Social Insecurity?

SmartMoney.com recently posted a story reminding everyone that Social Security taxes are temporarily lower this year by 2%, but that next year they will return to their normal rates. (http://www.smartmoney.com/taxes/income/just-what-you-needed-higher-taxes-1306271420886/#article_tab_article)

Later in the article, the author bemoaned the fact that during a 35-year career that included work as an employee and as a self-employed individual, a total of $260,000 has been paid into Social Security both by him and on his behalf. He wrote:

 “Believe me, if I could get the $260,000 back, stop paying the tax, and forego receiving any benefits, I would do it in a heartbeat. In fact, if I could just stop paying the tax in exchange for walking away from any future benefits, I would do that too. Why? Because I have big doubts I will actually receive the promised level of benefits when the time comes.”

Social Security certainly has its problems. But even when the Social Security Trust Fund “goes broke”, it will still be able to pay about 70% of the promised benefits simply on the taxes it collects on an ongoing basis. Beyond that, the fact that anyone would forfeit their Social Security benefit suggests that they don’t have a full grasp on how powerful that benefit really is.

Social Security is essentially a special type of insurance product called an inflation-adjusted payout annuity. With these types of annuities, in exchange for some premium amount, an insurance company promises to pay you a certain amount of income for the rest of your life. That payment is adjusted upward each subsequent year by the level of inflation.

Inflation-adjusted annuities are available on the commercial market, which allows for a comparison between the government program and how much a similar benefit might cost privately. Today, with a $260,000 premium payment, a 66-year old male could purchase an inflation-adjusted, single life annuity with lifetime payments that would pay him about $13,416 per year. (Source: Income Solutions). Contrast that with the average payment received by retired workers, which as of April, 2011 was about $14,160/year. (Source: http://www.ssa.gov/policy/docs/quickfacts/stat_snapshot/)

Granted that’s not the fairest comparison, since the pool of retired workers receiving benefits paid in a variety of Social Security contributions. So imagine a 66-year old individual who makes $50,000 this year. Based on an assumed growth rate of 2% for previous earnings, Social Security estimates that individual’s benefit at full retirement age (66 years and 12 months) to be $1,431/month, or $17,172/year.

Additionally, with a commercial annuity, there’s always the risk that the insurer will go out of business. While there are some protections for this event, they might not cover your full annuity benefit.

What’s more, this doesn’t even factor in the potential benefits of delaying your Social Security benefit beyond your full retirement age. Individuals who wait experience a guaranteed 8% increase in their monthly benefits for each year they defer Social Security after their full retirement age up to age 70. No stock, bond, mutual fund or annuity can come close to making such a guarantee.

The SmartMoney writer didn’t indicate his projected Social Security benefit, so it’s hard to really figure if he would have been better off not contributing at all. But the guaranteed aspect of Social Security, along with the inflation-adjustment for future years, make it a pretty tough benefit to give up, particularly once you see how expensive it would be to get a similar benefit elsewhere.

About Ben Birken

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