Is Social Security Stealing Your Chance Of Being A Millionaire?

The following is a guest post from Marotta Wealth Management.

I have edited it a bit to tone down the political rhetoric and just focus on the facts.

I've previously brought up the issue that I wish I had been able to keep what I have invested in Social Security. I know that society (and me as a result of that) benefits from people having a retirement safety net. But that doesn't change the fact that what I could have done with the money would have been much greater than what I'll get back from the system.

After you've read the piece below, leave your thoughts on the costs and benefits of Social Security as well as any comments on how it could be made better for all savers.

Imagine a man named William Jones, born in 1948, who is celebrating his 66th birthday today by filing to collect Social Security at full retirement age. William's final salary was $50,000 per year, although when he started working in 1968 he was only earning $7,304 annually.

For the past 46 years William has had Social Security withheld from his paycheck. When he first started, the total Social Security withholding was only 7.6%, which for William was $46.26 of his $609 monthly paycheck. On his last pay stub, the government took 12.4%, or $516.67 of his $4,167 monthly salary.

Because William was not subject to the current 12.4% withholding during his entire working career, his Social Security benefit will receive a more generous return than any of today's young people will receive.

Social Security withholding is split into an employee portion and an employer portion. But practically speaking for the employer, both portions are just additional costs of hiring the employee. Neither gross nor net wages would change if technically the employee or the employer were paying the entire amount.

William's lifetime withholding totaled $152,068. In today's dollars, that means William paid $260,163 to Social Security.

This withholding qualifies William to receive $24,180 a year, just under half of his former salary. When he dies, only if Williams has a surviving spouse whose earning record was smaller than his will this benefit survive him.

Many have said that Social Security is a Ponzi scheme with no lockbox that is going bankrupt. But the real way to test is what would have happened had William been allowed to keep his Social Security benefit and invest it in a private IRA account.

We computed this hypothetical return in an age-appropriate portfolio between the S&P 500 Stock Index and the US Aggregate Bond Index. With only a monthly contribution of his Social Security withholding, by age 66 William's portfolio would have grown to $1,431,487.

With a safe withdrawal rate at age 66 of 4.43%, this IRA would give William an income of $63,415 per year rising with inflation. On average this withdrawal rate would be sustainable until William's 101st birthday. But at his average life expectancy at age 84, he would leave an estate that would still be over a million dollars in today's dollars.

To be clear, Social Security offers William only $24,180 a year, half of his former salary. In contrast, this IRA account would allow him to retire with $1.4 million and a 27% raise as well as leaving a legacy for his heirs.

Workers under age 60 should tilt heavily toward stock investments. But even if William had blindly invested in 40% bonds, his portfolio would still have grown to $1,186,472, a yearly income of $52,561 rising with inflation.

Every 46-year investment horizon since Social Security was made law would have produced better returns had the withdrawals been invested privately. Even the Social Security withdrawals of average workers would produce millionaires if they were allowed to be saved and invested in private accounts.

Comments

[mb]

The one thing progressive defenders of social overlook is how bad this system screws the poor. It was not until 2005 that the average black man reached retirement age and the poor die younger - if you do these calculations for the life expectancy of the poor or blacks - they lose money. If Social Security is around for you or I to collect, it will essentially mean that we will be able to pass more on to our children or charities of choice. That generosity is subsidized by the poor that die young pay into the Social Security system - never collecting or only collecting a portion of what they paid. Imagine if the poor could pass their Social Security onto their children? Do you think they would benefit? Of course. The system is disgusting, the poor subsidize the rich's retirement, while the government takes a big cut. You can also get a better return just by investing in T-bills.

[Jon]

Far be it from me to argue with an expert like Mr. Marotta, whose blog I read often. I also would personally prefer to have control of my SS contributions. However...

It would have been practically impossible for the average person to have achieved the types of returns he talks about over the time period in question. First, the tax-advantaged vehicles such as IRAs, 401K, and Roths have appeared somewhere within that time period, and were not available for a working person who wanted to invest 40 years ago. The ones that first appeared were offered mostly by insurance companies and featured proprietary funds with heavy fees which would have eaten into that hypothetical rate of return. It was not possible to simply invest in a no or low-load S&P index fund back then, and the process of getting a brokerage account, which today seems so simple to most of us with an internet connection, was neither easy nor simple. Hiring a financial manager with Mr. Marotta's expertise to help you direct your money into an "age appropriate" mix would also have been problematic, as some of the portfolio allocation theories he and other competent managers use today were not in vogue at the time, not to mention that even today his fees are just out of the reach of Joe Six Pack. Also, long term success in investing has been shown to be as much a matter of psychology as economics, and your average investor, if trusted with his own retirement funds, would a) never have shown the discipline to invest them in the first place, and b)have sold at the very worst times, due to panic at "losing money".

That said, I agree in principal with the ideas in his post, I'm merely quibbling over the practical applications.

[elb]

It's not all about returns. Social Security is half insurance (the survivor and disability components, which help the poor and those who run into bad luck that mb appears to be concerned about -- for instance, Paul Ryan paid for a material portion of his college with SSI survivor benefits), and about half a (weak) retirement fund / annuity.

It's not designed to maximize returns. There are plenty of vehicles both in the private sector and subsidized by government which help build wealth (401(k), IRAs, Roth IRAs, SEPs, deferred comp, mortgage interest deduction, etc).

Savers and investors would do better to find other ways to save and invest than to complain about "the system." Social Security will exist in one form or another for our entire lives -- financial planners have been telling my family not to count on it since the 60s, but it has always been there, so it seems like a political position not supported by facts.

[BillyBob]

Any change to the system based on statistics from the current situation would change the system such that the previous analysis would not apply to the new situation. In other words, any ostensibly workable fix, once implemented, would create new problems which seemingly would be repairable by switching back -- true or not.
Plus, our broken political system is incapable of massive change as insinuated in this article, sorry to say. Any bill or law would be so altered and packed with favors, bloated and expensive... at this point in my opinion it's best to concentrate on wealth protection and your family's financial security and not to waste time dreaming about pie in the sky. Given our debt, the bomb will blow but no one knows the length of the fuse.

[Jason]

This is an unfair comparison that completely misses the point of social security. Before social security, there was a massive problem with people being unable to afford basic necessities in old age or after disability that has been significantly reduced.

Any money in the trust fund is invested in Government bonds which would be a more apt comparison for return than a stock/bond portfolio. You are ignoring the benefit of the disability insurance portion of these taxes which is significant. The average US Citizen has a savings rate around 5% and if they invest (big if), tend to lag the market returns by over 2% a year.

It is a social insurance program. If you were to get rid of the insurance aspect and invest in riskier classes of investments, of course the numbers would look better comparing to past US history. However, the way it is designed, it will stand up under much worse conditions (like Japan's economy has gone through in the past 30 years which isn't even a worst case). Without additional taxes to support social programs, you would end up with millions more disabled and old age Americans who could not afford basic necessities like food, clothing, and shelter.

Having made the decision to run this story, I would hope this site will run a counter story on such a controversial topic. I would be interested in writing one should the site not have another author interested.

[Daniel Gray]

I appreciate you toning down the political rhetoric, but Marotta can't get his political biases out of his writing, and I don't think he should be given a voice here until he does. You can see he's still calling it a Ponzi scheme, but he does it indirectly. Taxes are not a Ponzi scheme, but a political system of governance agreed upon by the people, regardless of whether you personally agree with them or not.

Yes he has a point, that given completely ideal circumstances, private investment outperforms Social Security. But SS was never intended to be an investment vehicle -- it's a tax. The tax dollar I put in does not go towards my direct withdrawals in retirement. It supports the current retirees. The purpose is to provide a very meager baseline for all citizens to prevent them from being completely penniless, not to maximize returns. And of course, given that it is government, it is not going to be a highly efficient system, but again that's not it's purpose.

I agree that there needs to be a response to Marotta, or he should not have a place on this blog. I really don't see how his post contributes to personal finance, when other writers can clearly describe the the importance of retirement investing over social security without resorting to the tired old Ponzi scheme language.

[joe16]

I agree with many of the comments here:

(1) It is unfair to assume that the full amount set aside for social security taxes would be available to invest. If not withheld, that money would be taxed as income for starters.
(2) Social security may provide a lower monthly income than a 1.4 MM stash, but SS is guaranteed for life (with some cost of living increases). A better comparison would be to calculate the lump sum needed to produce an annual $24k annuity for life that has cost of living increases as well as some survivor benefits....good luck. (3) This doesn't even mention the increased benefits the person would receive by waiting another 4 years to begin collecting the benefits at age 70.

[Erik]

I agree with the tone above. Inflammatory article rather than informative.

On the topic of social security, I'd like to talk about:
1) Gaming the system. Why can couples play all kind of games with taking 1/2 of partners amount and later switch to their own and get credit for 'waiting' to take SS. I may have the details wrong but there seem to be too many ways to game the system
2) Spousal benefits in general. Again not sure I have this right but I think that when my wife and I get to retirement age, we will essentially be getting 150% of my full benefits since she will be entitled to half of my benefits. On the one hand I understand this and I wouldn't want divorced couples to get more money that couples still married but it also doesn't align with what you put in is what you get out.
3) Buying a fixed annuity versus delaying taking Social Security. Let's assume 40k/year from SS at age 67. Is it worth forgoing the 40k a year for a few years or would you be better off using that money and buying a fixed annuity assuming you have savings to support either approach.

[JayCeezy]

Three points...
1) people born around 1960 (where the full age goes to 67) are right at the tipping point for benefits/tax being about equal. The example of William Jones born in 1948 would mean Jones will get far more than he paid in.
2) commenter 'mb' point about poor and blacks being penalized is incorrect; low-income people benefit far more in the benefits/tax ratio than do the highest earners, and life-expectancy for black men is skewed lower by the inordinate amount of black males in their teens, 20s and 30s who pass.
3) this Marotta point is not new. GWB tried to reform SS, and got his head handed to him by the AARP and other self-interest groups. There is no political will for politicians to make any change other than raise the rate or the age, and no majority will from US citizens and the newcomers who will also be covered in 'immigration reform'.

[Josh]

I think the safe withdrawal rate should be closer to 3% not 4.43, even most aggressive ones I have seen do not go above 4%

[Bob]

The simplest flaw in this proposal is that, if all workers kept control of their own contributions (and kept them out of the government's hands), then no one prior to "William Jones" retirement this year would have ever received Social Security, and a whole lot of our elders would have retired nearly penniless. Within the first years of its beginning, Social Security was paying out benefits for those who had not been in the system long enough to invest for the same return.
Yes, the system began before 1948, but that only pushes the hypothetical dates back a few years; seniors still would have starved (or died on the job, leaving windows to starve).
Plus, I know very few people savvy enough to (a) know where to put the money, and (b) leave it their until they retire. "Mr. Jones" might have pulled it off, but most of America didn't (and doesn't?) have a clue.

[Tim Russell]

The author also used the full SS amount. The employer pays half and the employee half. So you can cut his figures in half since his checks were only reduced ~$23 when he started and ~$258 when he finished. I doubt the employer would give the employee more money if they didn't have SS to pay. Assuming the same returns he would have ~$716K so if we used his 4.43% withdrawal rate we get $31707/yr.

Taking into account what elb posted about the insurance component which the worker in the article would not have now how bad a deal is SS? Sure it is a better deal for some than others but that's the way of many things in our system. We do not all benefit equally or proportionally in the taxes we pay.

The poor that die younger and so do not collect or die only a few years after they start to collect. The still had the insurance component. They also likely work jobs where they're more likely to be injured or killed on the job? Likely the only insurance they and their loved ones have.

[Mark]

I don't understand why Social Security can't be indexed in a mix of age appropriate stocks and bonds for folks automatically.

It would actually benefit poor people because they could leave an estate to their children. They could also allow for early withdrawals in the case of disability.

The only reason they don't want to do it is because there really is no "trust" fund. All the revenue from Social Security is spent as it comes in. The system is dependent on today's workers paying for today's retirees.

Financial issue aside, the other reason politicians don't want to go with automated, age appropriate indexed investments is because they don't want to let go of POWER.

[JeffinWesternWA]

of course there is no "SS fund", the money was used, justas "income taxes" for the general fund, so regardless of teh article, tax brackets for most "are" 12.4% "higher" than the IRS code explains and the government pays you a pension at "old age" based on an earnings formula, that's how I see it - theory vs. reality...

P.S. with the current formula of an 8% annual increase by waiting, and good health/longevity in my genes, I'm waiting till 70 to collect.

I'll let teh insurance company holding my annuity assume the risk of the promised lifetime income and tap THAT account before SS in old age..(can't say retirement, I did that at age 47 :)

[Old Limey]

I stopped paying into SS back in 1992 and started receiving benefits in 1996 when I was 62 so the discussion about offering other options for younger people is something that I haven't given any thought to.

What does irk me a little is that every year more and more of our SS income becomes taxable again even though our income was of course taxed when we earned it. However I can't gripe since America has been good to us and we are both very fortunate to be in the financial position that we are, as are our 3 children.

[M]

First, I appreciate FMF's efforts to tone down the rhetoric----some of the prior articles from Marotta have been both densely unreadable and blatently politically biased.

On specific topic of SS, I agree with Jason and others that the article neglects the insurance element of the program. Its a social program to prevent destitute seniors and should be celebrated as largely successful. If the amount of money the typical person in their 50s has in a 401k/IRA is any indication, society needs this program and would not be well served in some of the alternate plans that are often suggested.

Lastly, I feel that as a nation, topics like this are too often looked at through an individual's prism, instead of a societal view. A money manager thinking that it would be good if money managers managed more money.....go figure. Instead, I'd suggest that we should be asking as a nation what's a reasonable system that we can design (and afford) that each or us would be willing to live with REGARDLESS of how smart, rich, talented, etc. we were lucky enough to be born. Many of us have won the birth lottery (as Buffett has often said) and it would be best if we didn't forget that.

[jim]

FMF, thanks for toning down the rhetoric. As is this article is fine as far as that goes.

I'd love to see Marottas actual math so we can find where he made the errors or what unrealistic assumptions he used.

The assumption that a retiree today would be getting $24k a year after making $50k is odd and certainly not at all ordinary. Typical benefits for someone making that much would be closer to $16k. The average benefit in '13 was just under $1300 a month. But its odd that he found an example where someone would get a HIGHER SS benfit than normal. Probably just how Marotta contrived the math to paint a worst case.
Plus Marotta is ignoring spousal benefits as if its some sort of rare exception rather than fairly common +50% increase to the return. But even worse the average person retires at 62 and gets only 75% of their full benefit.

The reality is that the average investor STINKS at managing their money.

I read recently over at The Big Picture blog that the average investor has gotten returns of 2.3% in the past 20 years versus 6.3% for bonds and 8.2% for the S&P500. (Source: JP Morgan Guide to Markets 2Q|2014) Lets face it most people do a pretty bad job when managing their own money (as the facts clearly show) and then throw in 1% admin fees and 1% expense fees and 5% loads where the financial industry takes their cut and you end up with poor returns when people invest on their own., Of course there are exceptions and some people do quite well (Old Limey ) but the average person has done very poorly when managing their own investment money.

So we've got a contrived example versus an unrealistic expectation.

For actual numbers you can see the internal rate of returns for various income levels and situations :

http://www.ssa.gov/OACT/NOTES/ran5/index.html

Returns range from 0.75% to 6.7%. with a signal higher earning male netting the worst and a low income single income married couple getting the best.

SS is a progressively designed paygo tax and social insurance system and always has been.

Is it a super awesome investment? no. Is the average investor better on their own buying stocks? no.

[rick]

If we are to be real we must admit that the social security system has been a lie from the beginning. I it was a way to generate additional revenue for the general fund without imposing additional tax. There is no asset in the "fund" except unique federal notes which are supported only by the federal governments ability to tax or borrow in the future. The current Social Security payment rates will almost certainly be reduced in the future as we will only have 2+ workers to support each retiree and the working population will no longer be willing to provide at the level currently provided for the senior population. This program has always been a legal variation of a Ponzie scheme and will eventually become "means tested". In other words it will become just another welfare program and any of us who have provided for our retirements will not be allowed to access these funds since they will all be required to support those who would otherwise starve.

[Old Limey]

M
Your comment about "The Birth lottery" really got me thinking.

What takes place at conception probably has the greatest impact upon your life because it has a huge effect upon your lifelong health and the genetics that you are born with. Next would be the impact that your parents had on you as well as that of relatives and siblings. This is followed by the impact of school teachers and close friends.

Looking back on my 79 years of life some of the major turning points came as the result of completely random and unplanned encounters and occurrences during my teenage years. One occurrence was that of WWII which started when I was 5 and included being bombed by a German Focke Wulfe 190 that was trying to evade a British Spitfire, but was shot down as it passed directly overhead of me at rooftop height. Other encounters led to marriage, choice of education, decision to become an engineer, then to emigrate. Emigrating at age 22 changed our lives dramatically since my wife and I left all of our roots behind to start life in the New World, living first in Toronto, then Denver, and lastly Silicon Valley. Financially, timing the dot.com (or Internet) bubble perfectly made a huge difference and how often do life changing events like the Internet come along?

[Mark]

@M.

I think I already laid out a reasonable system. Indexing takes the money managers out of it. As does automating the asset allocation process. I.E. You move on a "glide path" over time of 90% stocks when you're 20 to 40% or 50% in your 60s.

Obviously, I can't go into great detail in a short post like this, but that is the general concept.

[Steve]

I assume this assumes the money would still be unreachable and one could not ever access it prior to retirement age and at retirement age they would have to turn it into a lifetime annuity.

Otherwise, the money would not be saved and invested and last through, it would be spent by the average american just as they do with every other dollar they make in their lifetime. I think every statistic out there proves that SS is what keeps most of the elderly eating, sheltered and clothed, and we'd just be shifting our SS crisis to a welfare crisis if money was not forced from them.

[M19]

What a great debate. This FMF community is always interesting,
thoughtful and educated.

My views on the politics aside, if the dollars were not taxed and
Held by the Feds, there would be no money saved by typical
Americans. SS is better than the alternative for most.

Great comments and discussion!

[Old Limey]

Steve:
I think that your comment that SS is what keeps most of the elderly eating, sheltered and clothed is probably exaggerated.

My wife and I retired in 1992 and 1993 respectively. She was a teacher's aide and I was a senior staff engineer for the largest defense contractor in the US. We took our SS at age 62. Our checks amount to $1,160/month for me and $424/month for my wife. I don't think many seniors of our age could feed, shelter, and clothe themselves for $1584/month, particularly in high rent areas in California.

The Social Security Administration also make significant deductions for:-
.... Medicare Part B
.... Income related adjustment based upon our tax return
.... Prescription drug coverage.

These lowered my check from $1,483 to $1,160 whereas my wife's check was lowered from $745 to $424.
Admittedly our income is quite high even though a great deal of it is tax exempt. We also receive nice pensions, mine is static but my wife's pension increases every year.

[Steve]

I have to disagree Old Limey. I'm not saying its a good living, far from it, I'm saying its what people actually do live off in retirement and so what must be what keeps them eating and sheltered.

We all see plenty of stats like this:
"The majority of retirees (65 percent) get half or more of their income from Social Security. And over a third (36 percent) of people age 65 and older receive at least 90 percent of their income as a monthly Social Security payment."

I don't know how to draw any other conclusion then without SS these people would have difficulty with the most basic needs.

[Old Limey]

Steve:
Here in Silicon Valley the cheapest home that you can buy is now close to $500K so we probably have very few retirees that get half or more of their income from Social Security - they probably left the valley a long time ago for states with much lower living costs. Most of our travelling was overseas so there are many states, especially in the South that we have never visited. Even the mobile home parks have almost disappeared because of the very high land values. We do have guys that spend their days standing at freeway intersections holding up signs that that they need money. I also see them outside of some supermarkets and at the main exit from our Costco parking lot. There are also homeless encampments alongside some of the creeks, the authorities clean them out but they soon return. I also have to be very careful using an ATM since I don't want to be approached just as I have withdrawn some money for my wife. I no longer use money, I put everything on a rewards card. Life is certainly tough for a lot of people, particularly the homeless. In fact when my wife used the restroom this week in our local supermarket there was a homeless woman in it that was using it as her bathroom.

[Rachel C]

Long time reader, first time commenter. First off, I DO agree with the idea that SS keeps many elderly surviving. Many times, the poor elderly move in with poor relatives in "flyover" country, where a cheap, crappy 2-3 bedroom apartment can be found for $600-$800 per month. Add in Section 8 housing, and you have a 4-6 member blended family scraping out an existence for $40 per month rent (or less). Add in Medicaid health coverage for both kids and adults, food stamps, and the occasional utility bill help, and survival is certainly possible without going homeless or hungry. Apparently, children of the "impoverished black man" who dies before reaching full retirement age also receive SS benefits. People who have no wealth and see no chance of accumulating any know these loopholes and get government checks for every member of the family and are able to eeke out an existence on these meager funds. Without them, other areas of the welfare system would be even more stretched than they already are. I grew up without public assistance and had no idea most of these programs existed before I worked as a pharmacist in some impoverished areas. But, I would rather pay some taxes than have fellow citizens, even those who have made some stupid and poor decisions, literally starve in the streets.

As an aside, Old Limey, I found your story about WWII and a plane being bombed onto you fascinating and horrifying. Did you sustain lifelong injuries from that? If so, I am in awe of how you overcame those to make your life incredibly successful. If you feel comfortable sharing, I would like to hear about that. I've read of your path to success but did not know about the obstacles you overcame to get there. I think you are an inspiration to us younger people who are still building our nest eggs. Steady and slow, with some smart timing decisions along the way, can win the race.

Thanks for the forum FMF and the input from all the regular commenters!

Rachel

[MoneySheep]

From the above comments I get a sense that many readers would prefer control over their SS contribution dollars, rather having the government handle the "investment" for them. Also knowing that readers of this site are able and can handle their own money, I am not surprise to read that they can generate better returns than the government with their SS contribution dollars.

But I must say that SS is not a returns contest. It is an Old Age Survivors Disability Insurance. So like an insurance it must be taken a societal-collective view. It is not a guarantee total income replacement for when you retire. (I think the original idea was to replace something like 25% of your income, I could be wrong on this). So individuals who are able and capable must also make effort to save for themselves for retirement.

What about those who are not able? Suppose you lost in the birth lottery and you become an orphan in an early age, SS will supply the income for you. Or your parents died when you are young and didn't leave you anything, government will give you income. If you lost your limbs and can't work, SS will give you income. In these cases, you collect without paying into SS. Like a house insurance, you diligently pay the premium every year but you are glad you don't have to collect.

[Old Limey]

Rachel C:
Here are the full details of the day I had a close encounter with a bomb. It started out like a normal Sunday. My mother asked me to stay in our back garden to watch over my young sister. My father was a fireman and we lived in a flat adjacent to the fire yard. Suddenly I heard the roar of a low flying plane. Looking up I saw the German insignia on the single engine fighter bomber and could also clearly see the pilot's face. As I watched I saw a bomb fall. The bomb made a direct hit on a hotel about 100 yards away and a lot of debris filled the air for a short while. The hotel had a popular "Pub" and our next door neighbor rushed out of her flat, grabbed me and said please come with me to the pub because my husband has gone there to meet one of his friends. Thinking back I was about 10 years old and my sister was 4 years old. We rushed down to the hotel and saw a lot of badly injured people laying on the sidewalk. We also found out later that many Canadian airmen were billeted in the hotel and many them had been killed. There was also a second bomb that I didn't see fall that destroyed a major department store which thankfully was closed because it was a Sunday. My neighbor's husband happened to meet his friend who was waiting outside the pub. His friend said, "Why don't we go to another pub that was just a short walk away - they did - and that pub wasn't even damaged. Our flat just had a few windows blown out from the blast. We also had a government provided steel table shelter in our basement and spent many a night in it when the air raid siren would sound. Once the All Clear siren sounded we would all go back to bed. On another occasion my grandmother's house was bombed, the house was destroyed but they were both inside their shelter and survived.

[M]

I think the fulcrum of the debate is how people view SS witholdings: Is it belonging to the individual (like a uber-IRA), or to society at large?

I understand each side and the merits of each position.

However, for me, I think of it as insurance first. As a society level pool, I don't even tally up all my contributions any more than I might add up what I've paid over the years for car or life insurance. I do hope that I'll never need to rely on any of them!