Social Insecurity

Iím not a fan of big government. Being an honorary Chicagoboy, I think given any task, chances are, the private sector will do it twice as well for half the cost. So obviously, I think Social Security is a joke, and that private accounts are the way to go. Since itís the Christmas lull, I put some ink to paper, which me being a financial analyst, means putting it on Excel. I did a simple spreadsheet to see how a private account for a baby boomer household retiring in 2004 would have fared against the government. This is based on commonly available information, so is not a fine tuned model, but itís enough to make my point.

I took the Census bureauís household income from 1967 to 2003. I assumed 2004 income levels are the same as 2003 for simplicity sake since itís not available yet. I assumed the current 6.2% Social Security tax rate is the same from 1967 to 2004 also for simplicityís sake. The assumption is that the 6.2% tax would go into a government administered private account instead of the general pot. I then took the Dow Jones Industrial Average from July 1, 1967 to July 1, 2004, and calculated the compounded annual returns for the private account. I picked the July 1st mid-year point to correct for year-end fluctuations. I based the returns on the DJIA because itís available. I would have preferred the S&P 500, or a broad market index such as the Wilshire 5000, but they arenít available. The good is that the DJIA represents the best of American industry such as GE, Coke, and Boeing. The bad is that it doesnít truly reflect the technology revolution as say the S&P 500 would. But itís life.

Assume also that after retirement the account shifts to a low risk interest bearing account earning 5% a year on the unused account balance.

According to their website, the current, unfunded, maximum payout for 2005 Social Security payments is $869 a month; which translates to $10,428 per year.

Assume someone had a stroke of genius in 1967, and enacted the Social Security Reform Act of 1967, shifting all contributions to private accounts and invested the accounts in the DJIA.

Assume further that Incognitoís worker bee household began contributions to the account at age 25 in 1967, retiring in 2004 at age 62. If Nitoís household has always been in the mid-tier household income bracket, his final 2004 household income would be $54,453 a year. Under the plan, his monthly payout from the plan would be $1,417 a month, or $17,000 a year. This is 63% more than the current Social Security payout. The huge difference is that the private account is funded for 20 years of retirement, or to age 82.

Say Nitoís household is in the top income bracket for all or most of his life. His final 2004 household income would be $154,120 a month. His household payments for retirement would be $3,583 a month, or $43,000 a year. Again, this would be fully funded for 20 years of retirement.

Second tier 2004 household income would be $86,867 a year. Monthly payments would be $2,167 a month or $26,000 a year.

Say Nito wasnít very successful in life. Fourth tier ending 2004 household income would be $34,000 a year. Social Security payments would be $950 a month, or $11,400 a year. Fifth tier ending 2004 income would be $17,984 a year. Social Security payments would be $504 a month, or $6,050 a year. Again the big difference being that itís fully funded.

So the only time youíll be below the current Social Security maximum is if both husband and wife make minimum wage all their lives.

Change the number of retirement years from 20 to 15 or 10, and youíll be living well.

What-if numbers amount to exactly zero ($0). But it makes you think.

Maybe 37 years from now weíll still be talking about reforming Social Security. Maybe someone will say wow, wouldnít it have been a great idea to put it in private accounts?

Here is my Excel.

More thoughts: Based on the Census Bureau, there are 112 million households in the U.S. If you take the current annual mid bracket Social Security contribution of $3,376 a year as the average, that’s $378 billion a year. Investing private accounts for Social Security in a broad market index would imply putting 98% of the amount back into the economy (index funds charge about 1% for management fees, going by my rule of thumb for government implies a 2% management fee for lazy bureaucrats.) You can argue that putting $370 billion back into the economy would create a tremendous amount of new jobs, which in theory would cascade into more income, more contributions, etc etc. lifting all boats.

Update: Looks like good ol’ Cato Institute was way ahead of me:

For example, assuming historical rates of return, if individuals born in 1970 were allowed to invest in stocks the amount they currently pay in Social Security taxes, those individuals could receive nearly six times the benefits that they are scheduled to receive under Social Security, as much as $11,729 per month. Even a low-wage earner would receive nearly three times the return on Social Security.

Update 2: Thanks to Cole for pointing out the correct historical rates.

I’ve updated the excel and the numbers blow away the current Social Security payments. Even the lowest bracket is comparable to the current unfunded maximum payout:

18 thoughts on “Social Insecurity”

  1. Sign 102 that you’re a dork: you make excels for fun – and they’re educational! You have attained Geek Nirvana.

  2. Three issues: (1) the SS Tax was not always 6.2% so the early year contributions are overstated. (2) But the 6.2% is only half the current tax, the part paid by the employee. The employer kicks in another 6.2% (now, less in 1967). So if you had a 100% plan, you would be investing 12.4%. (3) Of course, you still would need cash to pay off those who had already retired, so some of your 12.4% would have had to go to that.

    A few more facts. Index funds only charge around 0.1% per year, even when run by the bureaucracy (see SS Income is actually around $650 Billion (see

    A nice start, but reality is more complex.

  3. Thanks Cole, good leads. First version was a quick sketch off the top of my head. It’ll be interesting to see how more accurate assumptions affect the model. (guess I don’t get enough of financial modeling at work…)

  4. Now, how does this affect the returns of traditional investors (how much of this comes out of Wall St. and old money types’ pockets)? It seems it would redistribute income and wealth more fairly and circumvent government bureaucracy and corruption.

  5. While I agree that an enforced private savings plan would have been superior to Social Security in the long term, you’re ignoring a few things in your thought experiment. The first and most obvious is that if we had begun such a plan in the 1930’s it would have done nothing for the elderly in need in the the 1930’s. There would have been another plan on top of the enforced savings plan. Would that have shortened or prolonged the Depression?

    The second point is that the money was spent on student loans, highways, and the military (among the thousands of other things the federal government does with our money). It paid for the world we’re living in now.

    The third point is that if we just stopped putting the 6.2% into the general fund and into the enforced savings plan, since Congress has shown absolutely no intention of slowing the increase in spending let alone making a cut which would be required by the reduced level of revenue, either taxes would have to be raised or money borrowed. What effect would this have on the economy now?

  6. Aaron,

    I would think it more likely to have a positive effect on traditional investors than negatively. Two good reasons:

    1. More liquidity = higher growth = bigger pot. It would have similar effects of interest rate or tax cuts. The best argument against liquidity is that it encourages rampant speculation. I would argue that over a 40 year period, speculation tends to be corrected out by the market. At the same time, I think the US capital markets are large enough to handle the extra volume with minimal disruption.

    2. Higher participation = higher transparency. If you compare the stock market pre-internet and post-internet, it is night and day with regards to information available and investor scrutiny. Granted there are multiple factors contributing, but when more people have a stake in something, the participation acts as a form of control.

  7. Dave,

    Tough call as during the Great Depression, the stock market was significantly out of favor, hence the creation of the SSA. I don’t think it would have been feasible to implement this idea during the Great Depression. It was also a younger generation. I think the ratio of workers to retirees was north of 10:1 vs 2:1 or 1:1 projected for the baby boomers. The SSA worked then because there were so many workers to support the relatively fewer number of retirees.

    It may have paid for the world we live in now, but how better our world would be if our economy was 10%, 20%, or 30% bigger? You can equally argue that many of these programs created more reasons for more taxes. Compound the taxes over years, and you get a big number that would have otherwise created growth.

    Goes back to the bigger pot argument. If the economy were bigger, the tax base and revenues collected would be bigger at the same tax rate. I favor less government obviously. I think if we had done something smart with Social Security, and there’s a big pot of money sitting out there, the government would find some way to spend it.

  8. Your figures are interesting, but the comparison is not as stark as you present as the $869 maximum social security payment you cite is for SSI, which is disability not social security. Social Security is SSA. I believe the amount the Social Security Administration will pay me at full retirement age (66.5) is around $24,000 a year.

  9. What about people who were due to retire in the months or year immediately following a crash? Wouldn’t they lose a lot of their nest egg with no time to rebuild it? I know a few recent retirees who lost a bunch of their 401(k)s because of downturns of recent years. Also how would people know how to run their investments – would everybody hire a financial advisor?

  10. Fran,

    Sure, what about people who retire right after Social Security goes bankrupt or slashes benefits? My main contention is better to take money out of the hands of government.

    As to your second question, no, I think broad market index funds such as the S&P 500 or Wilshire 5000 would be ideal. Minimal management fees, and less risk of someone blowing all their savings on If the government is going to forcibly take money away from us for our own good, at least get a decent return on it.

  11. The market performance would not be as good as in the model because of the forced money coming in from forced savings account. Also, as the Baby Boomers begin to retire and change their stocks portfolios to bond and cash portfolios, the markets would experience sell pressures that would again force down stock prices.

    Your scenerio only works for those on the leading edge of the Baby Boomer bubble and it hammers the Generation-X crowd

  12. According to the NYSE, total market cap of all domestic listed securities is $33.6 trillion. Annual Social Security contributions of $650 billion is about 2%.

  13. Let’s say, when I worked in Stafford I made $60K and after three years $70K.

    Lets then say I started slugging to Rosslyn, I started at $75K and now break $100K.

    How much additional direct income tax would one pay. How much indirect tax, such as sales tax, increased property tax as we move up into bigger homes, new cars can one expect to pay.

    I am looking to use this as the basis of a “tax revenue” argument to oppose HOT. I can show that it reduces total commuter throughput. Now I need to tie that to revenue to the Government.

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