Monday, September 13, 2010

Social Security Part 1 - Work Less, Get More!

Let's say you are a very hard worker and you manage to earn $106,800 this year (which happens to be the limit for Social Security) you pay 6.2% of your income in Social Security tax ($6,621.60).  On the other hand, someone else works part time (leaving them with plenty of free, enjoyable time) and only earns $9,132 for the year.  They also pay Social Security tax of 6.2% on their income which is $566.18.  Let's assume that both individuals work at the same amount, adjusted for inflation, during the 35 years of their working lives.  Did you know that when it comes time for retirement, the lesser-working person will receive Social Security payments of around $8,218.8/year - about 14.5 times the amount they paid each year in tax - and the harder-working person will receive payments of about $30,672/year - only about 4.6 times the amount that they paid each year in tax?  To put it another way, the lesser-working person gets more than three times the amount of benefit from each dollar of Social Security taxes they pay than the harder working person does!

This is Part 1 of a 2-part series on Social Security.  In Part 1, we will take a look at how the harder you work, the less you get from Social Security.  In Part 2, we will take a look how your "return" on your Social Security "investment" compares with what you could get in the market.

For the sake of this article, we are going to assume that Social Security taxes will remain the same and Social Security (SS) will also pay benefits at the rate it currently promises.  Of course we know that this is a mathematical impossibility, but bear with me.

The primary reason for the factor of 3+ times disparity of SS benefit between the two workers is that SS gives lesser-working workers far more credit for working when determining its benefit formula.  AS you can see from this website and this website, the main calculation of SS benefits relies on determining your Primary Insurance Amount (PIA).  Here's SS's own website for how the PIA is determined:

For an individual who first becomes eligible for old-age insurance benefits or disability insurance benefits in 2010, or who dies in 2010 before becoming eligible for benefits, his/her PIA will be the sum of:
(a) 90 percent of the first $761 of his/her average indexed monthly earnings [MP: $761/mo = $9,132/year], plus
(b) 32 percent of his/her average indexed monthly earnings over $761 and through $4,586 [MP:$4,586/mo = 55,032/year], plus
(c) 15 percent of his/her average indexed monthly earnings over $4,586.[MP: up to the current SS maximum of $106,800/year]
To put it another way, for the first $9K of work you do a year, they credit you with 90 cents on the dollar, but that drops to 32 cents on the dollar from 9K to 55K and then drops further to 15 cents on the dollar for 55K to 107K.  Oh, they still take the same percentage of taxes from you, all right (6.2%) - they just don't give you the same benefit for the taxes that you pay.  In fact, they give 6 times the credit towards your benefit for dollars taxed below 9K than they do for dollars taxes from 55K-107K

Another way of thinking about it is when we compare the two cases, the lesser working person pays only $566.18/$6,621.60 = 8.5% as much taxes as the harder working person, but gets $8,218.8/$30,672 = 26.8% as much payment.  That is, their benefit per dollar of tax paid is 8.5/26.8=3.15 times greater than the hard working person.

So where does that leave us?
1) I am not in favor of the current Social Security pyramid scheme that is absolutely mathematically unable to pay the benefits that it is currently promising to people.  I think that the lie is shameful - and frankly ridiculous and detracts from governmental credibility.
2) Any old-age pension system should have the funds set aside - out of the irresponsible reach of government - and should offer equal benefits for each dollar contributed/taxed for all citizens.  You want to limit the dollars that you can contribute/be taxed out of?  That's fine with me, but stop discriminating against those that work hard.  Every dollar should earn the same. 
3) In a larger sense, I certainly agree that we don't want destitute people falling down in the streets and I really don't have an objection to an enforced retirement savings program that is fair for all citizens and provides a good return for its participants.  However, fairness is important - America was founded on a principle of equality for all citizens. 

As for good return, in Part 2 we will take a look at the actual performance of the Social Security system as compared to market performance.  That is, assuming that someone invested an amount equal to the Social Security tax every year for 35 years and then bought an inflation-protected annuity with the proceeds, would it be a better or worse deal than what Social Security currently provides?


  1. Oh, the old privatize social security game. I'm fine with this theory as long as a nation we're OK with several million, actually many tens of millions of elderly who "didn't work as hard" living in ultra poverty. That's fine, I suppose, this country's well on its way to being India having a hyper wealthy class and an untouchable class.

  2. Hi EvrenSeven,
    No, I'm not saying we should privatize Social Security. We can keep SS in the government's hands if we wish - privatization is a whole different question. However, the SS funds that are collected by the government should be placed into a separate fund and not immediately spent as "general revenue." The SS trust should be stocked with actual dollars - not IOUs from tax revenue. That's a pathetic shell game and is really going to be painful.

    I don't want people to live in ultra poverty. However, I think that each dollar that is taxed away should provide an equal benefit to the person it is being taxed away from. When did equality become a bad thing? This would lead to each person having the same percentage of income replaced - just like most pensions do right now - and pensions do not cause "hyper poverty."

    With regard to your remarks about India, I don't see how they apply to the issue at hand. I don't see anyone becoming hyper wealthy on SS benefits.

  3. I'm really intrigued by your SS series, and it has me thinking... especially as I'm doing the research on the spousal benefits you mentioned to me earlier....

    Not only is there a huge discrepancy in the benefits for different income levels, there is also a mathematical discrepancy when using/forfeiting the spousal benefit. I think I might take your calculations above and see how much more return is earned when spousal benefits are claimed too.

    And yeah, I'm with you on the IOU being an irresponsible way to handle the money. We all know pyramid schemes don't work, so the government shouldn't be able to run one either.

  4. Hi Madison,
    You are right - the calculation above is the simple case of a single person - without including spousal benefits. Including spousal benefits will make the difference even greater. Here's a page at the SSA website about calculating the spousal benefit.
    The benefit is typicaly 50% of the primary benefit, but can be reduced if the spouse retires before full retirement age.

    Madison may be the Madison from My Dollar Plan at
    My Dollar Plan is an excellent website that I have mentioned before.