Social Security Ripoff

A few weeks ago I got my annual "Your Social Security Statement" from the government.  This is a statement carefully crafted to look like it's telling you a lot while at the same time covering up Social Security's dirty little secret.  But with a spreadsheet and 5 minutes of work, one can figure out what is really going on.

The statement shows the total of my social security taxes paid into the system, including the employer share.  It also shows my taxed earnings per year, and my "benefits."  The main benefit is the monthly annuity payment Social Security will make to me after I retire.  My statement shows that \$140,139 total taxes have been paid into the system on my behalf over the last 25 years.  Based on these taxes and (this is important) the assumption I and my employer will continue to pay in at least \$7440 per year until I retire, I can expect an annuity at retirement age of 67 (under current law, which the statement makes clear can be changed at any time) of \$1,985 per month.

So I built a spreadsheet (click to download excel file), going back to my first year of employment.  Each year, I added the social security taxes to savings, and grew the accumulated balance by some interest rate.  For past years I used actuals from the report, for future years I used the \$7440 tax number the report uses to calculate the social security payout.

This allowed me to answer a question:  If I had been able to take these social security taxes and instead put them in a savings plan, and then took the accumulated balance out at age 67 and bought an annuity (at current rates), what would be my monthly payment?  Well, assuming a very conservative after-tax rate of return of 5%, I would have \$1,077,790 at age 67 to buy an annuity, which at current rates quoted on the Vanguard site, would give me \$7,789 a month until I die.  This return is just about four times the amount I get from having the Social Security Administration manage the money for me instead. Ugh.  Also note that I did not assume "risky" equity investments or whatever straw man anti-reformers are using nowadays.    If I assume a higher return of 8%  (the stock market in the 90's returned something like 18%) then my annuity will be \$17,860 per month, or 9 times the Social Security payout.  Double ugh.

In fact, this all opens up the obvious question, what actual rate of return is Social Security paying out on your "premiums?"  Well, in fact we can calculate this with the same spreadsheet.  I plugged in 2% for the interest rate.  No go -- resulting annuity is to high.  Then I plugged in 1%.  Still too high.  Could the government be paying you 0% on your money?  I plugged that in.  Still too high.  In fact, the implied rate of return on my money in the Social Security system is -0.8% a year.  In other words, not only is the government not paying me any interest, they are charging me to hold my money.

Social Security defenders insist that it is not a welfare program.  For example, Kevin Drum quotes this with approval:

The men in my family of my father's generation returned home after serving
their country and got jobs in the local steel mills, as had their fathers and
their grandfathers. In exchange for their brawn, sweat, and expertise, the steel
mills promised these men certain benefits. In exchange for Social Security taxes
withheld from their already modest paychecks, the government promised these men
certain benefits as well.

....These were church-attending, flag-waving, football-loving, honest family
men. They are rightfully proud of providing homes and educations for their
children and instilling the sorts of values and manners that serve them well as
adults. And if I have to move heaven and earth, now that they've retired, the
Republican party is NOT going to redefine them as welfare
recipients.

Fine, let's call it a retirement program.  Well, as a retirement program, it is a really, really big RIPOFF.  Ever worker in this country is being raped by this retirement plan.  In fact, it is the worst retirement program in the whole country:

• As we see above, it pays a negative rate of return
• It is not optional - you go to prison if you choose not to participate
• Unlike a private annuity contract, the government can rewrite your benefits level any time, and you have to take it.  In fact, my statement says "Your estimated benefits are based on current law.  Congress has made changes to the law in the past and can do so at any time.  The law governing benefit amounts may change because, by 2040, the payroll taxes collected will be enough to pay only about 74 percent of scheduled benefits."
• There are no assets backing this annuity!!  An insurance company that wrote annuities without any invested assets backing them would be thrown in jail faster than Jeff Skilling.  The government has been doing it for decades.

A couple of months ago, news-hog Eliot Spitzer had a well-publicized (what else?) suit against H&R Block for not providing high enough returns in its low-income retirement savings accounts.

New York Attorney General Elliot Spitzer [official website] Wednesday launched a \$250 million lawsuit [complaint, PDF] against H&R Block
[corporate website], the largest tax preparation service in the US, for
fraudulently coaxing its customers into a retirement account plan that
lost them money. Spitzer said that money in the retirement accounts
decreased over time because the low interest rate did not cover the
fees associated with the account.

Doesn't this exactly match the situation in my social security spreadsheet?  At least H&R Block's customers had a choice whether or not to sign up.

Postscript: As is usual with retirement issues, tax is a messy topic, so I mostly left it out.  My spreadsheet is correct if you call it an "after-tax" rate of return.  This may mean the nominal rate is higher, but it got taxed, or it could posit some tax-free savings alternative to social security.  Note also that we pay income taxes on the amount that gets taxed by Social Security (at least our employee portion).  This means an IRA type replacement for social security would actually have higher returns and dollars at retirement than those in my spreadsheet, because it would eliminate or at least defer income taxes on the premium.

Also note that the analysis is all in nominal dollars, because that is the way the dollars are on my SS statement - there are not inflation escalators in the program.

Postscript #2:  When last social security was a national topic, opponents of reform got a lot of mileage out of the 2001-2002 bear market in stocks.  They would ask, what if people had invested in stocks, they would have lost their money.  Well, as of today, if you had invested every dollar of your retirement savings on the worst possible day, the 2000 peak in the Dow, you would still be up 5% today.  This is a disappointing  return of less than 1% annually, but is STILL higher than the negative return in social security.  And remember, we are using nearly the worst five year before and after dates in this generation.  A real-world steady investment in stocks over the last 20 years, with equal amounts each year, would be way up  (anyone with an exact number is welcome to post it in the comments).

Postscript #3:  In an earlier post, I took on Social Security as intellectual welfare:

Advocates for keeping forced savings programs like Social Security in
place as-is by necesity argue that the average American is too stupid,
too short-sighted, and/or too lazy to save for retirement without the
government forcing them.  Basically the argument is that we
are smarter than you, and we are going to take control of aspects of
your life that we think we can manage better than you can
.  You are
too stupid to save for retirement, too stupid to stop eating fatty
foods, too stupid to wear a seat belt, and/or too stupid to accept
employment on the right terms -- so we will take control of these
decisions for you, whether you like it or not.  For lack of a better
word, I call this intellectual welfare.

Update #1:  In response to some comments, the spreadsheet does work right, it is just labeled wrong.  The column that is labeled "investment income" is actually the saved balance to date plus the investment income.  The "End of Year" column is the correct balance at the end of year after investment income and new contributions.

Update #2:  A commenter reasonably points out that investment at the top of the market in the Nasdaq would still be way underwater.  However, I took this point investment on the worst day as an extreme example.  Even in the Nasdaq, which is still off 50% from its peaks, a steady monthly investment from 1997 or 1998 to date would be above water in total.  Leftists do a lot of bad things for the country, but trying to scare average workers away from equity investments for the long-term is certainly on of the most hypocritical.  I guarantee that every liberal politician has a big fat chunk of their savings in equities, because they know that is the way to create wealth over the long haul.

Update #3:  In a follow-up post, using this same spreadsheet, I conclude that only 17% of my Social Security taxes are going to my retirement while 83% are welfare for someone else.

1. JEH:

The thought of the outcome you describe has always kept me from running the numbers myself - too depressing. In any case, you have forgotten the insurance aspects of social security: disability payments, payments to family survivors. Though I doubt it changes your results much if you figure them in.

2. Brian:

It's even worse. Since the threshold for taxing your benefits is not "cola'd" and set at \$32,000 since 1983, 85% of all your payments will be taxed as regular income. We have to pay income tax on our money twice!

3. Brandon Berg:

But Social Security is a welfare program. The rate of return sucks for us partly because the government uses revenues from high income earners to subsidize the low income earners.

And partly (mostly?) because the money isn't used to fund productive investments, of course. But I do bet that there are people getting positive returns. Maybe even positive real rates of return.

4. Michael Sullivan:

"Well, assuming a very conservative after-tax rate of return of 5%, I would have \$1,077,790 at age 67 to buy an annuity, which at current rates quoted on the Vanguard site, would give me \$7,789 a month until I die. This return is just about four times the amount I get from having the Social Security Administration manage the money for me instead. Ugh."

You're making two big mistakes. First of all, an after-tax and after inflation return of 5% is not especially conservative, but we'll go with it anyway. Secondly, the SS rate is inflation adjusted, in fact it's adjusted by more than CPI, IIRC following some index that reflects average worker compensation. So if wages in general go up 4%, your SS will go up 4%, even if CPI doesn't go up at all. In general, wages increase faster than inflation, so this is a pretty good deal.

Try seeing if you can buy an annuity with a COLA for the same price as one without? It's a *huge* difference. Probably not the 4 times that you calculated, but it's very large. Also, you're investing in stocks to get that 5% real after tax return. Which means that there a significant chance you won't do that well. I'm not saying you can't make that assumption, but realize that tthere's some variance in your assumption. You're likely to see somewhere between a 2% and a 9% real return long term on a reasonably prudent stock portfolio.

I've worked this out -- if you used a 2-3% (i.e.: safe) real return, and looked for an annuity with a COLA equivalent to the one given by SS (or calculate the equivalent NPV), you do... wait for it... not much better than SS. In fact, there is relatively little redistribution going on under the covers, assuming the plan stays in place. If it doesn't, then at some point there will be a great deal of redistribution from the first uncovered workers to the last covered workers. There's as much being stripped out of your fund to pay for disability (which is mandated insurance, essentially) than there is to cover people who would otherwise get very low retirement benefits.

So in fact, there is not some ridiculous amount of waste, nor any massive wealth redistribution in the SS program. It's basically a forced retirement fund that only invests in nearly risk-free securities. With a few added tricks. Of course it's not a great deal for people who would invest alternate funds wisely, and who are less likely to become disabled, but for what it actually does, it's fairly efficient, and big-time redistribution isn't high on the list of what it does (although there is some).

I really hate seeing these calculations which ignore salient features and make things look *far* worse than they really are.

5. John:

Re: postscript 2: to be fair, Your Coyoteness, had someone invested at the peak of the NASDAQ, they would still be down 50%.

Even worse, if someone was doing it with margin (I know some gamblers who were doing exactly that), they could be down a lot more.

Having said all that, I know I could do better than SS using sound investment principles and a bit of intelligent risk-taking.

6. Jeff S.:

Michael Sullivan,

Did you mean to say the Coyote erred in not inflating his monthly benefit in current dollars (\$1985) at some rate the SSA uses, so that the nominal monthly benefit he'll receive when he turns 67 is a larger number? I think you are correct in this. Then he can compare that monthly benefit to what he would get by purchasing a COLA adjusted annuity with his \$1,077,790 at that same point in time. This seems to me the fair comparison.

However, I think you are either wrong or not clearly explaining yourself when you talk about "real" rates of return. His use of a 5 percent after tax return is sufficient (whether you agree with the rate is another matter); to say it's a mistake because it isn't a real rate of return is your error. And please tell me you didn't inflate your current monthly benefit by an amount equal to what you think is a "real" rate of return.

Also, do you have back-up that the SSA uses an adjustment factor exceeding the CPI, like wages? Just wanting to know so I can make this very valuable calculation for myself. Thanks.

7. Rob:

I've learned that it IS possible to NOT pay social security. I know a family friend which has gone through the process of removing his SS#, I believe it was an ugly process, and in hindsight he says that it's not really worth it. I'm not sure of the technical details (maybe someone can post it)?

8. Doug Murray:

I've been telling some of my friends and most of my relatives this for years, even done the spreadsheet. Yours is better so they'll be getting a copy or link shortly.

One thing I add, though: run your spreadsheet through today and see what your heirs get back if you and Mrs. Coyote die tonight. Compare that to the SS benefits they'll get. My wife and I have paid in about the same as you and our two grown boys would be due nada.

9. Craig:

"You're likely to see somewhere between a 2% and a 9% real return long term on a reasonably prudent stock portfolio."

You would have to be a horrible investor to get a 2% long-term return on stocks. Over the long term, the stock market returns 8-10%. Put your money in some low-cost index funds, and you'll probably do better. 5% is quite conservative, considering these numbers. One could get 5% investing in bonds.

I really wonder what your definition of "reasonably prudent" is.

10. Steve:

Craig,

If the stock market goes up 10%, and you lose 25% of that to taxes, and inflation was 3%, you'd have a 4.5% return, right? If the stock market goes up 8%, and you lose 4% of that to taxes, and inflation is 2%, you'd have a real after-tax rate of return of 2.8% right?

I find people generally overestimate their what their real rate of return is likely to be in a taxable account. If the account is tax-deffered, who knows what the tax rate will be when the money is withdrawn? People also tend to forget to account for the fact that they will often move money to less risky investments as they get closer to retirement, so using the expected return for equities for the entire investment period is probably not a good assumption for many.

I'm around 30, and when I run the numbers for my retirement plan, the one thing that becomes readily apparent is that my assumptions about rate of return, future tax rates, and inflation have way more impact on my chance of success than the amount of money I currently have invested and am investing on an annual basis. When I input a range of (my perception of) reasonable assumptions, some say that I don't need to do anything beyond SS and my Defined Benefit pension plan, and some say I need to save 30% of my income. The biggest problem is that I'm tempted to put an expected value of zero on my pension and SS benefits, which makes planning for retirement very difficult.

Anyone know if it's legal to sell the rights to your future SS benefits?

11. Jeff S.:

Steve,

I agree with your caution to use real after-tax rates of return when estimating retirement savings. But Craig merely misread the 2-9% to read nominal before-tax rates, I think, while Michael Sullivan meant real after-tax rates.

12. ANONYMOUS:

SAVE SOCIAL SECURITY NOW
Fed chief Bernanke errs in concluding that boomers soon
to retire is the problem with social security. He told
Congress that in 1983 the Social Security and Medicare
trust funds were replenished by legislation but then the
Congress borrowed the money from and left IOUs, leaving
the funds now less than full as the law was intended.

The clearcut answer is right there: replenish those funds
with a new law which restricts the funds for the American
people. Congress is made up of representatives of we,
the people. They make no sense when to undo the law they
created for us. Bernanke told them about 80 million more
boomers will retire beginning in 2008, and the funds will
be broke in ten to thirty years.

A fund is not a fund if the funds are allowed to be used
for other purposes. So, the Congress we elected created
a law which made the funds solvent and then the same
Congress broke the law which benefited us, the American
people. I doubt they would want their own personal retirement
funds to be treated the way they continue to treat the Social
Security and Medicare funds of the American people. Our own
representatives are robbing us of secure retirements
and continue to tax us for a bogus fund. They are guilty
of creating a Ponzi scheme of the worst dimensions.

This is not rocket science, and does not need reduction
of benefits nor increase of taxes. The answer is simple
and not even Economics 101. Stop the talk and just do it:
fund the funds and leave the money in The Social Security
and Medicare Funds. Leave the funds alone for the
American people.

13. Scott H:

Although I would certainly not doubt that SS doesn't give a high return like private investment, you seem to fail to account for the fact that Soc. Security payouts have traditionally (not guaranteed in the future) had cost of living increases each year. They aren't much, just 4.1% last year (I think last year, maybe 2005). Yes, that adjustment isn't accruing as interest, but this increase in payout will decrease the difference between an investment and SS because Investments don't get cost of living increases.

At least I think so.

14. ThrobbingGristle:

You wrote "there are no assets backing this annuity"

There are, in fact, government bonds backing the social security "trust fund". Some call them nothing more than IOUs, but that is what all bonds are. The real question is; will the government honor these bonds, and if so where will they get the money?

15. James:

We all know Social Security is terrible.
So why is it still around and why do people still defend it?
Will the government have to go into more debt then they will finally cancel the program...or is this program forever?
Anyone heard of anyone advancing the issue of just "opting-out" of SS?

16. Roberto:

Social Security is nothing more than theft, and we can't do anything about it. My benefits are being reduced because they " overpaid " me! It's about keeping us marginalized and unable to fight back. America needs fixing