OK, I got my annual Social Security statement yesterday, and I was paying a little more attention than usual.
Assuming I retire at 66, which is in three years, I and my employers will have contributed around $270K into this fund, mostly over the previous 35 years (my income during my 20’s was pretty low). It was a rising curve for maybe 25 years, and then pretty flat since 2007.
When I retire, I will receive close to $30K per year in SS payments, according to their statement.
Based on my family history, how well I expect to take care of myself, and improvements in medicine, it is not unreasonable for me to expect to live 25 years after retirement (dying at 91). That’s a total of $750K in SS payments to me over that period, not even counting for cost of living increases (assuming those continue).
Is the power of compound interest for my earlier contributions enough to have this make economic sense? Will I benefit extra for living longer than average?
Or was there never the intention that my contributions would be enough to cover my retirement payments?
I’m not interested in a political argument (since this is GQ), but rather in a discussion of the economics of this system and how it’s supposed to work.
Roddy
Actually, those numbers work out fairly well, if I assume a constant contribution over the 35 years. I just ran a quick dollar time scale:
from years 0 to years 34, payment of $7700/yr.
from years 35 to 60, withdraw $30000/yr.
The interest rate which makes this balance is a bit under 3.5%/yr. Specifically, the pot of money at year 35 would be about $550K. That money would continue to draw interest on the reduced amounts over the 25 years you withdrew from it. Of course, if your pay ins are skewed more heavily to the end of the 35 year interval, and the payouts increase over the 25 year payout period, this would require a higher rate.
Don’t forget that whatever’s in the system keeps earning interest while you’re collecting. Don’t have a calculator, but I can believe that $270,000 invested over 35 years could net you close to one million with a slow withdrawl rate over another 30 years.
Your payments are supposed to cover the retirements of the generation before yours (which is what they’re now doing), plus an extra payment into the General Fund. Your retirement will be covered by the generation after yours, with some contribution from the General Fund. “Interest” doesn’t really enter into it (except for the bit that was loaned to the general fund). The solvency of the program is determined by the ratio of workers to retires.
Plus of course, while you might have good genes and take good care of yourself and live to a ripe old age, plenty of other people won’t. It doesn’t matter if your particular pension pot is economically viable, as long as the average of all the pensions in the fund is.
You do of course benefit from all the other contributors who on average put in about the same amount and yet keeled over with a heart attack before 70. You share their largesse with the others whosurvice to 91 and with teh freeloader who insist on outliving you past 91.
Odds are their are a lot more who kick off at 70 than who live past 91 - and I bet there will continue to be.
Other than that, as others point out, the numbers are not horribly far off. The SS fund may have foregone higher returns over the decades in order to help the feds and other governments get lower interest on their bonds, but that’s GD and the feds promising to make up the difference as time goes on.
Just to add to the comments on the numbers, I prepared a spreadsheet to try out a few scenarios. Obviously 35 years ago the contributions were much smaller, but will have had longer to grow. I looked at a 60 year period (35 contributing, 25 collecting) with the following parameters:
1st year contribution: $2,989 (calculated via goal-seek)
Growth in contribution: 5% per annum (I know the OP’s situation was not linear, but I am just working on a general scenario here).
This gives $270,000 contribution over 35 years.
Growth of fund: 4% per annum. This results in the $270,000 having grown to $469,000.
Initial withdrawal: $30,000
Inflation: 3% (i.e. the withdrawal amount increases by 3% each year).
Based on this, the original contributions (plus growth) will fund payments for a little over 17 years. So any retiree who lives to at least 83 “wins”, and those that die earlier “lose”, in more ways than one.
Obviously I made a lot of assumptions, but it all seems to fit.
Thanks, this is the sort of calculation I was wondering about.
[QUOTE=Simplicio]
Your payments are supposed to cover the retirements of the generation before yours (which is what they’re now doing), plus an extra payment into the General Fund. Your retirement will be covered by the generation after yours, with some contribution from the General Fund. “Interest” doesn’t really enter into it (except for the bit that was loaned to the general fund). The solvency of the program is determined by the ratio of workers to retires.
[/QUOTE]
I would like to follow up on this line of thinking. I know this is a sort of common wisdom about Social Security, along with all the laments about how my generation is going to bleed the system dry when we retire, but I would like to know if you have a cite for your assertion that this is the way it was intended to work. Or is that just the way it worked out?
Also, are you saying that none of the money contributed “in my name” was ever drawing any interest, i.e. that it was immediately paid out to retirees at the time?
[QUOTE=Eonwe]
Don’t forget that whatever’s in the system keeps earning interest while you’re collecting. Don’t have a calculator, but I can believe that $270,000 invested over 35 years could net you close to one million with a slow withdrawl rate over another 30 years.
[/QUOTE]
If this is true, it sounds like I might have done better taking these contributions and investing them myself, assuming I could have gotten my employer to kick in the same amount without the force of law. They contributed some matching funds to my 401(k), and also there is a pension fund. Is it greedy to expect more?
Employer contributions to Social Security, a whole 'nother thread, probably.
Roddy
Right. Although Social Security is often considered to be one part of an individual’s retirement plans, it really isn’t useful to think of Social Security as being run like a retirement plan (like a 401k or whatnot). People don’t have individual accounts in Social Security, for one thing.
It may be more helpful for the OP to think of Social Security as an insurance plan. People pay in, some may collect a lot, others may collect nothing. Just like you pay car insurance and you are not guaranteed a return, but if you happen to crash a couple of cars, you may get tens of thousands of dollars back that you never paid in. Same with Social Security: everyone pays, some people die before they are eligible to receive benefits, others may receive benefits for a short time, still others may collect for decades. The risk is managed across all Americans paying into the system, rather than calculating what one person paid in and is “due” to get out of it.
That would be true, if the money you paid for Social Security throughout your life actually was “in the system… earning interest” and was not being immediately paid out to other Social Security recipients.
Yes. It was originally called “Old-Age, Survivors, and Disability Insurance.” Like everyone else, I think of it as part of my retirement but it’s not actually a retirement plan, it’s insurance against getting old and/or unable to work. If I fall over today (and if I was unmarried, with no kids, etc.) I would get nothing out of it.
I’m not lamenting. I think the system I described is a good way to fund the system, and that it will remain solvent with some minor tweaking into the forseeable future. But in any case, it is indeed the system that exists. I don’t know if that was “always the intent” (despite your statement, I never “asserted” that) but its the way it works now and has worked since at least the 50’s. The solvency of the system is determined by the people paying into it now vs the number of people collecting now.
Most was paid out immediately. Some portion was put into bonds, which are redeemed at a low interest rate. But that interest is a very small part of the funding of the program, and none of it was collected “in your name”. The interest rate doesn’t affect your pay out. and money in the fund is paid out as needed, its not stored away anywhere for a particular person. And its a temporary measure to deal with the baby-boomers, its not part of the main funding mechanism of the program.
I’m sorry if you thought I was putting words in your mouth. I did not mean to imply that the laments were yours, just the general sense from a lot of people (accurate or not) that the boomer generation will be the death of Social Security. For the rest, I was just trying for further clarification. I apologize for any misunderstanding that was the result of my clumsy wording.
The insurance idea does make sense to me as a model for this. Insurance companies don’t keep my premiums in a little account for me, all the costs and all the revenue are pooled across millions of people, with the premiums determined by statistical analysis of what will profit the company over the long run. They do, however, keep large sums of money invested and earning income, which seems to be a major difference between them and Social Security.
Roddy
Also there’s people who work in the private sector for a little while then end up in a scenario where they’re no longer paying in to Social Security and don’t rack up enough “points” to collect it.
My mom was in that position - worked in retail as a teen and before kids. Then she started working for the public school system in the 90s and never had to pay in to SS (they have a pension thingy). She ended up $5000 in private-sector income short of qualifying for Social Security benefits after retirement.
Anyway, her money went into the pot and stays there, regardless of her ability to draw on it. Congratulations, pot!
The system works on certain assumptions that do require tweaking. An increase in average life expectancy might require smaller payments or an older retirement age. COLA adjustments are linked a bit to cost of living benchmarks.
One factor that cannot be easily tweaked is the number of new workers entering the system( i.e. the birth rate). Smaller families means fewer new workers paying into the pot. This is perhaps a greater concern for the overall solvency of the SS program in the long term.
Lifting the cap on SS taxes or reducing payments by a quarter both cover the future shortfall created by changing demographics. Neither of those is really “easy tweaks”, but if you do half of one and half of another (or some other mix of relatively small changes in taxes/payouts), then you can cover the shortfall without any drastic changes to the program.
The older retirement age is the one that seems to make rational sense. If we’re living longer, we should expect not to start pulling entitlements from the SS pot as soon.
People aren’t going to like it, but gradually ratcheting the “retirement” age up to 72 or thereabouts would make economic sense. I quote “retirement” because it’s really “benefits” age. There’s no law that says you have to actually punch a clock at a job until you’re 72, if you have worked out a way to support yourself without doing so. With the longer time frame, more people might make managing “early retirement” on their private investments more of a priority.
Perhaps I should have said “quickly tweaked” rather than “easily tweaked”.
If there was the political will to do so all sorts of changes could be implemented in a matter of a few days/weeks/months.
However it would take many years for an uptick in birth rate to be reflected in the number of workers contributing to the system. I suppose a widespread loosening of immigration requirements could get more workers into the system.
