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Social Security's rate of return is tough to beat

Is Social Security a good deal? Many Americans worry that they will put more money into the system via payroll taxes during their working years than they will ever get back in benefits - and their concerns help fuel the ongoing push by Republicans to transform Social Security into a privatized system of personal accounts.

Mitt Romney has supported privatization in the past (see his book, "No Apology"), and running mate Paul Ryan argued for it as recently as last week's vice presidential debate: "Let younger Americans have a voluntary choice of making their money work faster for them within the Social Security system."

Could workers make their money grow more quickly with personal accounts? The actuaries at the Social Security Administration (SSA) ran an analysis recently that simulated real (after inflation) annual rates of return on payroll tax contributions for beneficiaries who were born between 1920 and 2004.

It showed that some workers might beat Social Security's returns in some years if they took risks in the stock market. But over a lifetime, Social Security's consistent, risk-free and inflation-adjusted returns would be very tough to beat.

I say "simulated" because the amount of your Social Security benefit is not based on tax contributions, but on your lifetime wage history and longevity. Moreover, Social Security is not an investment vehicle dependent solely on market returns - it is more like a form of insurance, annuity or pension, since its promise is to pay a monthly benefit amount no matter how long you live. In that sense, there is a peace-of-mind value that is difficult to quantify.

"Since you're guaranteed an inflation-adjusted income stream for life, you can think about your other sources of income and assets knowing that you'll always have Social Security," said Melissa Favreault, a senior fellow at the Urban Institute.

The simulations 
The SSA ran simulations analyzing workers with low, medium and high wages, and broke out results by four different life situations: single men, single women, a one-earner couple, and a two-earner couple. Then they adjusted the results for other key factors, such as mortality rates and disability. In addition, mindful that reforms will be coming at some point, they ran variations from the current outlook showing the impact of lifting the ceiling on taxable wages, and another scenario showing scaled-back benefits.

Overall, they found that the current Social Security program is a good deal. However, your mileage will vary by lifetime earning history, longevity and your year of birth. The payroll tax rate for Social Security's retirement and disability programs reached its current peak level - aside from the current payroll tax holiday - in 1990 (6.2 percent each for workers and employers).

Since we do not know what will happen on the policy front, I focused on the SSA's numbers assuming no change in current law. They found that every age group received a positive return. Among current workers and retirees, the rates of annual return varied by about two percentage points - from a high of 6.52 percent (for single-earning couples born in 1920) to 4.52 percent (for their counterparts born in 1985). So if you wonder whether you will "come out ahead" on Social Security, here are some key differentiating factors to keep in mind:

  • Younger workers will get less. Today's young people will see lower rates of return, because they will have paid the highest payroll tax rates of all the age groups compared in the SSA analysis.
  • Couples do better. Marital status is a key factor affecting Social Security returns. In every age group, the best returns went to married couples where one spouse works. That is because Social Security's design includes valuable spousal features that pay benefits to nonworking spouses and surviving widows. Spouses are entitled to receive the greater of his/her own benefit or half of their spouse's benefit. And surviving widows can step up to 100 percent of a deceased spouse's benefit. A single-earning couple with medium wages, born in 1943, will see a 4.59 rate of annual return, while a single female born the same year - also with medium wages - can expect a 2.49 percent return. (Spousal benefits are also available in cases where a lower-earning spouse had some earnings but so much less that their worker benefit is less than half.)
  • Longevity matters. All pension and annuity systems are structured around mortality credits - that is, they use assets of those who die young to fund the benefits of those who live to a very advanced age. A projection by Favreault of Social Security data found that 82 percent of individuals who live to age 85 get back more in benefits than then pay in taxes; about 52 percent of those who die between 75 and 84 come out ahead. Meanwhile, just 21 percent of those who die between 62 and 69 get back more than they put in to the system. The odds here are especially good for women, since they have a higher likelihood of surviving to retirement age and longer lives after retirement. That gives them higher rates of Social Security return - a medium-earning single female born in 1943 can expect a 2.49 rate of return compared with 2.09 percent for her male counterpart.
  • Lower-income workers come out ahead. Low-income workers enjoy higher rates of return by design, because Social Security's benefit formula is weighted toward lower-earning beneficiaries and their payroll tax contributions will be relatively lower. A very low-income couple born in 1943 will receive a 6.79 percent annual return, compared with 3.92 percent for their high-earning counterparts.

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