Social Security uses wage indexing to adjust past earnings to current wage levels when calculating a worker’s Average Indexed Monthly Earnings (AIME). The AIME is used to determine the initial benefit amount. Wage indexing is also used annually to increase two separate dollar amounts (“bend points”) used in the benefit calculation formula (the Primary Insurance Amount). Wage indexing ensures that the worker’s benefits in retirement reflect productivity increases during his or her working life, as well as standard of living improvements. Historically, over long periods of time such as a person’s working life, average wage increases in the economy have exceeded increases in prices by about one percentage point per year.
Some Social Security reform proposals would substitute price growth for wage growth in the benefit formula. Using prices to index a worker’s wages gives less value to wages earned early in a career and would reduce replacement rates and lifetime benefits for all workers.
One alternative to full substitution of price indexing for wage indexing is called progressive price indexing. This would maintain the current benefit formula for a certain percentage of wage earners (such as the lowest 30 percent), but it would require a blend of wage and price indexing for initial benefits at higher levels of lifetime earnings and full price indexing for the highest earners. Although this alternative protects those with the lowest lifetime earnings, it would over time substantially reduce the benefits of middle- and upper-income workers
Wage Indexing vs. Price Indexing: Policy
AARP supports retaining wage indexing of both the Average Indexed Monthly Earnings and the bend points used in the formula for the Primary Insurance Amount.