Social Security's rate of return is tough to beat

[fleur-de-lisa]

By Mark Miller, Reuters, posted on NBCNews.com, 10-19-12


Is Social Security a good deal? Many Americans worry that they will put more money into the system via payroll taxes during their working years than they will ever get back in benefits - and their concerns help fuel the ongoing push by Republicans to transform Social Security into a privatized system of personal accounts.

Mitt Romney has supported privatization in the past (see his book, "No Apology&quot , and running mate Paul Ryan argued for it as recently as last week's vice presidential debate: "Let younger Americans have a voluntary choice of making their money work faster for them within the Social Security system."

Could workers make their money grow more quickly with personal accounts? The actuaries at the Social Security Administration (SSA) ran an analysis recently that simulated real (after inflation) annual rates of return on payroll tax contributions for beneficiaries who were born between 1920 and 2004.

It showed that some workers might beat Social Security's returns in some years if they took risks in the stock market. But over a lifetime, Social Security's consistent, risk-free and inflation-adjusted returns would be very tough to beat.

I say "simulated" because the amount of your Social Security benefit is not based on tax contributions, but on your lifetime wage history and longevity. Moreover, Social Security is not an investment vehicle dependent solely on market returns - it is more like a form of insurance, annuity or pension, since its promise is to pay a monthly benefit amount no matter how long you live. In that sense, there is a peace-of-mind value that is difficult to quantify.

"Since you're guaranteed an inflation-adjusted income stream for life, you can think about your other sources of income and assets knowing that you'll always have Social Security," said Melissa Favreault, a senior fellow at the Urban Institute.

The simulations:

The SSA ran simulations analyzing workers with low, medium and high wages, and broke out results by four different life situations: single men, single women, a one-earner couple, and a two-earner couple. Then they adjusted the results for other key factors, such as mortality rates and disability. In addition, mindful that reforms will be coming at some point, they ran variations from the current outlook showing the impact of lifting the ceiling on taxable wages, and another scenario showing scaled-back benefits.

Overall, they found that the current Social Security program is a good deal. However, your mileage will vary by lifetime earning history, longevity and your year of birth. The payroll tax rate for Social Security's retirement and disability programs reached its current peak level - aside from the current payroll tax holiday - in 1990 (6.2 percent each for workers and employers).

Since we do not know what will happen on the policy front, I focused on the SSA's numbers assuming no change in current law. They found that every age group received a positive return. Among current workers and retirees, the rates of annual return varied by about two percentage points - from a high of 6.52 percent (for single-earning couples born in 1920) to 4.52 percent (for their counterparts born in 1985). So if you wonder whether you will "come out ahead" on Social Security, here are some key differentiating factors to keep in mind:

•Younger workers will get less. Today's young people will see lower rates of return, because they will have paid the highest payroll tax rates of all the age groups compared in the SSA analysis.

•Couples do better. Marital status is a key factor affecting Social Security returns. In every age group, the best returns went to married couples where one spouse works. That is because Social Security's design includes valuable spousal features that pay benefits to nonworking spouses and surviving widows. Spouses are entitled to receive the greater of his/her own benefit or half of their spouse's benefit. And surviving widows can step up to 100 percent of a deceased spouse's benefit. A single-earning couple with medium wages, born in 1943, will see a 4.59 rate of annual return, while a single female born the same year - also with medium wages - can expect a 2.49 percent return. (Spousal benefits are also available in cases where a lower-earning spouse had some earnings but so much less that their worker benefit is less than half.)

•Longevity matters. All pension and annuity systems are structured around mortality credits - that is, they use assets of those who die young to fund the benefits of those who live to a very advanced age. A projection by Favreault of Social Security data found that 82 percent of individuals who live to age 85 get back more in benefits than then pay in taxes; about 52 percent of those who die between 75 and 84 come out ahead. Meanwhile, just 21 percent of those who die between 62 and 69 get back more than they put in to the system. The odds here are especially good for women, since they have a higher likelihood of surviving to retirement age and longer lives after retirement. That gives them higher rates of Social Security return - a medium-earning single female born in 1943 can expect a 2.49 rate of return compared with 2.09 percent for her male counterpart.

•Lower-income workers come out ahead. Low-income workers enjoy higher rates of return by design, because Social Security's benefit formula is weighted toward lower-earning beneficiaries and their payroll tax contributions will be relatively lower. A very low-income couple born in 1943 will receive a 6.79 percent annual return, compared with 3.92 percent for their high-earning counterparts.

[reformist2]

1. It's INSURANCE, not an investment portfolio.

[Jersey Devil]

2. edited by author

I apologize. I was trying to make a joke, obviously rather clumsily.

[fleur-de-lisa]

3. Are you a rude misogynist?

[fleur-de-lisa]

5. Thank you.

[alc]

4. longevity matters - not all demographics are equal in that

if you don't live to be 85, there's less than 50% chance you come out ahead. Die before 70 and 80% chance you paid for someone who lives past 85.

Since life expectancy is under 85, it sounds like most people would have been better off putting the SS taxes in their mattress (actually US bonds to deal with inflation). If they die under 85 they can leave that money to their children. But if they live past 85, they may be screwed. SS isn't about "coming out ahead" on rate of return. It's about security in old age. As soon as we make it about rate of return, we are likely to lose all support from young people, especially in certain demographics with lower life expectancy.

[exboyfil]

6. Whenever anyone talks about opting out of the

system to get a higher rate of return, they do not understand that the higher earners subsidize the lower earners (at least those making up to $106,800). By inflation adjusted income levels the formula works like this:

Up to $9,204/yr. benefits are calculuated at 90% of the highest 35 years of earnings. So maximum amount is $8284/yr.

Between $9,204/yr and $55,488 is 32% (or $14,811/yr for this portion)

Between $55,488/yr and $106,800 is 15% (or $7697/yr for this portion)

Using the 6.2%/6.2% and assuming 35 years of contributions. The total contributions for the three pay scales are as follows:


So the max earners get about $30,792/yr (assuming a 4% interest rate they and their employer have contributed $975,391)

So middle earners ($55,488) get about $23,095/yr (after contributions at 4% interest of $506,765)

So low earners ($9,204) get about $8284/yr (after contributions at 4% interest of $84,059)

An inflation adjusted annuity with 50% spousal payment and 100% survivor for spouse is very valuable. Nothing in the market quite duplicates it. Social Security also has the Survivor's benefit and Disability benefit. The one feature of S.S. that is not typical of market conditions is that if you die one day before retirement (purchasing your annuity in the market so to speak) and have no spouse, your family gets nothing except a small payment under $1,000. Of course the day after you buy your annuity both cases are now the same. A recent article in USAToday states a 65 year old man can get an inflation adjusted annuity at 65 of $4548/yr/$100,000. This has no survivor feature though. 100% at 67% survivor for a non-inflation adjusted annuity is 87% of the no survivor option. So the actual number should be $3957/yr/$100,000.

So a comparison of payments and value as follows:

Earner Invested S.S. Return
Lowest $3,326/yr. $8,284/yr. 2.49x
Middle $20,053/yr. $23,095/yr. 1.15x
Highest $38,596/yr. $30,792/yr. 0.80x


I would like to see the cap lifted and income over $106,800 taxed at 4.3%/4.3% with no subsequent increase in benefits. This would put the highest earners at about the same Return on Investment on those lowest contribution dollars as those currently taxed at the highest rate.


You could price in a term policy for someone on S.S. to better characterize actually how S.S. works, but you would also have to price Disability insurance and what a term policy would cost for your survivors.

A higher rate of return than 4% could be brought into calculations, but a long term Treasury should be used for comparison - not the stock market. You can use your 401(k) for balance in equities if this is a concern. This is your floor investment in an ultra secure asset.

[exboyfil]

7. Some additonal benefits of S.S.

I am around 50 and have been working as an engineer my entire professional career. I put my estimated lifetime earnings in a calculator and got the following results
67 retirement benefit $28K
Disability insurance $27K
Survivor benefit $1712 per each spouse and child to a $4000/mo maximum

Value of the Disability and Survivor benefits:

A policy at my age for disability would cost $1,500-$2,000/yr
The max survivor benefit for ten years would be about $500-$1000 (say a $500,000 term policy – mine for 20 years purchased at 38 is about $700/mo).

So my employer and I pay about $11K/yr for S.S. I immediately derive $2K-$3K in benefits, and I will have an inflation adjusted annuity at 67 of $28K (with wife one of $14K). See the value of inflation adjusted annuities above.

[kentuck]

8. The right wing doesn't want to do away with SS as much as they want...

the proceeds of the fund and put them in the stock market.

[exboyfil]

9. No money to put in the stock market

We are at near pay as you go now and will start draw down of Trust Fund pretty soon.

Better 401(k) options are desired and that should satisfy the taste for equities that these vultures are after. How about we lift the cap, go to pay as you go, and reduce the withholdings for everyone. The remaining money could be invested directly in Treasuries and/or in broad market mutual funds (how about a mandatory formula of your age + 10 or 20% in bonds). I think it is desirable for poorer people to build up a nest egg of their own outside of receiving a monthly check. Eventually this option will go away as more withholding money is used to satisfy current retirees.