Social Security is Robbing Me of $1 Million; You Too?

On my post titled What is the Most Hated Tax in America?, I had a very interesting comment:

I know it isn't the biggest chunk of change, but what if I could have put my 7.5% plus my employers 7.5% into a mutual fund over the past 15 years? It makes me want to tear my hair out.

I thought this was an interesting proposition, so I decided to tackle it -- what would someone have saved if they had put their FICA tax and their employer-paid FICA tax and invested it instead of paying it to the government. Here's what I did:

1. I found a historical listing of FICA rates on the University of Wisconsin website.

2. These rates break down into two groups -- Social Security Tax (6.2% in 2007 and subject to a wage maximum) and Medicare Tax (1.45% in 2007 with no wage maximum -- though there was a limit up through 1993.)

3. I assumed a person started work in 1963 (the first date on the rate schedule I found) and had an income of $50,000 (good pay level, but not super rich) in the middle of their career (at age 44, 1985.)

4. They worked until age 65 in 2006.

5. They got 4% raises per year. I used this number to calculate the salaries back from $50,000 to the start of their work life at age 22 and to calculate it forward from $50,000 to age 65. Using these numbers, they started their career in 1963 earning almost $22,000 a year and ended it in 2006 making almost $114,000.

6. For each year, I calculated what the employee paid, then doubled it to get the employer share as well.

7. I assumed they saved their share as well as the employer's share each year and got an 8% return throughout the years.

Want to make a guess as to how much their nest egg would be worth when they retired in 2006?

$865,690

Yikes!

This, of course, would be in addition to whatever they had saved from other funds for retirement (like most people do now.) But even if the person saved nothing else, they would have a nice little next egg.

Now let's play with the numbers a bit. Here goes:

• If they were only earning $40,000 in 1985, they would have had $837,065. Still a decent amount.

• If they were a high earner and made $75,000 in 1985, they would have $901,305 at retirement. Are you getting the theme here? There's not much difference based on the person's income since many of the taxes max out at the higher rates.

• If they were a low earner in 1985, earning only $10,000, they would have had $296,044 in 2006. Obviously, the higher incomes are paying more into the system and funding it for lower income earners.

• Now let's stay with the original assumptions but say the savers could have earned 10% a year on their investments. They would have had almost $1.3 million saved at 65.

• Now let's say they earn 10% and they grew their salary 6% on average a year (not just 4%.) Still $1.3 million. Why? They're over the maximum each year on the FICA, so no more is being taken out.

So, while this was a bit of fun, what's the conclusion?

My conclusion is that I would rather opt-out of the program, keep my money myself, invest it myself, and count on the government for nothing at retirement. Since I'm already counting on the government for nothing, but I'm having to pay in anyway, my alternative/preferred solution would ultimately net me over $1 million.

I'd take it -- if they'd let me.

Comments

[tinyhands]

Well sure, taking the "social" out of Social Security is better for half the population, but not so good for the other half.

[wanda]

I think this depends on what you think Social Security should ultimately accomplish - if it is to 1. maximize returns and encourage individual action, then yes, your way is the way to go. If SS is meant to 2. ensure a minimum level of payments for the elderly, then it's probably not best to depend on a privatized system. Two different philosophies with two different solutions.

Although I am not including social security in my retirement calculations, I think the program will survive (albeit with lower benefits and an older qualifying age). The current FICA system already favors high-earners, and the lower-income families predominately depend on SS for basic living expenses. Any type of SS overhaul needs to have those factors in mind - efficiency is great, but it's not the be-all and end-all, especially if your put 2 over 1.

[plonkee]

I agree with Wanda, it really depends on what the aim of the program is. What it seems to be is a method of ensuring that old people don't die of poverty. This is definitely not best served by leting people invest all of the money privately. That would mean that the ill-educated would lose out compared to the well-educated (in a financial sense) which doesn't correlate with ensuring a minimum level of income for retirees.

If you think that this aim is not what the government should be doing, then thats a perfectly valid opinion. I happen to think its a laudable and civilised aim myself.

[LivingAlmostLarge]

Can't do it. If we were paying for ourselves then opting out would be a great option for responsible people.

However since we're paying for current retirees, there is no way to change the system. Our money is not being put into an acount for ourselves, so we can't opt out even now.

[segfault]

A couple of observations:
1) The Social Security system is a really good "value" for people who always earned a low income. I don't remember the breakpoints off the top of my head, but a low-income wage earner will receive about 90% of their former earnings as a Social Security payment.

2) The Social Security payment is, essentially, a lifetime annuity (with survivors benefit). How much income would a 65-year-old person get from a $865,690 inflation-indexed annuity? I didn't run the calculation, but I'm sure it's substantially more than that same hypothetical person's Social Security payment.

[Suze]

Social Security is a government mandated insurance program, not an investment program. It is designed to provide a mininum income flow for senior citizens, disabled citizens and minors who lose the income of their parents.

Agree with it or not, government statutes mandate all types of insurance coverage. For example, the state of Michigan has "no-fault" auto insurance, which requires that those owning autos in the state carry a certain amount of auto insurance.

I'd like to have those payments back for investment purposes, too.

[Duane Gran]

See the following for a detailed analysis on the "return" on SS:

http://www.coyoteblog.com/coyote_blog/2007/01/social_security.html

Clearly it isn't an optimal system for the individual, but we all reap the social capital benefits of not letting people become too destitute in old age.

[Lord]

If you want to calculate your personal return of social security, a calculator is available at
http://politicalcalculations.blogspot.com/search?q=social+security+return

[Bill]

It is social SECURITY. If you don't like it, invest another 7 1/2 or 15% in your own plan! The wages you refer to are not low income wages. As a public school teacher with a masters degree, I earned $5300 in 1968 and I was making $60k as an administrator at retirement. My social security will be much less than most because I get a pension. I invested on my own, but most people living on my wage will not or can not. Keep social security and do not depend upon the common folk to invest wisely!

[Lord]

I would argue we are all better off, simply because plan and act as much as we may, there but for grace go I.

[Jay]

Sure, it sounds great in theory. Most Libertarian ideas do.

So what happens when people take their money and play in the market and lose. What if there is another Great Depression? At least now there is SS which can help keep the market going. If a huge portion of people's retirement is in the market and the market declines then there's even less money to spend and the market suffers more. It's a very domino effect.

While you say you could get better returns in the market, you're still taking a chance. It's likely you'll get better returns. But what if the market tanks? I think a guaranteed government payment is somewhat comforting. It also means those who can't provide for themselves and who we end up providing for have at least pay into the system.

So, for those reasons, while reform is needed, it seems like we'll never completely get away from it. Ideals and reality rarely coexist.

[lorax]

Like most of the other posters here, I call BS. SS is a forced annuity, mixed with an insurance program. It was put into place because before it existed elderly who didn't have a savings, or whose savings were exhausted were cared for by their kids. If you weren't lucky enough enough to have kids, you were eating dog food. And if you're kids couldn't or wouldn't support you, you were in similar trouble.

So, sure, those who are ahead of the game now resent the program. It's a normal reaction. And there's a kernel of truth to the detractors argument - since it's government run it isn't very efficient. But I can't think of a better system that would actually work in the real world, over the long run.

Read the end of _Irrational Exuberance_ for a good description of social security's pros and cons.

[Debt Free]

I agree 100%. I've had this argument with the liberals in my family for years. They just can't seem to get past the risk factor. They point to some Europeans that claim out SS system is a paragon of virtue. They have little understanding, despite my (mostly futile) attempts to educate them, of the financial forces at work for 30 or 40 years. They can't grasp the fact that they needn't put their money in tech stock IPOs, just in a nice, fairly safe, value oriented mutual fund or 4. What if you lost all your money? Wake up, you already have!

[Lin]

Perhaps you would invest it; I fear most people would not. Then what?

[Charles J]

At some point, something will have to be done to the program. As many of the posters above have mentioned, SS is not an investment or security program. However, the options that are on the table now will not help. We can't pushing the retirement age up to extend the program. If we keep cutting back benefits, the amount "guaranteed by the government" will amount to pretty much nothing. If you keep kicking the can down the road, eventually it'll hit a wall.

It doesn't have to be all or nothing. We could take a percentage of it and let younger people invest it in something with a low return, like a FDIC-insured savings program or Treasuries, etc.

I think it's our responsibility to fix it soon. But as many people in my age group (I'm 26), I don't plan on seeing anything from the government.

[Charles J]

I have so many glaring errors in the post above, but I hope the "spirit" of the post is understood. :-)

[mbhunter]

I agree with Charles J. And I'm almost a decade older.

It's a tax that I think is going to get larger. Lots of boomers will be counting on their house to fund their retirement, and when they find out that this isn't going to happen, and that the government has an off-the-books liability equal to several times the national debt, they're going to complain. Not wanting to lose votes, Congress will comply and make the workers pay more.

It's a tax, plain and simple. Beyond fixing. Say good-bye to the money forever.

[Minimum Wage]

Two observations:

Social Security is a good "value" for low earners ONLY if they live long enough to get their money out. Low earners have lower life expectancy than the rest of us, and a high proportion DON'T live long enough to get their money out, making SS a bad investment for them.

Some have noted that black male life expectancy in particular is short enough to make SS a negative-ROI proposition for them.

Also, cheap unskilled labor is plentiful and other business demands more pressing and in the absence of the SS tax, I would never presume that the "employer's" share of SS tax would ever make it into my paycheck, i.e. I would count only on the "employee" share of SS tax making it to my net pay, thus cutting my available nest egg in half.

[Minimum Wage]

Follow-up (kinda) to Charles:

As a low earner, I note that ALL of the "conventional" fixes (raise taxes, cut benefits, raise retirement age) are all highly regressive.

Privatization (full or partial) is the only fix which isn't regressive and happily us also sustainable.

[Rich]

Did your calculations take into account the fact that the SS tax applies only to a certain amount of income? For example, in 2007 the tax is only levied on the first $97,500. It is more every year. I assume you did do this, but you didn't mention it in your write-up.

[FMF]

Yes, I took them into account. For instance:

"They're over the maximum each year on the FICA, so no more is being taken out."

[Tim]

Isnt there a way to file against the government or something and have your taxes and social security money that you have paid paid back to you???

[Don]

The biggest problem with this whole thing is too many people in this country want to depend on the government for their needs. Some may think me a jerk but the majority aren't bright enough to handle their own finances. Look at the amount of credit debt in this country. You also have people like myself who late in life (age 38) are learning better ways to handle money wisely on their own. I didn't have good opportunites to learn about saving and investing earlier in life. So now I am trying to educate myself as much as possible in order to play catch-up as much as possible. With the wages I make, that isn't going to be easy. I'm in the lower income bracket, so I have to sacrifice twice as much as someone else. If certain people get elected next November it will definitely get worse.