Monday, January 24, 2011

What is the "Return" on Your Social Security "Investment"

Despite the naysayers (some may put me in this camp), odds are social security will be part of your future. No question our national pension systems has many well-documented problems, but they are potentially solvable through a combination of cost cutting and tax raises before the money runs out.

One question I've always had is Social Security worth it? Are the benefits you will received for a career's worth of taxes adequate compensation? If Social Security were treated as an investment what would be your compounded rate of return? I've read articles over the past several years that claim those returns are anywhere from negative to in the low teens. The latest answer provided by a new Urban Institute Social Security study is that you will received back more than you paid in. However, to arrive at this positive return the people conducting this study needed to bundle Social Security and Medicare, leading me to believe the picture for Social Security by itself is not so rosy. The Urban Institute assumes a 2% real return above inflation for their calculations, which given the current low interest rates seems to be an optimistic number.

A walk through the Urban Institutes numbers show that Social Security definitely plays favorites. Women make out better than men with their tax dollars because 1) they live longer 2) they are more likely to collect widow's benefits, and 3) they are not just stuck with their benefits, but are also entitled to half of the husband's benefit if that is higher. If you retired last year as an average wage-earning man, for example, you could expect a lifetime benefit worth $417,000 in today’s dollars on $345,000 in taxes. If you were a woman with the same work history, you could expect to collect $464,000 on the same taxes.

Other Social Security winners include married couples with single breadwinners (this is what you might expect from a system launched in 1935), as well as baby boomers and their parents.  The payments tend to decline for later generations after the baby boomers.  It is vital for them to save for retirement outside of Social Security.

What is not covered in this study is the opportunity cost of the social security "investment," what people could earn if they were allowed to invest this money on their own.  A 30 - 40 year investment that does not at least double the original investment seems like a pretty crummy deal to me for those disciplined enough to save and invest on their own.


  1. Love the comic in the previous post...

    I often think about both of my grandmas in reference to social security. Grandma 1 didn't work at all until she was 50. She started drawing benefits at the minimum age she could until she died at 88.

    Grandma 2 never worked at all, ever. My grandpa died at the age of 63, and she collected his benefit until she died at the age of 97. I am guessing both got a pretty darn good rate of return.

    Then there are all the people that contribute and die young. My uncle died just before his 65th birthday, so he never collected a dime of his contribution.

    I have no plans to be able to collect SS. Not being a pessimist, just a realist and I would rather plan on relying on myself. Anything else will be a bonus.

  2. Social Security was a great deal for our grandparent and parents since many of them collected significantly more than they paid in. But demographics have changed, people are living longer, and the people that come after us will not get anywhere near as good a deal. In fact, after adjusting for inflation they could have a negative return on what they paid into social security.

  3. I am with Kris. I am not planning on collecting any SS and only relying on myself. If I do get SS, it is a nice bonus that I would definitely be able to use. :-)

  4. I plan on working until I'm 95, the year that will eventually mark the minimum age for eligibility.

    Just kidding. I'm not going to work that long.