Monday, July 11, 2011

Do You Pay More into Social Security than you take out?

Is Social Security a giveaway or a con game?

A reader asks:

"Do you get out more in Social Security Benefits than you pay in, or vice-versa?"

Good Question!  And since the government is talking about cutting benefits, a relevant one.

Taking my 2010 Social Security Statement as an example, it shows that since age 17, I have been taxed on $1,266,659 in earnings.  I never earned a lot of money in my life, but over time, it adds up - to well over a million bucks.

The tax rate on this has changed over the years, and a .pdf table, in typical government-speak, can be found here.

The rate this year is 4.2% with employers kicking in another 6.2% for a total of 10.4%.

If we assume this 10.4% is a rough average of the rates over the last 30 years or so, the total I have "paid in" to the system is about $129,199.22, which is not a lot of money.  Assuming I pay in the same amount for the next decade, the total will be 172,265.62.

According to my Social Security 2010 Statement, I can expect to receive about $1420 a month if I retire at age 62, which, as we noted before is a good thing to do - as opposed to waiting until age 70 to "get more" - because you don't really get more, in the long run.

If I live the average of 78 years or so, that means I will collect for 16 years, or receive a total of $272,640 in benefits in my lifetime, or about twice what I contributed so far, or about $100,000 more than I am projected to contribute by age 62 or so.

Of course, some folks die early and collect less - or collect nothing.   Others go on disability at age 25 and collect for life.   Yet others get survivors benefits and yet others live to 100 and collect a LOT.  I suppose it all evens out.

But what about compound interest?  If we take these numbers at face value, yes, the average person takes out twice what they put in or at least a lot more.

Say that over my 30 year career, I put in an equal amount every year, or about $4306.54 a year.  Yes, this skews the calculation somewhat, but I can't go figuring out the actual amounts - it would take hours.  Assuming a 5% rate of return, that money, invested, would be equal to about $300,434 by now, and $546,253 by retirement, which is why some folks were so keen on "privatizing" Social Security - you could make out much better than investing with Uncle Sam.   But that assumes a 5% rate of return, which is not guaranteed in this day and age (but by no means is unusual or impossible for a balanced and conservative portfolio).

So as you can see, while the amount I contributed is somewhat small, if we take into account the fact the government is borrowing that money over 30 years (to pay its bills) it is, in effect, getting an interest-free loan from me.  Well, not interest-free, but they pay me back a premium of 100,374.28 over what I paid in.

Again, going back to our compound interest calculator, we plug in some interest numbers, and it looks like Uncle Sam basically borrowed against my Social Security contributions and paid me back with 2.1% interest over 40 years.  Not a bad loan - for the Government.

So, although I take out more than I paid in, the amount I take out is about what I paid in, plus a measly 2.1% interest.  You could tweak the numbers here, but I suspect the outcome won't change by much.  The actual interest rate will be higher, as my early years contributions were a lot smaller.  But let's make it 3% or 4% just to be fair.

Even at that rate, the government is getting a bargain basement loan rate, historically, and even today, long term T-bills are at about this rate.  And back in the day, they were much, much higher.

So yes, it is true, retirees will take out "more than they put in" but on the other hand, they will get back the money they put back in, plus interest at very advantageous rates - for Uncle Sam.

Privatizing Social Security would result in higher rates of return - for some people, but not for others.  And given how the 401(k)/IRA concept has worked out for some folks, I am not sure that privatizing the "safety net" is such a swell idea.  3-4% might be a crappy rate of return, but at least it is guaranteed.  We hope, anyway.

And you know, some folks might look at this and say, "Gee, can I contribute MORE than the minimum amount and get a larger guaranteed payback?  Because 3-4% beats the hell out of my 401(k) account!"

And of course, you can, by investing in T-bills or other government debt (and hoping they don't default next week!).

But in terms of rate of return, Social Security isn't great, but steady.  I would say it is a "safe" investment, but since the benefits are at the whim of Congress, it would have the rating of a junk bond, if sold as a security.  Any scheme like this, where the payout is determined by the whims of elected officials, would be viewed as a D- rated junk security.

A security.  An interesting thought.  A Social Security.  And you have to think, whether it is a good idea for the Government to tax people, borrow their money at sub-prime rates, and promise to pay it back later on - and then renege on that promise.