Privatizing SS – The Rest of the Story
The View from the Middle
A couple of weeks ago I told you a story about Jane or John Doe who started working in 1970 at age 21 and retired in 2015 making the US median income for his or her entire life. The fact is that this person would earn $1874 per month is Social Security payments from our generous yet corrupt and inept government. So, if Jane or John would die one month later, they would have paid into Social Security for his or her entire life and had $1,874 to show for it.
This whopping $1,874 monthly payment is a product of Jane or John’s SS taxes paid, AND the matching taxes paid by Jane or John’s employer. Today, that total tax paid per year is 12.4% (6.2% contributed by the employee and 6.2% by the employer).
I then calculated what an investment in an S&P 500 index fund would have produced just for the 6.2% employee paid portion over those same years. That monthly investment would have produced a nest egg of $467,989 with a monthly potential income of $3,159. If Jane would die one day after retirement, she would have almost a half a million dollars to give to her heirs vs nothing from our government.
Today, you will hear “The rest of the story”, as Paul Harvey would have said!! If Jane and John were allowed to also invest the employee portion of their SS payments, the numbers double, as you might expect. Jane and John would retire with a nest egg of almost a MILLION DOLLARS ($935,978) and a monthly income of $6.318. Again, this compares to zero nest egg and a monthly income of $1,874 from our government.
The million-dollar nest egg is NOT a projection, but just a calculation of actual results of the S&P 500 from 1970 to 2015. The $6,318 monthly income simply assumes a similar return for that index fund in the future, which is 8.1%.
So here is the bottom line. If the government had just taken Jane’s contribution and her employer’s payment and invested it in a simple index fund, she would have had almost a MILLION DOLLARS and a monthly income of over $6,000. But our government has managed to reduce these results to ZERO lump sum and a paltry monthly income of $1,874. The government steals the rest from each and every one of us.
The reason I decided to release these numbers in two steps is because they are so wildly disparate that they are almost unbelievable if exposed in one. Can there be any more evidence of the inefficiency, incompetence and corruption of our federal government. When will we learn? We need to make our government smaller, not bigger, and give the money and liberty back to the people. Remember the words of Ronald Reagan who said, “The 10 most frightening words in the English language are - I’m from the government and I’m here to help you.”
The numbers tell the story! Love the quote from RR to wrap up the article. I resigned myself to the fact long ago that there will be no SS for me when I retire. I'm not leaving it to the govt!
ReplyDeleteThat is why I wrote Reagan
ReplyDeleteI would have loved to have this option but not sure most Americans could handle the responsibility of saving 12.4% of their disposable income (past 10 years averaged 2-5%) and then actually make wise investment choices. SSA helps to protect them for themselves. As the brokers always say, past market performance is not a reliable indicator of future performance.
ReplyDeleteDead spot on as usual!
ReplyDeleteI am 63 years old and was planning to hold off starting my SS until I am 66. This well written post is giving me pause and justification to reconsider my SS start date. Just may be time NOW to start the recovery of the money I have given to the U.S. GOV in the name of SS over the years!
ReplyDeleteKevin – This is a gross oversimplification of what occurs in the real world. Let’s start with the assumptions you’ve made.
ReplyDelete1) You assume that the S&P 500 will continue to rise in the future at the same rate it has risen between 1970 and 2015. While I also think the market will continue to rise over the long-term, there is no guarantee that it will or that the rate of increase will match the past. Remember: Past performance doesn’t ensure future results.
2) You assume that the gains in the S&P 500 are the same 8.1% each and every year. You know as well as I do that the stock market doesn’t perform like that. There are frequently major swings from year to year. Since 1970 there have been seven corrections – losses of at least 10% - with four of those being more than 15%, topped by a loss of 38% in 2008. There have also been 25 years when the S&P 500 gained at least 10%, topped by a 34% gain in 1995.
3) You assume that John or Jane Doe will invest all of their retirement savings in an S&P 500 index fund from the beginning of their career until they die. No financial adviser worth his certificate would ever recommend such an investment plan. First of all, the portion of a portfolio invested in domestic equities should be in a broader fund that the S&P 500. Second, even at the beginning of their working life at least 10% of the portfolio should be invested in something other than domestic equities, such as bonds and foreign stocks. By the time the worker reaches his/her mid-30s, the portion of the portfolio not invested in domestic equities should be in the range of 20-25%. When they get closer to retirement, say the mid-50s, that number should be in the range of 40-50%, and that number would probably hold during their retirement. Foreign equities are much more volatile than domestic equities, and bonds historically haven’t had the returns that equities do. The bottom line is their savings account would not grow at 8.1% while they were working or in their retirement.
You state that the surviving spouse of a beneficiary who dies at 66 would receive “a big goose egg from the current SS plan.” This is incorrect. If a beneficiary is retirement age when they die, the surviving spouse receives 100% of the deceased’s benefits until he or she dies. It’s called survivor benefits. Here’s the link: https://www.ssa.gov/planners/survivors/onyourown2.html
Now let’s look at your numbers in a more realistic setting, although one that is extreme only to make a point about timing. Here are the assumptions:
1) John or Jane Doe retired ten years earlier at the end of 2005 at age 65 with a savings account balance of $467,989 (your number, but one that is overstated).
2) The S&P 500 will continue to grow at 8.1% from 2017 forward (an assumption that flies in the face of reality).
3) Like most Americans in their income bracket, they haven’t put away any other savings, and the monthly income of $3,159 that you project is what they need to live on. This is an annual income of $37,908 before taxes. After 15% federal tax and 7% state tax, they will have $29,568 to live on in year one. Assuming their mortgage is paid off, this is doable.
4) Because of inflation (assumed at 2%), their monthly withdrawals will have to increase each year just to meet expenses.
To be continued.
The first year of retirement goes well. Their saving account balance increases to $493,728 thanks to a gain of 13.6% in the S&P 500. The next year isn’t so good. The S&P 500 only returns 3.52%, or $17,379, while they are withdrawing $38,666 (inflation adjusted). Year three is when disaster strikes. The S&P 500 loses 38.49% and their saving account drops to $251,159. This sets in motion a doomsday scenario where future gains in the S&P 500 can’t make up for their increasing annual expenses. By March of 2020 they are out of money. You might counter by saying they will die the year before at age 79 (the average life expectancy) or they will adjust their spending habits. I would counter that by saying that someone earning the median income is likely to have gotten good health care throughout their life and is likely to live longer than the median, and cutting back would be problematic when they are already getting by on less than $2,500 a month in year one. Cutting back to $2,750 per month ($2,145 per month after taxes) in year one only extends their saving another three years. Again, you can counter by saying they will probably be dead by then. This scenario assumes that the S&P 500 will grow every year in their retirement at 8.1%. This isn’t going to happen. What if they experience a correction of 10% in 2018? In that scenario they will be out of money the next year.
ReplyDeleteThere are all sorts of variables that can be used with this analysis. What if their accumulated savings at retirement is reduced to a more reasonable number like $400,000 or $375,000? What if there is another large market correction like in 2008 or a string of losses like the ones that took place from 2000-2002 (10.14%, 13.04% and 23.37%)? It’s the timing of these large losses that make all the difference in the world.
Of course the situation looks much better is you include the employer’s contributions, which is a realistic assumption. They can start their withdrawals at $5,000 per month (increasing each year with inflation) and not run out of money until they are 87 years old. If the withdrawals are reduced to $4,000 per month, they are still going to have more than $600,000 in savings when they are 93. However, keep in mind that these scenarios both assume they are starting retirement with $935,978 in savings, that the S&P 500 will grow at 8.1% every year in the future, and that they will have 100% of their savings in the S&P 500. If we start with a more realistic number for the balance in their savings account at retirement, say $800,000 (probably still too high), their money will last until the year they turn 90. If we reduce the rate of earnings to a more realistic 5% during retirement years from 2017 forward, their money still lasts until they turn 88. But what if the S&P 500 has a three-year stretch like it had from 2000-2002 and that bad stretch occurs starting in 2020? If this were to happen, they would run out of money at age 82. Now let’s apply that same scenario to your example where the retirement takes place in 2015. Let’s also assume that their savings at retirement are a more reasonable $800,000, but also assume that the savings will grow at 8.1% throughout retirement except for the three-year drop in the S&P 500 described above. If the three-year drop takes place beginning in 2018, they will be out of money by the time they turn 80.
To be continued.
I know that while you’re reading all of this you’re thinking “They’re still better off than with Social Security.” It’s true that most people can’t live off Social Security only because it was never intended to be the only income in retirement. Its purpose is to keep people from being destitute. If the COLA going forward is only 1% annually, their SS income of $24,488 per year would be $27,290 at age 79. If the COLA is 2%, their income would be $29,091. If the COLA matches the historic 1975-2016 average of 3.7%, their income would grow to $36,064. Even with the COLA, it would be hard to get by on any of these annual incomes, but they aren’t going to be destitute. And unlike their savings account withdrawals, Social Security payments won’t stop while you’re living, aren’t subject to state tax and only a portion is subject to federal tax. Is Social Security going broke? Like you state, the trust fund is going to run out of money under current conditions. That’s not the fault of the system. There is one easy step that could be taken that would help. Eliminate the cap on FICA withholding. How is it fair for someone making $200,000 to contribute only 3.9% of their wages while someone making $127,200 (the current cap) contributes at a rate of 6.2%. Then there is the misconception that Social Security is a huge Ponzi scheme. That’s only true to the extent that current retirees are being paid by current workers. What is causing the current problem is the population bulge in the Baby Boomer generation. As this generation begins to die off over the next 20-30 years and the Millennials make up a greater percentage of the work force, the situation will turn around because the Gen X population is smaller than either the Baby Boomers or Millennials. The Millennials are now the largest generation in the U.S.
ReplyDeleteThere are a multitude of questions surrounding the implementation of a privatized system, chief among them is who will handle all of these savings accounts? As a free-market person, I would expect you to advocate for letting individuals make that choice. Maybe there would be some sort of clearinghouse that would certify companies and individuals, allowing them to handle these monies. The result could be a nightmare for employers who have to do the paperwork directing the withheld money to a myriad of different institutions and individuals, instead of all of it going to the Social Security Administration. There is also the unavoidable consequence of having private companies and individuals administering these savings accounts: Some people are going to lose their retirement savings because of theft and mismanagement. Would you advocate establishment of something like the Pension Benefit Guarantee Corporation, a government entity? Of course, it’s going broke because so many companies have bailed on their pension obligations, and they don’t guarantee that you’ll get 100% of your pension. I would also challenge your statement that the financial industry would be willing to charge a “tiny fee of .25%.” Since this money is likely to be spread between thousands of companies and individuals, there is a very good chance those fees would approximate the current industry average of slightly more than 1.5%, a number that has more than doubled since the advent of the mutual fund industry in spite of economies of scale and advancing technology. Administrative fees in the Social Security Administration have declined since 1957 from 2.2% to the current .7%.
Here’s my bottom line. Privatization of Social Security is a huge gamble with people’s retirement savings. That’s why it’s never been implemented.
P.S. I would be happy to send you my spreadsheet so you can check my numbers and play around with different scenarios.
Bob,
ReplyDeleteFirst, my guys at UBS charge me less than .5% on my measly portfolio and they have done the benchmarking studies that suggests that is fair. I'm not sure where you get the average of 1.5%, but I don't know of anyone who would accept that. I'll stick with my estimate of a .25% fee.
Finally Bob, let me just say that I'll take my million dollars in the example I gave (not a projection but the actual numbers) and I'll manage through the ups and downs of the market and I believe I'll be way better off than letting the government minimize my contributions, but I'll let you take your $1,800 a month. Maybe we should just offer a choice.