Social Security – What You Need To Know
What it is, and what it is not
Social Security is on the front burner of the political range and will be for at least the next four years. Social Security has been described in many ways, including, “The political third rail - touch it and your political career is over.” But whatever it is, there are some very important things we citizens need to understand about Social Security.
Social Security is a well-intentioned, humanitarian concept for providing financial security for those who have retired from the work force. Here are some words that are commonly used in discussions about Social Security and a straightforward discussion about what those words mean when associated with Social Security, and what they mean when used in other contexts.
Trust Fund
A trust fund is a bank account or investment of some sort that is created by one or more individuals or organizations, for example the parents of a child, from which the beneficiary (in our example, the child) can withdraw at some time in the future. Typically the creator of a trust fund puts money into the fund, either in a single lump sum or periodically over time. The trust fund grows from the interest or dividends and price appreciation from the investments, and from the periodic contributions of the fund’s creator. The beneficiary withdraws money from the fund and receives the amounts that have been put in plus the money earned on the investment. The beneficiary receives exactly what has been put in plus the earnings, no more and no less.
Social Security has a trust fund, of sorts. The Social Security Trust Fund consists of the excess in Social Security taxes paid by those currently working over the amounts being paid out to current recipients of Social Security. These excess funds are invested in relatively low yield Government securities. In other words, the Federal Government has borrowed those funds from your Social Security contribution. When the Social Security Trust Fund begins to be used to pay benefits the government will have to use other tax revenue – not Social Security taxes - to repay its loan from Social Security, tax money that is now being spent elsewhere.
The Social Security Trust Fund is not the same as a trust fund established by parents for a child. The Social Security Trust Fund exists at this point in time only because the receipts of Social Security taxes from those who are working have been greater than the Social Security benefits paid out to retirees. For the time being this is a stable arrangement because there are more people working than there are retirees.
When Social Security was introduced in 1935 the average life expectancy after retirement at age 65 was about 13 years on average for men and women (1). In other words, Social Security benefits were expected to be paid for 13 years. Today the average life expectancy after age 65 is about 17.5 years . This means that Social Security benefits must be paid for 1.3 times as long as was planned in 1940.
Today there are about 3.4 people working for every retiree.
As recently as 1950 there were 16 people working for every retiree.
At the current levels of Social Security taxes and benefits it takes 2.9 workers to support every Social Security recipient. It is clear that this trend will lead to disaster for the Social Security System.
If left unchanged the Social Security System will become unsustainable. And when that happens, either the people working will have to pay a larger and larger amount in Social Security (or some other) tax or Social Security benefits will have to be reduced. There is no way around this inevitability.
Investment
An investment is something that you own, in the same way you own your house or your car or a piece of jewelry. When you own an investment you have a legal right to that investment, which is subject to no one’s whim or control.
Social Security is not an ‘investment.’ You have no legal claim on the amounts you and your employer pay in Social Security taxes. What you have when you retire is an entitlement (a bureaucratic word meant to allay our fears that we won’t receive our Social Security benefits), at the sole discretion of Congress, to Social Security benefits, which are paid to retirees from the taxes currently being collected from those who are working. There is no pre-defined or legal relationship between what you pay in over the course of your working life, and what you receive when you begin collecting Social Security. Social Security benefits are established by Congress. They can be changed by Congress, and they can just as easily be reduced as they can be increased.
An investment, for example in real estate, in a savings account, in an IRA or 401(k) plan, in stocks and bonds, in the home where you live, is a financial arrangement where you expect to earn a positive rate of return on your investment. The return on a real estate investment is typically the increase in the price of the property (appreciation) at the time you sell it over the price you paid when you bought it. The return on savings accounts, IRAs, 401(k)s, stocks and bonds, etc., is the interest or dividend paid to you by the entity that uses the money you give them, plus the appreciation in the price when you sell.
The rate of return on an investment is a measure of the over all value of the investment, and takes into account the interest or dividends you receive while you own it plus the appreciation in price when you sell it. The higher the rate of return on the investment the better. But there is always risk associated with an investment. For example, the market price of your home might go down instead of up. A company in which you buy stock might reduce its dividend or run into some difficulty that causes its stock price to go down instead of up. The rate of return on an investment is always in proportion to the risk associated with that investment. That is why U.S. Government Bonds have a low interest rate relative to bonds offered by private companies. The financial marketplace judges the risk to be low that the Government will not live up to its obligations for its bonds, and the rate of return is correspondingly low as well.
As an investment, for most people Social Security produces a negative rate of return. This means that, on average, the amount you receive in Social Security benefits is less than the amount you and your employer contribute.
In fact, as an investment, Social Security results in a long term loss of over $1,000 per year. In other words, Social Security is costing you money.
In fact, if the amount you contribute to Social Security plus the amount contributed by your employer were invested in the stock market at historically achieved returns over the course of your working life, you could retire at full pre-retirement income for as long as you live, and still leave an estate of well over $1,000,000 to your heirs.
The Bottom Line
Social Security will become insolvent (in other words, the tax revenue collected from those working will be less than the benefits paid to retirees) at some predictable point in the not distant future.
It is not possible to predict what upheavals this will cause in our society. It is certain they will be severe. It is certain the cost to the economy will be huge. Unless something is done now to correct this problem Social Security will eventually be bankrupt. Depending on how old you are now, you may or may not receive the Social Security retirement income you have been expecting. But your grand children definitely will not. Nor will the grand children of hundreds of millions of others. It is immoral and unethical to continue on a path where the known, predictable outcome is so disastrous for so many.
There are many plans and ideas that have been put on the table to prevent the impending Social Security train wreck. The one that makes the most sense is to make Social Security a true investment. That is, rather than transferring money from those who are working to those who are retired, individual and employer Social Security contributions should be invested in private, individual, widely diversified accounts, completely and unalterably unavailable to the employee until retirement age, and only then at some specified, reasonable rate. Such accounts would belong to the individual, and would follow the individual from employer to employer. Historically, the stock market, for example, has experienced a net positive yield (dividends plus price appreciation) of around 10% per year on average. Other investment options do as well, some better, some worse. But a 10% growth rate over 40 or 45 years is more than sufficient to provide an extremely comfortable retirement for anyone.
There are those who say, “But what if the market goes down?” First, over any 20 year period there has never been a time in which the stock markets have not experienced growth. Second, with adequate diversification among stocks, bonds, real estate, and other readily available investment options, the prospect of a sufficiently severe down turn in the economy that would wipe out an individual’s retirement nest egg is nil.
The other major question that must be addressed is, “What is to be done for those who are nearing retirement and don’t have time to build up sufficient savings. You can’t all of a sudden tell them they won’t be getting any Social Security.” This is a tougher nut to crack. And it must be dealt with in a fair and equitable manner. One solution might be to phase in the ‘privatization’ of Social Security until it can become totally private. In other words, people in their twenties who are just starting their working lives would put perhaps half of their and their employer’s Social Security contributions into a private account. The other half would be transferred to current retirees, just as happens now. Those in their thirties would ‘privatize’ one-third of their Social Security contribution. Those in their forties, one-fourth, and so on.
Another possibility is to let each person choose whether they want a private Social Security Plan and forego the right to Social Security retirement benefits, or continue the traditional Social Security Tax and benefit system.
It will probably still be necessary to find a supplementary source of funding for those who retire during this transition period. On obvious source is the existing Social Security Trust Fund. Why not use the trust fund now to get the Social Security program on a sound financial footing?
The critics of privatization say that it would be too costly. It is true that it will be costly. But it will be far more costly, and costly in ways that cannot be foreseen if the impending Social Security insolvency is not addressed. It is immoral, unethical and cruel to our children and our children’s children to ignore this problem, not to mention bad fiscal and social policy.
What will future generations say about us when the Social Security benefits they were expecting are not available, and they realize that we knew it was going to happen and did nothing?
- Social Security Administration Website.
William E. Crisick is a businessman, inventor, engineer and entrepreneur residing in Walnut Creek, California. He hold the degrees of Master of Science in Industrial Administration from the Krannert School of Management at Purdue University, and Bachelor of Science in Mechanical Engineering from Purdue University. He is a Registered Professional Engineer in California.