Social Security: A Look at Three Options

Although Social Security has now been providing retirees with benefits for 75 years, there is a swirl of talk about cutting benefits in order to reduce deficits in the federal budget.

While cuts would affect everyone who receives Social Security, a study released this summer by the Washington-based think tank the Center for Economic and Policy Research (CEPR) found that three widely discussed changes would impact low- and middle-income retirees the most.

Retirees with the most income receive money from sources outside Social Security, notes David Rosnick, coauthor of the report, "The Impact of Social Security Cuts on Retiree Income."

"But if you don't have any other income besides Social Security, that cut in Social Security will disproportionately hurt you," Rosnick says.

The study looked at three possible changes: (1) increasing the retirement age, (2) decreasing the annual cost-of-living adjustment (COLA), and (3) adopting a "progressive price index" (PPI) formula to determine benefits. Price indexing would tie the growth in future Social Security benefits to prices rather than to wages, as they are today.

The study calculated the impact these cuts in benefits would have for retirees and near retirees, a group that "has been hardest hit by the collapse of the housing bubble and the resulting plunge in stock prices."

Increasing the retirement age to 70

The first possible change to Social Security is raising the full retirement age incrementally to 70 from the current 66. "An increase in the [national retirement age] is essentially a cut in benefits since the vast majority of workers start collecting reduced benefits not long after they reach the early retirement age of 62," the report states.

The younger the person, the greater the impact, the study found. For workers between the ages of 40 and 44 in 2007, such an increase in the retirement age would lead to a reduction in benefits of 10 percent. For workers between the ages of 50 and 54 in 2007, the reduction in benefits would be 4 percent.

Reducing the COLA

The second potential change to Social Security analyzed in the report is a reduction of the annual cost-of-living adjustment.

This change would impact not only future retirees but current ones as well. Benefits would grow by a smaller rate every year. The CEPR analysis found that reducing the COLA by 1.0 percent would result in a benefits cut of 12 percent for a retiree at age 75 and more than 20 percent at age 85.

"A change in the COLA hits equally the benefits all recipients, but disproportionately impacts retirement income for the lower income groups because Social Security represents a greater percentage of their retirement income," Rosnick says.

Adopting the PPI formula

Your Social Security benefits are based on your lifetime earnings as well as a formula that takes into account average wages. The third proposal, adopting a PPI formula, which is tied to prices, would likely slow the growth of initial benefits — the amount of the first Social Security payment — because prices tend to rise slower than wages.

According to the CEPR report, here's how the initial benefits of three income groups would fare under a PPI formula proposed by Robert C. Pozen, who served on President Bush's Commission to Strengthen Social Security in 2001 and 2002:

• For the lowest-income earners, there would be no change. That is because for this group the initial benefit would continue to rise based on average wages.
• For high-income workers, the initial benefit would increase at a slower rate, because it would be tied to the increase in prices.
• For middle-income workers, initial benefits would rise at a rate that is somewhere in the middle — and less than under the current formula.

For example, if you were a middle-income worker between ages 45 and 49 in 2007, under today's Social Security formula you might receive $200,000 in retirement benefits over your lifetime. But under the proposed PPI formula, you would receive about $187,600, or 6.2 percent less.

So, while workers making the least amount of money would receive the same in benefits that they receive today, middle-income workers would receive less.

Tamara E. Holmes is a Maryland-based journalist.