Is Social Security A Good Deal?

[Joe Economist]

The goal of everything that I write is to reduce the complicated jargon of the SSA into down to earth terms. Feel free to tell me if this goal is not met.

There is no short answer, but that doesn’t mean that people will not try to give you one. Some say that Social Security is a good deal, and some say that it is a bad deal. When you get a short answer, you have to understand that the hypothetical characters used in the research do not reflect the population as a whole. So it is easy to take the research out of its context.

Moreover, it is easy to manipulate the data to fit any agenda. If someone wants to make the system appear to be effective, they will show you the results of a couple with a single low-wage worker. Those who want the system to appear less effective will talk about single high-wage workers or dual-income workers. Same data: opposite conclusions.

The data is real. It comes from the Social Security Administration and the Urban Institute(2013 Update). The results compare what you would have had if you had invested your contributions to the amount of money it would take to buy the benefits that you expect to collect over time.

If that process sounds simple, it isn’t. Through the magic of mathematics, the research computes what you would have had if you had invested the money. The research uses the same process to calculate the value of your future benefits in today’s terms. The research is wrapped in beautiful language with words like ‘cashflow’, ‘present value’, and ‘real interest rates’.

It sounds very precise. What is not well disclosed is that the research assumes you have invested the money very poorly. The research that is quoted by virtually every organization applies only to people with less investing acumen than a drunken monkey with dull darts.

The key phrase is “discount rate”. Social Security uses 2.9%, and it is achieved largely by the worst investors in history. Even with the financial crisis, the lowest 45 year rolling return of the S&P is about 4%. The rolling 45 year return of the S&P500 is normally above 5%. So the what-the-reader-would-have might be two or three times larger than what the research suggests.

People can argue about what the correct rate should be. There a number of things that you can’t argue:

• 2.9% is the express way to poverty. It is insane that the government created a leg of a retirement stool that delivers a hopeless level of poverty on its citizens.
• A low discount rate will make the what-you-would-have lower. It will make poor returns look great.
• A low discount rate will make the what-you-get higher, much higher.

Is Social Security a good deal? Maybe, but it is much less of a good deal than the research suggests.

 

[worldlymrb]

Is Social Security A Good Deal?

Ponzi schemes are never a good deal.

 

[trapdoor]

Is it a good deal compared to what? Compared to long term stock investment, no its not usually a good deal. Compared to having no retirement at all, it's a pretty good deal.

Whether it is or isn't a good deal has never been a primary concern of mine. It's not a constitutional deal.

 

[Zam-Zam]

The goal of everything that I write is to reduce the complicated jargon of the SSA into down to earth terms. Feel free to tell me if this goal is not met.

There is no short answer, but that doesn’t mean that people will not try to give you one. Some say that Social Security is a good deal, and some say that it is a bad deal. When you get a short answer, you have to understand that the hypothetical characters used in the research do not reflect the population as a whole. So it is easy to take the research out of its context.

Moreover, it is easy to manipulate the data to fit any agenda. If someone wants to make the system appear to be effective, they will show you the results of a couple with a single low-wage worker. Those who want the system to appear less effective will talk about single high-wage workers or dual-income workers. Same data: opposite conclusions.

The data is real. It comes from the Social Security Administration and the Urban Institute. The results compare what you would have had if you had invested your contributions to the amount of money it would take to buy the benefits that you expect to collect over time.

If that process sounds simple, it isn’t. Through the magic of mathematics, the research computes what you would have had if you had invested the money. The research uses the same process to calculate the value of your future benefits in today’s terms. The research is wrapped in beautiful language with words like ‘cashflow’, ‘present value’, and ‘real interest rates’.

It sounds very precise. What is not well disclosed is that the research assumes you have invested the money very poorly. The research that is quoted by virtually every organization applies only to people with less investing acumen than a drunken monkey with dull darts.

The key phrase is “discount rate”. Social Security uses 2.9%, and it is achieved largely by the worst investors in history. Even with the financial crisis, the lowest 45 year rolling return of the S&P is about 4%. The rolling 45 year return of the S&P500 is normally above 5%. So the what-the-reader-would-have might be two or three times larger than what the research suggests.

People can argue about what the correct rate should be. There a number of things that you can’t argue:

• 2.9% is the express way to poverty. It is insane that the government created a leg of a retirement stool that delivers a hopeless level of poverty on its citizens.
• A low discount rate will make the what-you-would-have lower. It will make poor returns look great.
• A low discount rate will make the what-you-get higher, much higher.

Is Social Security a good deal? Maybe, but it is much less of a good deal than the research suggests.

Do you have a source for the 2.9 % discount rate? Thanks.


Something else to consider:



African-American females typically live longer than their male counterparts, yet even they have a rate of return lower than the general population. An African-American single mother 21 years old who in 1996 made just under $19,000 (the average for African-American females) can look forward to a real rate of return on her Social Security taxes of only 1.2 percent. Under conservative assumptions, if she had saved those same tax dollars in a private investment account composed of government bonds, she would have received a real return of around 3 percent per year. With a mixed portfolio of bonds and equities, she could expect a return on her investments of at least 4.35 percent. This means that even with a low risk/low yield portfolio composed entirely of Treasury bills, this single mother could have generated at least $93,000 more in retirement income (in after-tax 1997 dollars) than she would enjoy under Social Security.3



3 Assuming that upon retirement this single woman is able to annuitize the lump sum at retirement that she accumulated at a real interest rate of 2.7 percent over 15 years. The current federal income tax rates (with current rate structure, exemptions, tax bands, and deductions adjusted by inflation as mandated in current legislation) are applied against this annuity income.

http://www.heritage.org/research/reports/1998/01/social-securitys-rate-of-return

 

[as seen on tv]

its a good deal if you lack the willpower to set aside a percentage of each pay for retirement.

its a bad deal to pay for current retirees out of current contributions. that guarantees that at some point soon there won't be enough workers and contributions to pay benefits to those who've earned them.

 

[Zam-Zam]

its a good deal if you lack the willpower to set aside a percentage of each pay for retirement.

its a bad deal to pay for current retirees out of current contributions. that guarantees that at some point soon there won't be enough workers and contributions to pay benefits to those who've earned them.

There is, and always will be, a certain segment of the population who will, for whatever reason, not do the right thing (the right thing is this case being to set aside some money for retirement). The intent of social security is, I believe, is to save these people from themselves. The problem, of course, is that it penalizes everyone else who would do the right thing by offering horrendously low returns.

In light of this, the logical move would seem to be to offer an "opt-out" clause for those who want to invest on their own, provided they are willing to sign a waiver declaring they won't come to the government for assistance in the event they squander their savings. The flaws in the plan are a) social security would collapse with so many defections, and b) those who lose it all would end up asking for assistance anyway. So there we are.

 

[Joe Economist]

Do you have a source for the 2.9 % discount rate? Thanks.


Something else to consider:



African-American females typically live longer than their male counterparts, yet even they have a rate of return lower than the general population. An African-American single mother 21 years old who in 1996 made just under $19,000 (the average for African-American females) can look forward to a real rate of return on her Social Security taxes of only 1.2 percent. Under conservative assumptions, if she had saved those same tax dollars in a private investment account composed of government bonds, she would have received a real return of around 3 percent per year. With a mixed portfolio of bonds and equities, she could expect a return on her investments of at least 4.35 percent. This means that even with a low risk/low yield portfolio composed entirely of Treasury bills, this single mother could have generated at least $93,000 more in retirement income (in after-tax 1997 dollars) than she would enjoy under Social Security.3



3 Assuming that upon retirement this single woman is able to annuitize the lump sum at retirement that she accumulated at a real interest rate of 2.7 percent over 15 years. The current federal income tax rates (with current rate structure, exemptions, tax bands, and deductions adjusted by inflation as mandated in current legislation) are applied against this annuity income.

http://www.heritage.org/research/reports/1998/01/social-securitys-rate-of-return

It is embarassing, but I was too lazy to put in the links, but you are right I should have. The assumptions are on page 4 : http://www.ssa.gov/oact/NOTES/ran7/index.html

It reflects the assumed long-range real interest earned by the Trust Fund. This applies to people who put 100% of their retirement investments into US Treasuries. Not many.

The 2.9% is used through SSA's analysis. Here it is shown in the 2013 Trustees Report, the last line under the economic variables. It is also used the moneys worth studies, but you would have to read the report to see it. 2.9% is the assumed rate of return of Treasuries over inflation. http://www.socialsecurity.gov/OACT/TR/2013/II_C_assump.html

 

[Zam-Zam]

It is embarassing, but I was too lazy to put in the links, but you are right I should have. The assumptions are on page 4 : http://www.ssa.gov/oact/NOTES/ran7/index.html

It reflects the assumed long-range real interest earned by the Trust Fund. This applies to people who put 100% of their retirement investments into US Treasuries. Not many.

The 2.9% is used through SSA's analysis. Here it is shown in the 2013 Trustees Report, the last line under the economic variables. It is also used the moneys worth studies, but you would have to read the report to see it. 2.9% is the assumed rate of return of Treasuries over inflation. http://www.socialsecurity.gov/OACT/TR/2013/II_C_assump.html

Thank you, that helps.

In light of the information presented here, it seems a bit of a stretch to consider Social Security a 'good deal'.

 

[Joe Economist]

Do you have a source for the 2.9 % discount rate? Thanks.


Something else to consider:



African-American females typically live longer than their male counterparts, yet even they have a rate of return lower than the general population. An African-American single mother 21 years old who in 1996 made just under $19,000 (the average for African-American females) can look forward to a real rate of return on her Social Security taxes of only 1.2 percent. Under conservative assumptions, if she had saved those same tax dollars in a private investment account composed of government bonds, she would have received a real return of around 3 percent per year. With a mixed portfolio of bonds and equities, she could expect a return on her investments of at least 4.35 percent. This means that even with a low risk/low yield portfolio composed entirely of Treasury bills, this single mother could have generated at least $93,000 more in retirement income (in after-tax 1997 dollars) than she would enjoy under Social Security.3



3 Assuming that upon retirement this single woman is able to annuitize the lump sum at retirement that she accumulated at a real interest rate of 2.7 percent over 15 years. The current federal income tax rates (with current rate structure, exemptions, tax bands, and deductions adjusted by inflation as mandated in current legislation) are applied against this annuity income.

http://www.heritage.org/research/reports/1998/01/social-securitys-rate-of-return

My internet is slow right now so I can't look at the Heritage piece right now. I have seen it in the past, and anything I say would be from memory.

I would be careful about mixing the views of Social Security's returns and those of a savings account. One is insurance for old age and the other is an investment. The former is an expense and the latter accumulates wealth. Social Security was never intended to be a primary line of support. It is a stream of income that allows older Americans to plan retirement better.

The real question for Social Security is if I put all of the contributions in an investment account how much insurance could I buy on the day on which I retire.

 

[Joe Economist]

its a good deal if you lack the willpower to set aside a percentage of each pay for retirement.

its a bad deal to pay for current retirees out of current contributions. that guarantees that at some point soon there won't be enough workers and contributions to pay benefits to those who've earned them.

There are a number of points here. SS was a very good deal for people who retired before 2010. They paid less than a dollar for the expected dollar. One of the things that limits the value of these reports for the larger population is the fact that they assume no periods of unemployment. So past contributions of these retirees are overstated.

Our problem is not workers to retirees. If it were, why did Social Security reach insolvency in 1983? That number of workers to retirees was much higher. The problem is that most of the retirees who collected benefits did not pay the full cost of them.

This is not 'earned'. Social Security in total has generated about 15 trillion (In ALL forms of revenue). Today the system has a projected 23 trillion dollar shortfall. Basically for every $1 that is collected, the system has promised $1.50. That is why many people thought that SS was the greatest accomplishment of government.

 

[Joe Economist]

Ponzi schemes are never a good deal.

I should have linked in some of the articles that try to present it as such.

 

[Joe Economist]

Is it a good deal compared to what? Compared to long term stock investment, no its not usually a good deal. Compared to having no retirement at all, it's a pretty good deal.

Whether it is or isn't a good deal has never been a primary concern of mine. It's not a constitutional deal.

As I said in the article, people will vary on what it should be compared to. Today it is compared to a long-term stock investment that has a poor return. I think we can agree that is the wrong benchmark.

Here is what your primary concern should be. There is a rising level of dependence upon the system and a falling level of benefit capacity. Those will collide at some point, and grannies will get thrown under the bus. A crisis in SS will work something like a Tsunami that targets people who can't swim.