While searching the internet, I found an old article by former New York Governor Eliot Spitzer entitled, “Privatize Social Security?! Can We Finally Kill this Terrible Idea?” Interested, I read through the article and was surprised that his analysis showed that the return from the current Social Security system would be about as good as a private account. Digging into the numbers a little bit, I discovered the reason. His analysis was plain wrong.
The Governor uses a hypothetical couple making $100-$150,000 per year at retirement. He states correctly that their Social Security income would be about $3000 per month. He then looks at what sort of return they could get if they instead saved in a private account – for example, if they had put their Social Security taxes into a 401k-like account during their careers. He comes up with a return of about $3000 per month if they get out in a good year like 2007, but only $2000 per month if they get out in a bad year, like after a market crash like 2008.
I was surprised that the return was so low when compared to Social Security, and soon discovered why. He simply states, without any sort of justification, that “With an income of that size, the couple would be able to save about $500,000.” Really? Let’s run the numbers.
I looked at average family incomes since the 1950’s and values of the S&P 500 index since that time. I chose the S&P 500 since it is a good measure of the overall value of the markets. For income levels, I used a chart from Stanford for the period of 1960-2000 and data from the census bureau for 2005 and 2010. For the S&P500 values, I used Yahoo. For simplicity I assumed fixed income for five-year periods and fixed values of the S&P 500 for the same five-year periods. For each five-year period, I calculated how many shares a family on the median income could purchase of the S&P 500 index (or an index fund tracking it). To find the values at retirement, I simply multiplied the shares accumulated by the price of the S&P 500 at that time. Here’s what I calculated:
|Year||Income||Yearly Contribution||Share Price||Shares Bought||Total Shares||Value|
So, in 2010 our family at the median income level would be making about $50,000 per year – about 1/2 to 1/3 of the amount Governor Spitzer’s theoretical family made. And yet, the amount they had invested in 2010 was almost $700,000. This means that the couple he described, which would be upper-middle class and have incomes well above the national median, would have between $1.4 M and $2.1 M saved. Assuming he calculated his annuity values correctly, this would be a monthly income of about $6000 to $8000 per month – far above the $3000 they would collect from Social Security.
So what if they retired in 2008, the worst possible year, instead of in 2010? Well, the S&P500 was at $815 that year, so the couple at the median income would have “only” had about $550,000 in savings, receiving about $3200 per month from an annuity – a little more than the Social Security income the wealthier couple would receive. Spitzer’s upper-middleclass couple would have had two to three times that, or $6400 to $9600 per month.
If they waited five more years, the S&P 500 would have recovered and then some, closing currently at $1771. Our median couple would have about $1.2 M in savings, or a monthly payout of somewhere like $7,000, and his upper-middleclass couple would have $2.4 M to $3.6 M and receive between $14,000 and $21,000 per month, compared with their Social Security income of $3000 per month.
But wait, it gets worse. Governor Spitzer says that the couple with the private account who buys an annuity would receive the payout until the death of the older of the two, which is correct. If the couple were on Social Security instead, the surviving spouse would lose income when his her husband/wife died. If they made equal incomes, this would cut their income in half to about $1500 per month. Meanwhile, the surviving spouse with the private account would continue to receive the full income level.
But what if the couple dies at age 65 before receiving Social Security? Social Security would pay a death benefit of $500 per person, or $1000 for the couple. All of the rest of the benefits would be gone forever. If the couple had private accounts, their children/heirs would receive the full value of the accounts, minus any estate taxes and income taxes due.
Social Security is not a pension fund or a retirement fund. It is a system by which money from one generation is paid to the previous generation with the government taking any excess and spending it however they desire. Because the money is not invested, the returns are terrible. And even with the terrible returns, the system is still running out of money since there are more people retiring than entering the workforce and because the government continues to spend more than it takes in and eventually it will need to make cuts somewhere.
The best thing we could do is create a real national retirement system where Social Security taxes were directed into private accounts that would stay with the individual. These accounts would provide better returns, could be left to heirs if the retiree dies early, and would not be subject to the uncertainty caused by political policy and deficit spending by the government. Elliot Spitzer’s “guaranteed” returns aren’t all that guaranteed, and are lousy besides.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.