Are your Social Security taxes a good investment?

(MoneyWatch) Will you get your money's worth from paying your Social Security taxes? If I received a dollar every time I heard a "no" answer to this question, I could retire right now! Unfortunately, many of these "no" answers are based on opinion, not facts and figures.

One authoritative answer comes from the actuaries at Social Security, who recently released a report in which they estimated the real rates of return that various hypothetical workers might receive from the contributions they and their employers pay into Social Security. This comprehensive analysis suggests that the answer to the question is "yes" for the vast majority of workers. Let's take a look.

First, the report is quick to point out that unlike your contributions to a 401(k) plan, the taxes you and your employer pay into Social Security aren't invested and accumulated in an account in your name to be paid to you during your retirement. Instead, the taxes you pay entitle you and your beneficiaries to monthly income amounts that are paid upon your retirement, disability, and/or death. The amount of the benefits you and your beneficiaries receive are defined by Social Security's benefit formulas and provisions, not by the accumulated taxes paid by you and your employer.

Nevertheless, it's possible to estimate the real rate of return, after inflation, for your contributions so you can see that if this rate of return were credited to the taxes paid by a worker and his or her employer over the course of a working career, the accumulated amount would pay for the estimated benefits that would be received over the expected lifetime of the worker and his or her beneficiaries. And that describes the calculations prepared by the actuaries at Social Security in their report for a very large number of hypothetical workers and scenarios in a thorough attempt to cover all the bases.

The actuaries looked at hypothetical workers who had very low, low, medium, high, and maximum covered wages, for years of birth ranging from 1920 to 2004. Within each wage and birth group, they looked at single men, single women, a one-earner couple, and a two-earner couple. They included additional hypothetical couples by assuming various combinations of spouses who had very low, low, medium, and high wages for a total of 297 hypothetical situations in all.

In order to reflect that it's inevitable that some adjustments to either benefits or taxes would be made to Social Security due to projected shortfalls in the program's funding, for each of these 297 hypothetical workers and couples, the actuaries looked at three benefit and tax scenarios:

In order to consider all the combinations of 297 hypothetical workers under the three benefit and tax scenarios, the Social Security actuaries prepared 891 "money's worth" calculations. Whew!

Now for a summary of some key results. First, in none of the 891 calculations did the hypothetical worker receive an estimated real rate of return that was negative. In other words, all hypothetical workers in all scenarios were estimated to receive a rate of return that at least equaled the projected rates of inflation. The estimated real rates of return ranged from an annual rate of 0.04 percent to 9.19 percent per year. It's instructive to look at the circumstances of the highest and lowest estimated rates of return.

The highest estimated rate of return under the current law was for a very low wage, single-earner couple, both born in 1920. This result reflects that the current generation of elderly retirees are receiving higher benefits relative to the taxes they paid compared to the current generation of workers. This result also reflects some social goals that are built into the program:

The lowest estimated rate of return under the current law was for a maximum wage-earner, single male, born in 1964. This result reflects the fact that men don't live as long as women as well as the front-loading feature described above, working in reverse.

Now let's take a look at the results for a group that represents a large number of current workers. For medium wage earners who are currently age 63 or younger, under the current law, the estimated real rates of return ranged from 2.13 percent to 4.66 percent per year. For the scenario that increased taxes to close the funding deficit, the real rates of return ranged from 1.92 percent to 6.52 percent per year. For the scenario that decreased benefits to close the funding deficit, the real rates of return ranged from 1.63 percent to 4.52 percent per year.

Looking at all the various combinations, large numbers of hypothetical workers received estimated real rates of returns of 2, 3 or 4 percent per year. This suggests that for the vast majority of workers, Social Security taxes are a good investment when you consider that you don't need to assume any investment risk in order to receive the benefits. A real, risk-free rate of return in these ranges is pretty darned good.

One explanation for these results is that the analyses prepared by the Social Security actuaries reflected survivor and disability benefits in addition to retirement benefits; these ancillary benefits are often overlooked in other "money's worth" calculations.

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Of course, it's possible to find scenarios not included in these analyses where the worker receives a poor rate of return. For example, single people who die while working and before retirement will receive nothing in return for the taxes they paid.

And you could make other assumptions on a variety of factors that could produce different results. For this money's worth analysis, the Social Security actuaries used the intermediate set of actuarial assumptions that are used to prepare their annual report on Social Security's financial status to Social Security's Board of Trustees. These assumptions are their best estimate of future experience on a variety of factors such as economic growth and demographic trends. For the annual Trustees Report, they also prepare forecasts using low cost and high cost assumptions; use of these assumptions for the money's worth analyses would have produced either more optimistic or less optimistic results compared to the best estimates.

Nevertheless, this comprehensive analysis should help dispel cynicism regarding the value of the Social Security program. It's a very important part of the retirement security of the majority of Americans and it deserves our continued support.

[Spaldam]

A "risk-free" investment will never allow you to retire with real dignity. The average 2-3% return noted in this article (over inflation) may be better then bonds and money market accounts, but it's still very poor compared to most other moderate-risk investment vehicles that usually give a minimum of 4-5% (over inflation) and as much as 10-13% long term.

I also think the analysis failed to take into account the fact that real investments have real value to them that can be inherited if you end up not needing them. Social Security won't pay you or your kids a dime if you die before eligibility with nobody being dependent on you (thus a 100% negative return). Those same funds, even if in a "risk-free" savings vehicle, could still provide a substantial amount of money to your heirs.

[stevevernon]

Hi to all our readers - thanks for your comments, which express a range of opinions. I think it's good public policy to provide some minimum protection to citizens that you can't screw up or be defrauded from, and Social Security does that job well. Before SS was enacted in the 1930's, poverty among the elderly was a real problem. But most people will be better off to supplement SS with their own savings, which I encourage people to do if they are able.

One comment for InvestorCoach -- the returns described in the article are real returns, in excess of inflation. So the returns quoted of 2, 3, or 4 percent are on top of inflation, therefore are beating inflation.

Best regards, Steve

[warner0683]

My main objections to this analysis is the assumption that the benefits and taxes don't change by law. For those now retiring probably not a bad assumption for for the 35 year old not a good assumption. Also, the article said it took in all of the benefits for SS including disability. Well that is a separately booked debt. The analysis should not have been included it as that money is set aside separately. As a recent report has come out saying the disability fund will be dry soon. So the law is going to have to change.

I wish people in discussing this problem would put the problem historically would put the problem on FDR for setting it up wrong. He didn't make SS to be inter-generational independent. If he had we would not have a looming crisis. For a modest increase in taxes when we had 15 workers to one drawer by 1960 the extra tax most likely could have been eliminated and we would not have this looming SS crisis.

Also, the report you site does leave out cases that has is a zero or less than zero return. A histogram of different cases and their percentage would have increased the information in the article. No need to exclude any cases as long as the percentage is stated. Besides this report doesn't jive with the recent one that stated the average income worker entering the workforce today will not get back what he or she will pay into the SS system.

[marychgo]

You can find individuals for whom Social Security is either a total loss or a ridiculously generous payback but, for most American workers, it's unquestionably the best bang for the buck.

A dear friend died of prostate cancer just short of 61; he of course drew no retirement benefits and a $255 death benefit, but he had the peace of mind of knowing, throughout his working life, that he had a modest disability benefit, and that SS would pay retirement benefits for both him and his wife. (She died three months after he did.)

People who work minimum-wage jobs for 40 or 50 years and live to 85 or 90 will no doubt get back more than they paid in, but their monthly retirement benefits will be far short of generous.

In the middle is everyone else: people who earn more than minimum wage but less than the Covered Compensation limit; people who live long enough to retire but for only four or eight or twelve years after they start receive SS benefit, not 20 or 30 years.

Compared to the stock market -- yes, for the vast majority of American workers, Social Security is the essential rock supporting their retirements. Any politician who wants to mess with SSA will reap the whirlwind!

[shenboe]

Yes it may be good for many low to medium earner people because it is a Ponzi scheme on a much larger scale than Bernie Madoff. It has been taking dollars from future retirees to pay off current retirees. It is not sustainable and our children will not have the benefits of current retirees despite the younger people having paid higher rates over most of their working lives. I for one never made more than the SS tax ceiling but invested 10 percent of my salary (less than the combined 15% SS tax for Worker and employer) over my working career. I have about $2 million in investments but will never see any payout close to that. Politicians are going to have to deal with the unsustainable SS mess that they created.

[InvestorCoach]

marychgo is way off base. Had her dear friend just invested the money in the S&P 500 he would have had an annualized return of over 9% for the 40 he worked AND more importantly, his heirs would have received the savings at a stepped up basis. For Vernon to say that a return of 2,3 or 4% is a good safe return is foolish. Those returns do not keep up with inflation. People lose money in the market because they follow the advice of the bullies on Wall Street.

[johnlockesghost]

"Social Security taxes are a good investment when you consider that you don't need to assume any investment risk in order to receive the benefits."--Actually, Social Security is not risk free. Its greatest danger is government.

[RetiredArmy_Nurse]

Right on that one, but remember it is REPUBLICAN government that we must fear. The Democratic Party is near united in its desire to protect and preserve SS & Medicare.

[tsigili]

Those retiring now and in the near future, will have paid more into the system, than they will take out. That has already been reported by reliable financial analysts.

[RetiredArmy_Nurse]

No, you have not been given correct facts. Any financial analyst who makes such a statement is not reliable. My contribution into the system will be paid back in just 3-4 years. Add in my employer contribution and you are looking at a 7 year payback.

[warner0683]

To retiredarmy_nurse.
Yes in total dollars you are right in total dollars but you need to adjust what you paid in to at least an interest rate by an universal life insurance policy. Tsigili is only partially right. Data from another report said a new high income person in earlier 90s would not get back what they paid. While this year new working person making average wage will not get what they put in. Of course this is assuming the person just get a return equal to inflation.

[ludvig1-2009]

For my wife it's a good investment. She'll get her contribution back in about 2 1/2 years. For me not so since I have only 20 quarters in and need 40 to collect. Since I'm under the Civil Service Retirement System if I were to get the needed 20 quarters in to qualify I'd get my Social Security benefit cut by around 67%. Since this is the case, I have no intention of contributing any more to the system, so I'll just make a 20 quarter contribution and get nothing in return.

[RetiredArmy_Nurse]

I have met a few people with this problem. I'm not sure what age you plan to retire, but here are some suggestions. You only have to earn $50 per quarter to get a quarter. If you are able, you might find a part-time job for a few hours a week that pays w-2 wages. You could find a family member (this includes your wife) to employ you for something that would earn enough to meet quarterly requirements. You'd have paperwork hassles of making a w-2 at year end and making quarterly SS tax payments. I actually employed my son at age 9, made the w-2 at year end, to qualify him for IRA contributions. At age 16 he got a drug store job, so I no longer had to do that, but it did allow IRA contributions from age 9 thru age 15 thanks to my home employment of him.

[RetiredArmy_Nurse]

Social Security is the best & surest retirement annuity for all of us in working America. I recommend all going to "My Social Security" online to calculate your monthly benefit. Over my working career of 40+ years I and my employers combined paid a bit under $200,000 SS taxes into my account. My max payment would be ~ $2,800 per month. Assuming I live into my 90s (a good possibility with good health), my total lifetime payout is ~ $1 million. A non-working spouse would get $500,000 collecting over same amount of time. We need to challenge this republican scam that SS is bankrupt and won't be there. It has enough money to pay out at current rates for 27 years. As with any pay as you go system, it needs adjustments every 25-50 years. Don't believe the republican propaganda about it. SS could be extended decades by simply making the rich pay a fairer share by raising the cap to $200,000 earned income. How many rich people would miss that 6.2% tax on the next $100,000? For them, it's but a drop in a very big bucket.

[askagain]

It is very much in vogue to take other people's money. Here is another suggestion. Have people who will get the most value from Social Security pay in more. Now that sounds fair.

[Banqueno]

you are assuming that the system will be there when you retire but what about when you try to collect on something you don't have.

[Counselor12]

Also, where else do you get a lifetime disability payment policy with an investment? The biggest private insurance companies can go bankrupt and their insurance be saved only by government (AIG.) 401k's alone are a disaster for many workers. They aren't well paid enough to contribute to sufficient retirement. Workers don't always make optimum investment decisions, have to withdraw money from them for emergencies, layoff income supplements, etc.

[fitstshu]

You are correct about the disabiliy payment.I worked in a very physical demanding job until 61yrs.old. I was 20 to 30 yrs. older than fellow workers.I worked until I absolutely could not any longer.I had surgery and couldn't come back.The company's disability insurance Co. required me to file for SSD in which I got.After a year private insurance wants nothing to do with you.They are more than happy to have SSD take care of it=$$$$ in their pockets. At any rate SSD was there in the end not the ins. co.Between SSD and my union pension I'm doing well both were good good investments.

[warner0683]

What... I have my own lifetime disability policy. Would pay me over $4000 per month if I was disabled for life. Now this article purposely doesn't separate out the insurance which is one tax 1.65% from the SS tax. They are booked kept separately. I think the disability tax is a great thing as it does insure the person and their family has income if they become disabled. Very good for the low income people. Higher income people should get their own disability insurance. The cost is rather modest.