What Are Indexed Earnings?
Indexed earnings is a calculation the Social Security Administration (SSA) uses that takes inflation into consideration when determining life-long wages. Inflation is the rate at which prices increase within an economy over a period of time. The amount someone collects from Social Security after retirement or disability after an injury is based on the wages made over a lifetime.
- Indexed earnings are used in the calculation of life-long wages when adjusting for inflation.
- The indexed earnings apply to the earnings prior to the two most recent years.
- Disability payment calculations take the 35 highest years of indexed earnings and divide them by the months worked in those years.
- Indexing earnings ensure receipts get paid fairly and equitably.
How Indexed Earnings Work
For Social Security purposes, the indexed earnings are calculated, as explained on SSA.gov, as such: For each year prior to the last two years of current employment, an individual’s yearly wage is multiplied by an "indexed factor" that increases the wage to account for inflation. For instance, for wages received in 1951, the SSA will apply an indexing factor of 15 or more and multiply this by the wages to determine the indexed earnings. For 2019 and 2018, the indexing factor would be 1.0, but in 2017 it was 1.0362 for someone born in 1958.
An individual's earnings are always indexed to the average wage level two years prior to the year of first eligibility. Eligibility for retirement is the year an individual can retire and get full benefits, which is currently 62 years old. Thus, if someone retires at age 62 in 2020, their wages would be indexed the average wage index in 2018, which was 52,145.80. The 2018 index was 3.62% greater than the 2017 index. Indexing factors depend on your eligibility year.
The amount of disability payments (SSDI) a person is eligible for is based on average indexed monthly earnings. This is determined by taking the 35 highest years (prior to age 60) of indexed earnings and dividing that figure by the total number of months worked during those years.
Thus, if you worked every month, without fail, your average indexed monthly earnings would equal the sum of 35 years of work divided by 144 months.
Making sure amounts are determined fairly and equitably for recipients of Social Security or disability is significant. Not factoring in inflation would have the effect of lowering the wages that the benefits are based on and would certainly impact someone’s quality of life. If inflation rises 2% per year, the price increases can add up over many years, which can eventually erode the value of Social Security benefits. A person might be forced to downsize from a larger home, cancel a planned vacation, or stop contributing to their grandchildren’s education.
Social Security benefits in the U.S. are calculated using average indexed monthly earnings, a type of indexed earnings. Indexing earnings allow the Social Security Administration to award benefits that account for changes in standard of living. If earnings were not indexed in this manner, then retirees would receive much lower benefits that would be out of proportion to the true buying power of their earnings in prior years.