What a 22 Year-old Needs to Know About Social Security

Prof. Antony Davies [Duquesne University] analyzes Social Security in the United States through the lens of a typical 22 year old American. Assuming that Social Security is completely solvent, the expected return on investment (ROI) of Social Security is far lower than the expected ROI of a private account. Further, if an individual could hypothetically opt out of Social Security payments and invest the funds entirely in Treasury Bills, the Treasury bills would even yield a greater ROI.

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.

Are Illegal Immigrants Propping Up the Social Security System?

I've written in other posts on this blog how Social Security is little more than a government sponsored Ponzi scheme where earlier "investors" get paid off by the contributions of late "investors."  And how Congress has turned it into a giant slush fund to tap into as an additional spending source, and their IOUs to the fund are kept in a binder in Parkersburg, WV.  Anyone who thinks Social Security works like a 401k where their money is set aside in an account just for them and the government is looking out for their best interests really needs to take the time to understand how the program works.

It's also no secret to anyone who has been paying attention to such issues over the past 30 or more years that Social Security is in trouble due to changing demographics (less people working, more people retired), longer average lifespans, longer retirements, and more generous benefits than previous generations received.  To deal with these issues it is very likely that the retirement age will have to be raised in the future and benefits frozen or cut to keep the program solvent.

To make matters even worse, an article this week in the Washington Post of all places reveals that an internal Social Security Administration study has determined in 2007 illegal immigrants contributed somewhere between 5.4% to 10.7% of the trust fund's total assets of $2.24 trillion that year.  Many of them are using a Social Security number tied to an invented name or one that belonged to someone else. Of the rest, many got legal cards when they entered the country under a temporary work visa. They stayed illegally after their visas expired.

Can you imagine what condition Social Security would be in without illegal immigrants?  As one Social Security official puts it: "If for example we had not had other-than-legal immigrants in the country over the past, then these numbers suggest that we would have entered persistent shortfall of tax revenue to cover [payouts] starting [in] 2009, or six years earlier than estimated under the 2010 Trustees Report."

The irony here, according to the Post and the Feds, is that illegal immigrants tend to pay Social Security taxes but don’t collect benefits, while legal immigrants tend to collect more in Social Security benefits than they pay in taxes.  This begs the question, are illegal immigrants necessary to keep the social safety net of the US Government solvent?  Is that why the Feds seem to turn a blind eye to illegal immigration?

The other irony is that granting amnesty to illegal immigrants would eliminate these gains to Social Security by allowing them to collect Social Security benefits in exchange for their taxes.  A classic Catch-22 situation that has no easy answer.

What do you think?  Should we just keep ignoring illegal immigration and collecting their tax dollars to prop up the faltering Social Security system?

Cashin' in Uncle Sam's IOUs

Parkersburg, WVa.  Remember that name.  It's where Al Gore's infamous Social Security lockbox from the 2000 Presidential election resides. Or rather the binder that contains the Social Security Trust Fund.  You see, there is no Social Security Trust Fund.  There is just a bunch of IOUs in the form of Treasury Bonds from the government to the Trust Fund.  $2.5 Trillion in IOUs from Uncle Sam.  The financial geniuses in Washington have already spent your retirement and my retirement.  Now it's time to start cashin' in those IOUs.

For the first time since the 1980s, when government last "fixed" Social Security, the system will spend more this year in benefits than it collects in revenues.  The government will now have to borrow more, much of it from abroad, to start paying back those IOUs.  This shortfall will probably not affect current benefits, but it is a wake-up that the system is in trouble once again and unsustainable over the long haul.   I'll stop short of calling Social Security a Ponzi scheme, but the demographics of the country have changed to the point there are not enough workers to fund the retirees without taxes being raised substantially.

People in their 40s and 50s will more than likely get something out of their Social Security "investment."  But anyone younger than forty should plan for retirement without Social Security.  Social safety nets are breaking down all over the world.  Lavish entitlement programs are bringing governments close to bankruptcy and are unsustainable in the long run.  The US is not immune to this disease and seems hell-bent on jumping in with both feet.  The only thing investors can truly count on is themselves and the money they've set aside for their future.

Social Security Cost of Living Adjustments Expected to be 0% over Next Two Years

In a surprise to America's seniors, and for the first time in three decades, the government announced that since the recession has held prices down and inflation is currently so low there will probably be no raises in Social Security payouts for the next two years. Since seniors spend a disproportionately large amount of the their income on healthcare cost (which are rising faster than inflation) this represents a real cut in their standard of living. Also, my personal, unscientific observation is that grocery store prices for the common items purchased by most families are slowly rising just as package portions are being reduced.

This should send a clear message for those still in the work force-- you need to take care of yourself and your family, and you can't count on the government. It is my personal belief that due to its financial problems, the government will have little choice but to peg future social security raises below the rate of real inflation. For those under 40, I would advise building their financial plans assuming they will receive no social security benefits. I'm not trying to be pessimistic, just realistic. Most of the government entitlement programs appear to be collapsing under their own weight, and the assumptions of the past may not apply in the future.

Long-term Viability of Social Security in Retirement Planning

After reading my previous post, several people asked about the wisdom and validity of assuming Social Security benefits in retirement income assumptions. They probably have a good point, given that just today Congressman Bachus expressed his concern that Social Security could be insolvent in two years and that the situation there is much worse than anyone knows. I based my previous post on the assumption that Social Security rules would remain largely unchanged into perpetuity, which is unlikely. I fully expect those who plan for their future will have their benefits reduced through mechanisms such as means testing in favor of those who do not adequately plan for their retirement. While we will all have the privilege of paying into the system, those who've accumulated even a modest degree of wealth will received reduced benefits compared to what they paid in. So my advice to anyone concerned about the future of Social Security is to plan your retirement with the assumption you will receive no benefits.