Don’t Plan on Social Security for your Retirement

Social Security has long been called the “third rail of politics.”  This is because whenever a politician suggests that Social Security benefits be reduced or changed in any way, there is a huge upswell that ends his career.  Unlike welfare programs, Social Security was sold as a national pension program where workers pay in and then receive the benefits they paid for in retirement.

The issue with Social Security, however, is that it has never been structured as a pension plan.  With a pension plan the money people pay in is invested in stocks and bonds so that the balance can grow with time.  The payout is based on the expected market returns over the period with a small degree of safety in case returns are less.  For example, if you expected the investments to return 10% over the period, the pension plan might pay out an effective return of 8%.

When you start to receive benefits from a pension plan, you are receiving the money you invested back, with market growth and interest, plus whatever contribution your company made as part of your employment benefits.  Essentially your are storing a portion of your labor for later so that you can pay others when you are retired and receive a like amount of goods and labor in return.  The ability of a pension plan to pay your benefits has nothing to do with future contributions from future employees or your employer.

Social Security has never been invested.  Instead, the money that people working today contribute goes to pay for the benefits of those who are currently retired.  Any extra money collected is loaned to the Treasury, which issues the Social Security program treasury bonds as a form of IOU, and then is spent along with revenues collected by the income tax, plus another trillion dollars or so each year.  Note that this is similar to a Ponzi scheme where early investors are paid money collected from later investors, while the person running the Ponzi scheme collects some of the money.  At least in this case the extra money is going to pay for things future retirees can “enjoy” now.

Unlike a pension plan, there is no ability to pay future benefits unless future workers are contributing.  You are making an agreement with people who have not yet been born yet to pay for your benefits if you pay for those currently retired, except those yet to be born have not made any such agreement.  (Note that if they decide not to honor the agreement, which they may do by either changing the law or simply not working hard enough to pay for your benefits, they are not doing anything unethical by doing so.  You should be mad at yourself and the politicians who did nothing to change the program during all of the years you were working rather than the next generation who had nothing to do with the agreement.)

For Social Security to continue to function and pay out full benefits, either the amount collected by current workers must equal or exceed the amount paid out to current retirees or the Treasury must direct money collected from other taxes to the Social Security program, paying back the bonds that were issued.  If the program isn’t collecting enough money and the Treasury is unable to pay back the bonds, either benefits must be cut or tax revenues must be increased to cover the shortfall.

As of about 2012, the amount collected by the Social Security program is less than the amount being paid out.  This is both due to the number of retirees increasing dramatically as the large number of people in the Babyboom generation retire and the number of young people not working increasing.  This will not be helped if, as predicted by the Congressional Budget Office, a large number of people quit work since they can get healthcare without working.  Amateur poets and guitar players won’t be contributing to the Social Security program, nor will 18-26 year-olds who are living with their parents and not working because they can stay on their parent’s healthcare plan.

Even if employment participation rates were near their norms, there are simply not enough working people to cover the number of retirees unless tax revenues are increased.  Trying to increase tax revenues by raising taxes will not work.  Raising taxes will lead to more people not working since the amount they make by working will be decreased, which will require taxes be raised further, which will cause more people to quit working.  Ironically, lowering taxes might actually bring in more revenue, as has been shown by the famous Laffer Curve.

So what about the option of the Treasury making up the shortfall, essentially, paying back all of those bonds that were issued?  After all, US Government bonds have been known to be one of the safest investments on the planet.   The trouble is that the US Government is now about $18 T in debt (increasing debt by more than $9 T over the last five years).  While in the past the government might have been able to simply borrow the money needed to pay back the Social Security bonds, this is rapidly ceasing to be an option.

There is also the danger of an interest rate increase causing debt interest payments to spike in a short period of time.  The interest rates currently paid on the bonds are very manageable.  (Note there is no reason for the US Government to default or miss an interest payment even if the debt ceiling were not raised – there is plenty of money to cover the interest payments without borrowing more if that were set as the first priority in the budget).  If the debt increases much more, however, the interest payments will start to climb and become more of a dominant item in the budget.  If interest rates paid by the Treasury were then to increase (note that the government must reissue bonds all of the time, so unlike a 30 year mortgage, rates reset every few months), the interest payments could quickly become so large that the government would need to choose between paying the interest payments, paying for basic government functions, and paying for welfare and entitlement programs.  This would pit Social Security recipients against the military, the roads, and welfare mothers for funding.

I am expecting the national debt to exceed $22 T by the end of 2016.  Given that the only fiscal restraint we have seen in the last 20 years came to an end with the last Continuing Resolution, and given that the debt ceiling limit has been lifted entirely without any plans for spending restraint, there is no reason to think that the rate of increase of the national debt will slow.  I also expect the credit worthiness of the country to be further questioned as the debt continues to grow, leading to an increase in interest rates paid by the government on the debt.  All of this means that the ability of the Social Security program to continue to pay full benefits should be questioned.

Hopefully I’m wrong and some miracle will occur that will  allow full benefits to be paid.  Perhaps, realizing the need to spur the economy, the next Congress will slash regulations, making it easy to start and grow businesses, leading to a rapidly growing economy and huge new tax revenues.  Maybe we’ll have an enormous wave of highly intelligent, entrepreneurial immigrants who will create all kinds of new wealth.  Maybe we’ll see a return to the welfare reform policies of the 1990’s and many people will return to work, creating more wealth and increasing the amounts paid into the Social Security program.

Those retiring should not count on any such miracle, however.  It is nice to hope for the best but you need to plan for the worst when it is about your financial future.  A good idea when determining how much you’ll need for your retirement savings, therefore, is to assume you will not receive anything from Social Security and save up enough to do without it if needed.  If full Social Security benefits, or even reduced Social Security benefits are received, that will just be gravy.  The only thing to fear then is that the government decides to take over the private retirement accounts as a way to “save Social Security,” or just raise income and consumption taxes dramatically, to shore up Social Security for those who did not save.

Please contact me via or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. 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. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Comments appreciated! What are your thoughts? Questions?

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.