Monday, August 13, 2012

Social Security: How bad a deal?

With the AP reporting that the current generation of retirees will be the first to collect less in Social Security benefits than it will pay in taxes, there’s been a lot of talk about whether Social Security remains a “good deal.”

The AARP pushes back, noting that Social Security offers some things that many private investments don’t: it’s protected against inflation, it pays benefits that last as long as you live, and so forth.

This is true, although someone wishing to replicated Social Security’s benefits could largely do so on their own: make low-risk investments, then at retirement convert them to an inflation-adjusted annuity (yes, they are available).

Moreover, while it’s hard to say whether Social Security is currently a good deal – that’s in the eye of the beholder – we can say pretty clearly that it’s not as good a deal today as it was in the past. The benefits haven’t changed much, it’s the taxes that have.

A person who retired in 1950 paid around 0.75 percent of his lifetime earnings into the program – a 2 percent tax rate, but accounting for only 15 years of taxes from 1935 through 1950. A person retiring in 1970 paid an average lifetime rate of 3.6 percent.


But a person retiring today paid an average of 10.7 percent of their lifetime earnings into Social Security, even though the benefits offered by Social Security today are roughly the same as in 1970. So you’re paying roughly three times as much in to get the same out.

Now, this may still be a good deal – who can say? But I would have been surprised to hear AARP argue in 1970 that Social Security would still be a good deal at three times the price. Yet that’s more or less what we’re looking at today.


Larry said...

Don't forget the spousal allowance and survivor benefits, which cost more than a single-life inflation-protected annuity.

WilliamLarsen said...

Life time taxes is basically the average when in fact the mathematical way is to look at the weighted average and that may not be mathematically correct. 30 years ago I looked at calculating the life time tax paid by workers for each cohort. First the payroll tax began in 1937, not 1950. The payroll tax was 2% up till 1950 when it became 3%. The problem is the time value of money. My father paid less than $21K into OASI while his employer paid the same amount. Looking at his life expectancy at age 62 when he took early retirement his theoretical balance at age 62 would have lasted about 7 years. However, my mom was a non working spouse who collected a benefit equal to 50% of his. Both lived slightly longer than the average life expectancy at age 62 and 65 when both began to draw benefits. The problem is that they took over 6 times more in value out of the system combined than was put in.

Taxes paid earlier are worth more than taxes paid late in life.

When I looked at my father’s work history (paid the max every year) it was fairly simple to calculate the year by year using the US Treasury Rates paid in each year he worked. His benefit was also known. The single largest thing I saw was he paid 2/3 of his OASI taxes in the last few years he worked. In simple terms the payroll tax was very little up until 1970 only after 1976 did automatic increases begin.

The chart is skewed a bit. The 6% life time OASI tax shown in ~1981 is too high, it is closer to 5%.

Also benefits were reduced by about 20% beginning in 1978-1979 after the OASI benefit formula was introduced. In addition, COLA was much less beneficial than the intermittent increases in benefits authorized by congress starting in 1950 with a 77% increase.

One thing that is not being pointed out is that Social Security states they can pay but 75% of promised benefits. Does this raise previous benefits to a 6 to 1 or even 7 to 1 factor above future beneficiaries?

The 10.6% OASI tax is 80% higher than needed to obtain the same identical benefit under the 1977 benefit formula. The 1.8% DI tax is sufficient to buy a disability/life insurance policy that covers what DI pays.

socialsecurity36 said...

Social security disability is available only for only those who have worked throughout his life and paid the Income tax as well. For claiming the social security the person must be at age of 50 or above when he is incapable to earn money to fulfill the basic necessities of his life.