Ever Wondered Just How Bad You’re Getting Screwed by Social Security?

As I’ve previously noted, most folks approaching retirement age probably have already figured out that they’re gonna get screwed by Social Security – e.g., that they will get less value back in benefits than they paid in in taxes.  But that’s only part of the issue.

You’re also not going to own a damn thing.  Your benefits are completely dependent on the whims of Congress; there is no contractual relationship between you and Social Security.  If Congress decides to cut your benefits in half because of future financial difficulties, well, sorry.  That’s life, and you’ll have absolutely no legal recourse other than to vote for a different Congressman.  And that  may not make any difference.

However, spreadsheets and the Internet are wonderful things.  I’ve developed a calculator that lets you see precisely what Social Security has cost you compared to a private retirement plan; you can download it here if you like.  So now you can see – if you’re so inclined – just how badly you’re getting screwed by Social Security.

This calculator allows you to input your income history.  It then assumes that the employee and employer contributions for OASDI  – the Old Age Survivors and Disability “Insurance” part of Social Security taxes –  are each then invested in an actual retirement account owned by the recipient, with returns based on the DJIA.  (And no, insipid – the fact that the Social Security Administration and other elements of the Federal government continue to lie through their teeth and call it “insurance” doesn’t alter reality.  Social Security is not and never has been insurance.  There’s no contract, no policy, no premiums.  Those OASDI deductions from your paycheck  are taxes, not premiums; Social Security is a PAYGO income-transfer program and is not any form of retirement savings program or insurance policy.)

The Alternative We Didn’t Adopt

Now, let’s assume Social Security had been converted in, say, 1965, into something like a “Super-Hybrid IRA with employer matching”, but with the earliest age one could begin making withdrawals set at age 62.  Under this scenario, there would be the obvious benefit for our children and grandchildren of not saddling them with a huge economic “Sword of Damocles” hanging over them regarding actually paying  future Social Security recipients’ benefits from current tax receipts.  (Remember:  today’s Social Security is PAYGO.  And the only collateral backing the system are Federal government IOUs from one government agency to another.)

The investment vehicle for these contributions is a hypothetical “DJIA Mutual Fund” that precisely tracks the DJIA – e.g., the fund consists of the stocks in the DJIA at proportions owned such that one share in the hypothetical fund costs exactly the DJIA.  Investments are presumed to occur on the last business day of the month, without load, and to consist of 1/12 of annual earnings.  (In actuality, they’d probably occur a couple of days later and consist of the previous months’ contributions, but I approximated due to data availability for DJIA aligned on end-of-month and the fact that I didn’t want to deal with different amounts of earnings each month based on slightly more/fewer days in a given month.)  At age 62, the owner would be allowed access to these funds, like any other retirement fund.   He/she would in fact own them – lock, stock, and barrel.  If he/she died early, his spouse/heirs would inherit them.

Since at least the employee contributions would be post-tax earnings going into the investment account, under Roth rules at least half of the withdrawals made from such a fund would be tax-free.  If employers were allowed to deduct the cost of such contributions as a mandatory employee benefit expense, the other half would be taxable.  That’s arguably still better than today’s Social Security, where up to 85% of Social Security benefits are subject to federal income taxes.

The Model

The spreadsheet model consists of 4 pages.  The first page allows you to input annual wage data for any year between 1960 and 2029.   It also contains other historical data of interest – minimum wage info for each year, the Social Security wage base, and the OASDI tax rates in effect for both employers and employees, and a hypothetical “midpoint” earnings case (e.g., an individual earning exactly halfway between minimum wage and the Social Security wage base each year).   The second page contains end-of-month DJIA data for all years from 1960 to July 2012 – there are multiple sources of such freely available on the Internet – and uses a placeholder value for future months.  (This placeholder value will obviously need to be updated each month in the future to reflect actual end-of-month DJIA figures.)  The third page gives calculations for each month in terms of amount invested, DJIA “shares” purchased, and an individual’s net account holdings and value based on the DJIA at that point in time.  A fourth page calculates retirement payments from this account based on a rate of return, an assumed monthly payment, and starting balance.  The payments are increased by the rate of return each year to at least partially account for inflation, and are (like federal retirement payments) truncated to the nearest dollar. Format is MicroSoft Excel 2003, so you’ll need software that can use this format in order to use the spreadsheet.

To use the spreadsheet, enter your career earnings on the first page.  You can also include future estimated earnings if you like, but since you don’t know what the DJIA will be you’ll be “flying blind” there regarding future holdings and values.  (The placeholder I used for future DJIA is 1, so any info after July 2012 is grossly inaccurate – but that also does clearly show you when you’re projecting into the future on the Balances page.)  Then assume an investment rate and monthly payment and enter it, along with the account worth, into the appropriate blocks on the Retirement Payments page.  Like Social Security, the retirement payments calculator assumes a 1-month lag (beginning of next month vice month of retirement) for beginning of payments.  This calculator also implicitly assumes you’ve “cashed out” into a fixed-value, income-producing  investment like Treasuries or Municipal Bonds and will be drawing from that source.  The month in which the EOM balance goes negative is when you run out of money.

Effects

So, how would this stack up with today’s Social Security?  What would be the effect on individual recipients?

AARP has a Social Security Benefits Calculator.  (The SSA does too, but unlike previous versions their current calculator/estimator doesn’t seem to allow entry of hypothetical incomes – it now seems strictly tied to one’s individual earnings record at SSA.  So while it’s more accurate in estimating your personal Social Security benefits, it’s rather worthless for general estimation and comparisons.)  Using that AARP calculator, I ran three scenarios:

1. A career full-time minimum-wage worker;
2. A career “midpoint” worker (e.g., halfway between minimum wage and the Social Security wage base)
3. Someone earning the full Social Security wage base throughout their career.

Two big caveats here:  first, the AARP calculator asks for an “average salary’.  I’m assuming that the AARP calculator is asking for that average salary in current-year dollars and converts this to equivalent salaries for prior years properly.  Otherwise, AARPs estimates could be high.  Second, I’m also assuming that it recognizes minimum wage as exactly that – minimum wage.  Otherwise, since minimum wage has risen dramatically over the last six  years the estimates calculated by the AARP calculator will be substantially higher than actual for the minimum wage case.

I assumed this hypothetical individual was born on 1 Jan 1951, started employment in Jan 1968, and will retire at age 62.  Here’s what AARP’s calculator gave for benefits under those scenarios.

1. Career Min Wage Worker, Age 62:  $656/mo
2. Career Midpoint Worker, Age 62:  $1548/mo
3. Career Wage-Base Earner, Age 62:  $1953/mo

So, how would those folks fare under a privatized scenario as described above?  Well, let’s “run the numbers” and see.  And since not too many people are career minimum-wage earners or stay exactly at one relative earnings point for their whole career, let’s look at how a more typical career pattern would look too.  Specifically, we’ll look at someone who (1) works for a few years at minimum wage, then (2) gets into a professional career field, starting at the entry-level, then (3) gets periodic promotions, and who (4) ends up earning around $90k a year for their last 3 years (ages 60/61/62).  (Income totals corresponding to this hypothetical scenario starting in 1968 and ending in 2012 are loaded into the version of the spreadsheet available for download.)  All are assumed to retire at age 62; the net worth shown below for each are as of July 2012.

Net Worth, Privatized Retirement Scenario

1. Career Min Wage Worker:  $204, 646
2. Career Midpoint Worker:  $606,585
3. Career Wage-Base Earner:  $1,008,524
4. Typical Professional Career:  $555,011

No, that first value is not a misprint.  Under the privatized option I presented above, a career minimum wage earner would have had a retirement account worth nearly $205,000 as of 31 July 2012. While he or she might be somewhat better off under Social Security, given life expectancies that’s also not a slam-dunk; if Social Security ends up paying less in a few years, he/she would be better off under the privatized scenario.  And in any case:  at 2.5% return, the guy/gal could draw benefits, starting at $656/mo and upped by 2.5% annually, for between 27 and 28 years – or until he/she were close to 90 years old.

A career midpoint worker would end up with the ability to draw benefits from his/her account starting at the same monthly amount provided by Social Security for roughly 34.5 years under those same conditions – or until roughly age 96 1/2.

Wage base earners?  44+ years of benefits starting at the same dollar figure provided by Social Security – or until age 106.

Oh, and that “typical professional career”?  31 1/2  years of benefits at approx $1450 per month, increased by 2.5% each year.  Or until age 93 1/2.

Further: under this scenario, you could opt to take smaller monthly payments to extend the period if you were seriously worried about outliving your money.  Any money left at the owner’s death would go to spouse or heirs.  And there’s also no reduction for spousal benefits above, either.  In fact, if the spouse had his/her own account, you’d add benefits for that to the above totals.

 

Now, can someone tell me again why the Social Security we have today is such a “good deal”?

Category: Politics, Reality Check