How much Social Security will you receive?

Will social security be there for you? It is almost cliche to say "it will be gone by the time I retire".  Yet, almost everyone is relying on it. Are you relying on social-security to be there for you? If you're preparing for the worst, good for you; but, what's the most likely way in which this will unfold?

How are "benefits" calculated?  This a very rough calculation: 

• First, estimate your average annual salary over your lifetime (up to the max. of about $100K, after which payroll taxes are not deducted). 
• You are promised $90 for each $100 of average earning, but only for the first $9000. Then, for the next "slab" you are promised 30%. Finally, for anything over $55K, it is 15%. (Benefits are indexed to CPI. These numbers assume 2010-equivalent dollars.)

Sample calculation: Suppose you just retired, having started working in the late 1960s. Your peak earning years were probably around 1990. Let's say you earned an average of about $ 32,000 per year. Suppose that (adjusting for inflation) it works out to $60,000 per year in 2010 dollars.

Look at the blue line in this graph. For an average of $60,000 after inflation adjustment [x-axis], you are promised a benefit of around $25,000 a year [y-axis]. 

Similarly, someone who earned an average of $100,000 gets just $30,000 in benefits.

(Use the "retirement estimator" at the SSA site, to get a better estimate of your promised benefits.)

So now you know how much you are promised. Next, look at the red line. That is my best guess for what you will actually get. At $60K, you will get $18K a year instead of $25K. And, if you are at $100K, you will get about $21K instead of $30K.

Anybody who is 30 to 50 years old should not expect to receive any more than this. If you are in your 20s, I have no guess for you. Don't bank on much.

(Warning: This is NOT expert advice. Expect real numbers to be quite different. Check everything with your accountant.)

My key assumption is that at some point, when as it becomes increasingly more obvious that Social Security must change, the country will implement some "middle-of-road" plan that uses elements from the various proposals now on the table. I assume it will be close to the "Simpson-Bowles" plan, because that one was bi-partisan. 

Simpson Bowles (Dec 2010): A bi-partisan congressional group proposed changes in social-security, in order to extend its life. The red line in the diagram above shows their proposed benefits. It makes the benefit-schedule more "progressive" (i.e. the richer you are, the less you "get back"). A person with the higher average earnings will "lose" a larger amount. Depending on your level of income, instead of the current promise to pay you 30% - 42% of your average salary, the new promise will be to pay you about 20% - 35%. [Note: These changes are phased in gradually. The promises will be lowered a bit each year.]

Other Simpson-Bowles recommendations: 

• Raise retirement age: under current law, it will rise to 67 year. They propose it keeps rising, linked to life-expectancy. They expect the retirement age to be 68 year in 2050.
•  Raise the maximum salary cap for payroll-tax, from the current $107,000 to the equivalent of about $170,000. This means that people earning above $107,000 in salary will pay a 13% tax when they otherwise would not. Since they only "get back" 5%, this is just a way to tax "the rich" (aka anyone who earns over $110K or so).
• Use a "chained-CPI" cost-of-living formula that increases benefits at a rate that is slightly lower than the standard CPI (Consumer price index). [President Obama actually proposed this if the GOP would give him something he wants in return.]

Paul Ryan's proposal: GOP Congressman Paul Ryan also proposes to raise payroll taxes (without changing the rate) as a side-effect of making employer-provided health-care benefits a part of income for social-security calculations. He will also lower promised benefits for those 55 and below today, particularly higher-earners. He proposes raising the retirement age. In addition, there is a minimum payout for those at the lowest end, somewhat analogous to the minimum wage. 

Free-market proposal: Paul Ryan's proposal also contains something that Republicans might see as a free-market component. It allows retirees under 55 to save one third of their social-security taxes in a savings account. This would be something like an IRA, but Ryan adds a government guarantee that the account will not lose money! The only way the government can make such a guarantee is if it limits the types of investments in such an account. This is definitely not a free-market solution. The government should not be ensuring that people save. Further, the government should not be choosing where we can invest our savings. The danger is that investment vehicles vie for whatever government certification is required. We've seen what a poor job the FDIC has done ensuring the safety of bank deposits. We've also seen how poorly the government-approved credit-rating agencies performed. Given this history, a pseudo free-market system versus a fully and honestly government-run system is a poor  choice of options. 

Rand Paul's proposal: Representative Rand Paul, who positions himself as a libertarian-leaning GOP politician has a proposal too. He would increase the retirement age and means-test the benefits. "Means-testing" is a Republican-approved way of taxing the rich. This tells us that the final law will tax "the rich".

The context of the Federal budget: Entitlements are the really serious threat to the U.S. Federal budget. However, within entitlements -- believe it or not -- Social Security is the easy problem to tackle. Mathematically, Medicare -- with its sky-rocketing costs -- is the bigger problem by far. That'll have to wait for another post.

What will become law? Currently, no concrete plan has substantial support, but the proposals above give us some idea of how things will transpire. Simpson-Bowles was a bi-partisan commission. Paul Ryan and Rand Paul are seen as more pro "free-market" than the average Republican. All three of these proposals have two common themes:

• Cut benefits in some "progressive"/means-tested way
• Raise the retirement age

Also likely:

• High-earners will pay more social-security tax (by raising the cap)
• Slower cost-of-living increases

The ideal: I would like to see Social Security wound up. People can save for themselves, without government "help". Politically, this will not happen in my lifetime. 

Fix social-security today, and forever: If we absolutely must have social security, I propose a simple rule. 

"Every year, the social security administration 
will pay out 

only the amount it takes as payroll tax."

This would solve social security's funding problem overnight and permanently. It is not rocket science to stick to the basic principle of never, ever running a deficit in the social security program.

No more deficits: Such a scheme would be infinitely more honest than what we have today. For example, recently the government has cut payroll tax from 15.3% to 13.3% for two years to "help" get through the recession. Meanwhile, payouts to retirees remained unchanged. Sorry folks, there is no free lunch. Either cut the payouts too, or let the tax be.

Want to pay out more to seniors? I'm not happy about it, but at least do not borrow. Man up...  pay for your desires. Raise the payroll tax if you want to raise the pay-outs.

Want to help the poorer among the retired, particularly when the economy turns down and we started screwing them with minuscule interest rates on the small nest egg they put into CDs? I'm not happy about it, but if you must do not borrow more. Man up... pay for your desires. Or man up and sock it to the richer retirees. Or, raise payroll taxes on people who still have jobs. 

If voters want a statist safety-net with income redistribution, let us at least not have it open-ended and hanging over the heads of our children. Pay up now like honest folk would.

(Published Sept 2012. Updated May 2013.)