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Social Security vs. Private Retirement

A large part of your Social Security taxes goes towards a forced savings plan intended to provide Americans with money for retirement. Economics professor Antony Davies looks at the Social Security system, and discusses alternatives that may provide Americans with more retirement money and more financial security.

To evaluate the merits of Social Security, Professor Davies examines how much average Americans will earn in social security benefits relative to how much they will contribute. As it turns out, social security is a very poor option: the average worker will earn an annual return of only 1.2% percent on his social security taxes.

Imagine, however, if workers weren’t required to pay into social security. If a worker took the money that would have gone to social security taxes and invested it in the stock market himself, he could expect to earn a lot more; upwards of $500,000 dollars more.

According to Davies, phasing out Social Security would enable government to honor its obligations to current retirees, shut down a program that costs half a trillion dollars each year, and allow Americans to transition to a system that would provide more safety and a better return on investment.

Social Security vs. Private Retirement

Your Social Security taxes pay for insurance in case you’re disabled and insurance for your survivors in case you die. The largest part of your Social Security taxes go to a forced savings plan that provides income when you retire. It is reasonable that we ask what sort of return one can expect from this forced savings plan.

To answer this, let’s look at what the average American worker pays into and receives from Social Security. We’ll filter out inflation, so the figures you will see are all in today’s dollars. To be conservative, let’s assume that our average worker doesn’t start working full time until age 22.

Economists generally agree that employers pass on their halves of Social Security tax to workers in the form of lower wages. This means that our worker pays 12.4 percent of his wages in Social Security taxes, but only 63 percent of those taxes go to paying for retirement benefits. So the total amount of Social Security tax the worker can expect to pay toward his retirement is just over $216,000 in today’s dollars.

Our average worker can expect to pay that amount from age 22 to age 66. According to the Social Security Administration, our worker can expect to receive retirement benefits of almost $25,000 per year in today’s dollars, starting at age 67. The average 22-year-old can expect to live to age 78, so he can expect to receive just under $300,000 in retirement benefits.

Now, to evaluate Social Security as a retirement plan, we combine the worker’s expected Social Security tax payments and his expected Social Security retirement benefits. Our average worker pays $216,000 toward retirement, receives almost $300,000 in retirement benefits. That’s the equivalent of an annual real return of 1.2 percent on his Social Security taxes.

In other words, the Social Security taxes that went toward the worker’s retirement earned him an interest rate that is about 1 percent better than inflation. How does this rate compare to other interest rates? Over the past 50 years, stocks in the S&P 500 have generated a return that is 5.1 percent higher than inflation. If our worker were able to invest his Social Security taxes in a private account then invest it in stocks, he could expect to collect over $950,000 in retirement, or more than three times the return that Social Security provides.

The counter argument is that stocks are risky and that the whole point of Social Security is to provide guaranteed retirement benefits. This is in fact false. The only thing that is “guaranteed” is that the Social Security Administration will invest the taxes it collects in government-issued Treasury bills. There is no guarantee that Social Security will give you the money back. At any time, Congress can change the rules and reduce your Social Security benefits.

If a person truly wants safety, one can use a private retirement account to obtain an investment that is safer than Social Security: Treasury bills. By investing privately in Treasury bills, the retiree gets the same safety of government-issued securities that Social Security claims to provide but without the risk of the Congress changing the rules and reducing Social Security benefits.

Historically, one-year Treasury bills have paid an average of 1.7 percent more than inflation. If our worker were able to invest his Social Security taxes in a private account that invested in one-year Treasury bills, he could to expect to collect more than $345,000 in retirement, or about 17 percent more than Social Security provides.

Today, Social Security retirement benefits cost the federal government about half a trillion dollars a year. And under current law the program is projected to be insolvent within 25 years. If the government started a 20 or 30 year phase out of Social Security today, the government could honor its obligations to current retirees, shut down a program that cost half a trillion dollars a year, and allow Americans to transition to private accounts that would yield more safety and better returns than Social Security provides.

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10 Comments

  1. M L Obonyo

    The Kenyan government has rigged rules for our National Social Security Fund, to efectively make it a monopoly, by forcing all persons in formal employment to pay 6% of their income into the Fund, and their employers to pay a matching contribution. (Of course, the employer’s contribution will some way, some how ultimately be borne by the employee, which means that an employee will actually pay 12% of his/ her income to the NSSF.)

    Previously, one had to make a mandatory contribution of Kenya Shillings 200 (about US $1.4) per month to the NSSF, in addition to any voluntary (private, and often honestly and professionally administered and regulated) pension fund. I wonder when political bigwigs and their bureaucrats will ever learn the basics of economics?
  2. Jonathan Taylor

    I think you answered your own question, they are all control freaks. Or, to put it more nicely, all the incentives are toward the government controlling more of our lives. If they give up SS that is one fewer thing that they can use to convince voters that they should keep their jobs.

  3. Anonymous

    How do you become independently wealthy?  Invest 12-15% of your income in a diversified portfolio of large stocks, AA, AAA bonds and preferred stocks, and a small amount in small to medium size stocks.  After about 30-35 years, you will have accumulated enough wealth to live at your current life style for about the rest of your life and give a nice estate to your heirs.

     

    What does the government do to the middle income and lower bracket earners?  They forcibly take over 14% (when you include Medicare) of their income every year and put it into a non-investment.  Since these workers are more or less living pay-check to pay-check, they guarantee at least half the population will be suppress and remain dependent on the government.

     

    And we keep voting these thieves into office – unbelievable.

  4. Anonymous

    >I wonder when political bigwigs and their bureaucrats will ever

    >learn the basics of economics?

     

    They already know – which is how they can manipulate the system so well.

  5. Piano Man

    I fail to see any downside to the solution suggested in this video. Someone please explain to me why this isn’t happening right now.

  6. ndvo

    The problem is that politicians are no angels. They’re people just like everyone else. This means that they take into account their best interests when they need to make a decision.

    If you think like a politician you’ll realize that if they allow people to choose their own retirement plan (or choose no one, in the case of someone who is in need to spend the money now) they will loose the power to command this money.

    The fact is that the money you are not earning is not fully disappearing. Part of it is being seized by politicians and bureaucrats.

    The business of politicians is not to make people’s life better. This is the business of people themselves. The business of the politicians is making their own lives better…

  7. Lukas Koube

    an even better plan would be to get a roth IRA when you are very young and wait until you turn 59….its easy to turn that money into millions with compound interest! (also, a Roth IRA means the interest grows tax free!)

  8. Anonymous

    The overriding problem seems to be that most Americans do not have the discipline and wisdom to save for retirement. Let’s be real, how many 16 year olds working their first job are really going to think about putting money aside for retirement, or have the knowledge of how to invest on their own? Very few I’ve met know how to create an investment account, buy treasury bonds or stocks, or even want to learn in the first place. That isn’t where the average person’s head is. Now, if investment were taught in school, and the government mandated that a certain percentage, that is currently social security and medicare, had to be set aside and either invested towards retirement or saved, we would have a different outcome and I believe a successful private sector plan would work. Until we can train Americans to put asside money from every paycheck and automatically invest it to either the stock market, or to bonds, this plan will not be successful. Many people left to their own devices would not have retirement savings becasue they would use the money for everyday living. Then when they are old, they are a burden to soceity and to the economy because they cannot pay to take care of themselves and are unable to work. And who then has to take care of them, either the government, or the private sector. I think most americans would be rather uncomfertable with the Government managing their life in their own age. It would create an altered version of the debt slave system. So most likely, the burden would fall on the average American Joe who has to not only pay for himself, but his retired, disabled, and ill parents and possibly grandparents. I am not advocating that Social Security is a good program, but I am saying that until the mentality of Americans towards investing for retirement changes, it is a nessecary program. 

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