SOCIAL SECURITY'S BENEFITS

5. Who gets benefits?

Social Security benefits are paid to workers who meet requirements for the time they have worked in "covered employment," that is, jobs through which they have paid Social Security taxes. Social Security covers about 96 percent of all U.S. workers; the vast majority of the rest are state, local, and federal government employees. Typically, workers must contribute for a total of 40 quarters (or ten years in total) to qualify, though the requirements are different if they become disabled or die. Workers and their dependents generally become eligible to collect benefits when the workers reach age 62, become disabled, or die.

Benefits are paid to family members of workers under certain circumstances. Spouses and divorced spouses of eligible workers may also be eligible at age 62 but can be eligible at younger ages if they are disabled, widowed, or caring for eligible children. An eligible worker's children under 18 are also eligible, and adult children are eligible if they became disabled before age 22. Dependent parents and grandchildren of eligible workers are also eligible for survivors benefits under certain circumstances.

Some workers qualify for Social Security benefits from both their own work and their spouses'. Such workers are called dually entitled spouses. Such workers do not receive both the benefits earned as a worker and the full spousal benefit; rather the worker receives the higher amount of the two.

6. What benefits does Social Security offer?

Social Security benefits are designed to partially replace earnings that workers lose when they retire, become disabled, or die. As a result, the first step of the benefit formula calculates a worker's average, indexed monthly earnings (AIME), which is based on the highest 35 years' earnings on which they paid Social Security taxes. The formula adjusts these lifetime earnings, or indexes them to changes in average wages, to account for the fact that

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About one-fourth of public employees do not pay Social Security taxes on the earnings from their government jobs. Historically, Social Security did not require coverage of government employees because there was concern over the question of the federal government's right to impose a tax on state governments and some had their own retirement systems. In 1983, Congress extended mandatory coverage to newly hired federal workers and to all members of Congress, regardless of when they entered Congress. See GAO, Social Security: Issues Relating to Noncoverage of Public Employees, GAO-03-710T (Washington, D.C.: May 1, 2003).

earnings across all workers grow over time.

Then, the benefit formula replaces a percentage of those pre-retirement earnings, replacing a larger share of earnings for lower earners than for higher earners. For example, retired workers receive benefits that equal about 50 percent of pre-retirement earnings for a worker with relatively lower earnings (45 percent of the average wage) but only about 30 percent of earnings for one with relatively higher earnings (160 percent of the average wage). To help ensure that beneficiaries have adequate incomes, Social Security's benefit formula is designed to be progressive, that is, to provide disproportionately larger benefits, as a percentage of earnings, to lower earners than to higher earners.5

GAO, Social Security: Distribution of Benefits and Taxes Relative to Earnings Level, GAO-04-747 (Washington, D.C.: June 15, 2004).

Figure 4: Benefit Formula Provides Higher Replacement Rates for Lower Earners

Note: Replacement rates are the annual retired worker benefits at age 65 for workers born in 1985 divided by the earnings in the previous year. For such workers, the full retirement age will be 67. Steady earners have earnings equal to a constant percentage of Social Security's Average Wage Index in every year of their careers. Those percentages are 45, 100, and 160, respectively, for low, average, and high earners. Benefits for disabled workers use the same formula, but since workers become disabled at different ages, it is more difficult to calculate a consistent replacement rate. See GAO, Social Security: Distribution of Benefits and Taxes Relative to Earnings Level, GAO-04-747 (Washington, D.C.: June 15, 2004) for more on replacement rates.

Finally, the benefit formula makes other adjustments to reflect various other provisions, such as those relating to early or delayed retirement, type of beneficiary, and maximum family benefit amounts. In addition, once payments have begun, Social Security benefits are adjusted annually to reflect inflation.

7. When can people get benefits?

For retired workers and their dependents, Social Security pays full benefits at the full retirement age, also known as the normal retirement age (NRA), which historically has been age 65. However, under current law, the full retirement age is gradually increasing, beginning with retirees born in 1938, and will reach 67 for those born in 1960 or later. (See table 1.) People may choose to retire at age 62 and receive reduced benefits. The reduction

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for early retirement takes account of the longer period of time over which benefits will be paid.

For disabled workers and their dependents, Social Security pays benefits for workers who are unable to work in any job and whose disabilities are expected to last for at least 1 year or to result in death. Social Security does not pay benefits for short-term or partial disability. Also, benefits do not begin until a worker has been disabled for 5 full consecutive months.

For survivors of deceased workers, Social Security pays benefits upon the death of the worker for those who satisfy the relevant age requirements. For example, a widow can start receiving benefits as early as age 60 or, if she is disabled, age 50.

8. How much interest do workers' contributions earn?

Workers do not earn interest on their Social Security contributions as they would on a savings account. Their contributions are not deposited in interest-bearing accounts for individual workers. Rather, their contributions

❝Social Security also pays reduced benefits as early as age 62 for spouses, and widow(er)s.

are credited to the Social Security trust funds, which are primarily used to pay current benefits. Any contributions not used for current benefits are invested in interest-bearing federal government securities that are not readily marketable but backed by the full faith and credit of the U.S. government. The benefit payments paid to any given individual are derived from a formula that does not use interest rates or the amount of contributions but rather uses the individual's average indexed lifetime earnings as a basis for determining benefits.

In technical terms, Social Security provides a defined-benefit pension, not a defined-contribution pension. A defined-benefit pension generally provides a periodic benefit based on a specific formula generally linked to each worker's earnings and years of employment. In contrast, a definedcontribution pension resembles an individual savings or investment account; retirement income from this type of pension depends on the total amount of contributions to the account and any investment earnings. As an example, 401(k) accounts are a type of defined-contribution pension.

The benefits workers receive under Social Security do, however, reflect a rate of return that they implicitly receive on their contributions. This implicit rate equals the interest rate that workers would hypothetically have to earn on their contributions to pay exactly for all the benefits they and their families will receive over the course of their lives. This implicit rate of return provides one measure of individual equity, that is, the relationship between contributions and benefits. It is important to recognize that this implicit rate of return individuals receive on their contributions is not the same as the interest that the Social Security trust funds earn on their assets. Implicit rates of return for individuals depend on the relationship between lifetime benefits and contributions, while the interest earned by the trust funds reflects the prevailing rates of interest in the market.

Implicit rates of return that individual workers receive on their Social Security contributions vary significantly across a number of dimensions. The variations mostly reflect several types of income transfers that the program is designed to provide as part of its social insurance function. Implicit returns vary by birth year, reflecting the program's income transfers to the first generations of retirees from subsequent generations. For example,

'GAO, Social Security: Issues in Comparing Rates of Return With Market Investments, GAO/HEHS-99-110 (Washington, D.Č.: Aug. 5, 1999).