorts, as the older retirees are less likely to have earnings, more likely to have exhausted their existing retirement resources, and more likely to incur higher expenses (primarily due to health care costs). Increasing benefits once beneficiaries reach a certain age could help mitigate annual PIA’s impact on this population.
• Creating a caregiving credit. Many Americans take time away from work at some point in their career to care for children or ailing family, forgoing both income and earnings years in their Social Security benefit formula. One study found that the median woman who reduces working hours to care for a parent loses $64,433 in lifetime Social Security benefits. By itself, the annual-PIA structure would further reduce benefits for workers who take time out of the workforce to care for family members, but lawmakers could offset this effect with reforms such as the Social Security Caregiver Credit Act or the Social Security Parent Penalty Repeal Act.