When to Take Social Security Benefits

Once upon a time, I promised a blog post on when you should take Social Security. Procrastination pays off because The Motley Fool just ran a post that did it for me. The short version: take your benefit as soon as you can (i.e., age 62). The trade-off is to wait and increase your monthly benefit at the expense of lower overall payout from Social Security.

Your “full” retirement age is between 65 and 67, depending on your year of birth. For younger generations, that age will probably increase as the system becomes insolvent. Currently, your monthly benefit increases about 8% for each year you delay your benefits. That could be the right decision if you don’t have enough savings to supplement your benefits. You will need your own savings because the current average Social Security benefit is only $1,372 per month. That’s $16,646 per year, barely above the poverty line for a two-person household. The maximum benefit at “full” retirement age is $2,687 per month ($32,244 per year).

Of course, all this Social Security talk only applies to those lucky enough to reach age 62 while Social Security is still solvent. According to the Board of Trustees, Social Security will pay more in benefits than it collects in taxes, starting in 2034. So if you’re under age 45, you’d better start saving to fund your own retirement. The earlier you start, the better, because of the power of compound interest. Learn more in Basic Personal Finance.

Learn From Boomer Mistakes

A MarketWatch article over the weekend pointed out some important facts about baby boomers being unprepared for retirement. The article claims baby boomers will need $658K in their retirement funds, but the average employer-sponsored defined-contribution plan for boomers only has $263K.

The article goes into specifics on asset allocation, but that’s not important. Let’s look at the numbers to put them in context. Let’s assume these retirees will live 20 years beyond age 65. A $658K nest egg, growing at a conservative 3% real return, will provide $44,228 per year, or $3686 per month. Add the average monthly Social Security benefit of $1,341, and you’re looking at living on about $5K a month. That’s just below the BLS average income for all households, which would give you a fairly comfortable retirement.

The boomers who only have $263K saved up will be living on $2,814 a month (including Social Security). Can you handle living on $2,800?

It’s an important lesson to the rest of us. I’ve never met a retiree who said, “You know what? I wish I’d spent more when I was younger because I have too much money now.”

The article warns that “the typical middle-aged American couple only has $5,000 saved for the future.”

Use this article to learn from the mistakes of others. Plan for your future now. If you’re not saving at least 10% of your income now, you’ll be the example used as a warning to others in the future.

Privatizing Social Security, Part III

The Expense of Transition Will Prevent Privatization

The previous posts already showed how privatizing Social Security would result in better returns for beneficiaries and how most opponents to privatization simply make emotional arguments in opposition to privatization. The real reason the system will not get privatized is the same reason the system will eventually collapse: it’s a Ponzi scheme. If that term is too inflammatory, call it a pay-as-you-go system.

John Goodman (not the actor) provides a list of reasons why most democratic voting countries have pay-as-you-go social security systems rather than privatized systems. The main reason is that such a system allows politicians to “appear to meet the need without really paying for it.” Next, the system generates revenues that exceed required payouts in the early years, allowing politicians to raid the “trust fund” to transfer money to their constituents (i.e., buy votes). The system cannot be dismantled because of the “ratchet effect.” That is, as the beneficiary base expands, it becomes too costly to transition them into another system.

As many people have pointed out, the Social Security system will eventually collapse because the number of beneficiaries continues to increase while the number of  contributors per beneficiary is decreasing. The promised benefits impose a huge unfunded liability to the government. Transitioning to a privatized system would be better for future beneficiaries but removes the funding of current beneficiaries. In short, privatizing Social Security would force the government to acknowledge the unfunded liabilities, and the deficit (and debt) would explode. No politician wants to take the blame for that.

Privatizing Social Security, Part II

Comparing Returns

Usually, any opposition to Social Security privatization will use some kind of emotional argument about the risks of stock investing versus the absolute certainty of the safety net embodied by Social Security. They never seem to produce numbers to back up the claims, unless they cite specific days when the stock market performed especially poorly (i.e., any market crash day). You can just as easily pick days when the government performs poorly (e.g., missed someone’s paycheck). That one event doesn’t reflect on all future Social Security payments for all beneficiaries. Let’s try to put some numbers to the argument to compare Social Security to the stock market.

The real return on social security “contributions” was determined by the Social Security Administration by running simulations for beneficiaries born between 1920 and 2004. The return for an individual is difficult to determine because it is based on lifetime earnings and the length of time drawing benefits. That said, the highest return was earned by single-earning couples born in the 1920s: 6.52%. Everyone else will get less. Younger workers have paid higher payroll taxes, so their returns will be lower. Single beneficiaries will earn less because they don’t receive Social Security’s generous spousal benefits. For example, a middle-income single-earning couple born in 1943 will get a 4.59% return, while a single earner with similar income will only earn a 2.49% return. Of course, the returns improve the longer the beneficiaries live, but the simulations show you have to live beyond 85 years old to guarantee a positive return (only half of the people who die between 75 and 84 earn a positive return).

How does that compare to the stock market? The minimum 45-year after-tax average annual return for the S&P 500 index since 1927 is 4.4% (1963-2008). The average is 6.4%, and the standard deviation is 1.1% (based on return data from Aswath Damodaran and inflation data from the Minneapolis Fed, as credited in my book, Basic Personal Finance). So you’re earning a positive return the moment you start saving. Unlike Social Security, this return is not dependent on marital status or longevity, and the proceeds can be passed on (increasing returns to future generations). Under Social Security, if you are single and have no dependent children under 18, your contributions produce zero benefits if you pass away. If you put your money in the stock market, that money could be bequeathed to anyone you specify.

Bonus: It turns out that minimum return of 4.4% is the magic return to ensure ANYBODY saving 12.4% of their income for 45 years could earn his or her salary for 31 years after retirement. Ask anyone drawing Social Security benefits how those checks compare to their salaries when they worked. According to the National Academy of Social Insurance, those benefits will be between 26% and 53% of career-average wages. (The higher number is for lower income earners.)

This is significant because whenever retirement advisors suggest people save at least 10% of their income, detractors say something like, “Easy for you to say. The poor can’t afford to save 10%.” Well, if they were allowed to save their Social Security contributions, that’s 12.4% (including the employer portion).

Let’s look at a worst-case scenario of an individual who makes minimum wage for their entire 45-year working career. We’ll use $7.25/hr with a 40-hour work week and 50 weeks per year. That’s only $14,500 a year. If this person’s 12.4% Social Security tax were invested at 4.4% for 45 years, the retirement account balance would be $242,836. That doesn’t sound like a lot of money, but if the account continued to grow at 4.4%, this individual could live on that money for 31 years and draw $14,500 in each year, the equivalent of the minimum wage salary. (The cool thing is that this works for any annual salary.)

That’s just using basic time-value of money calculations with average returns. A more thorough analysis would simulate real returns to capture the variabilities which could hurt (or benefit) the portfolio. Maybe someone with one of those many university research grants could do that. It would be nice of the proponents and detractors of privatizing Social Security would actually do SOME analysis rather than just regurgitating the tired talking points.

Privatizing Social Security, Part I

It Already Happened, and the Detractors Are Silent

I touched on Social Security in Chapter 6 of my book, Basic Personal Finance. It was a simple warning to younger generations to not rely on Social Security because the system will not exist much longer in its current state. In 2016, the Board of Trustees of the Social Security trust fund said the annual cost of the program will exceed its income by 2020. Despite repeated warnings by the Trustees over the years, any attempt to modify or privatize the program has been met with vehement opposition, usually from political talking heads with little actual knowledge of economics, finance, investing, or even basic math.

Take LA Times columnist Michael Hiltzik’s 2015 rant as an example. He tried to leverage recent market crashes into emotional appeals to warn against privatization. Anyone can pick and choose specific days for market returns to make things look horrifically bad. You can also pick specific days to turn anyone into a millionaire. Hiltzik’s column ignored long-term trends and the basics of diversification and asset allocation (i.e., moving to safer investments as retirement approaches) and painted Social Security privatization as if it were the end of civilization as we know it.

The funny thing is, privatized Social Security has existed since 1990 for part-time government employees. The 401(a) FICA Alternative Plan allocates 7.5% of these employees’ salaries into pre-tax private retirement plans (similar to a 401(k)). This is done in lieu of Social Security taxes (typically 6.2% from employee and 6.2% from employer). You don’t hear the privatized Social Security detractors complain about this system. Could it be because the perceived benefit of a state government not paying its matching 6.2% Social Security tax somehow outweighs the “dangers” of part-time employees being pushed into a private retirement system instead of Social Security? Imagine the outcry if a private employer tried to weasel out of its matching Social Security contributions.

What if we could all take advantage of a 401(a)-type privatized Social Security system? Part II will look at comparing returns from Social Security and the stock market.

Social Security: Take It While You Can!

Today’s post is for the chronologically gifted (i.e., those eligible for Social Security). The conclusion from a Sean Williams article on The Motley Fool: take your benefits while you can. The only way holding off on social security benefits pays off is if you expect to live beyond 85. It’s a morbid thought, thinking about when you’ll die, but that’s the fact of retirement planning. You have to make sure there’s enough money to support yourself while you are alive.

Williams used the average monthly Social Security payout for retirees ($1,363.66) and looked at lifetime payouts for various retirement ages (62 to 70). Assuming 2% cost of living adjustments, the 62-year-old retiree’s payouts exceeds all others until age 85. So if you’re eligible for Social Security, you may as well take it now. You’ll get lower monthly payments but greater total benefits.

For the rest of us, realize how little Social Security actually pays: $1,363.66 x 12 = $16,363.92. That’s not much to live on, even if you have no debt. You need to start planning now to make sure you grow a retirement nest egg that will support the quality of life you want in the future. Also read Chapter 6 of Basic Personal Finance and you’ll realize you’re Social Security benefits will be less than current retirees (if you get any at all).

Median Savings (Again)

CNBC is milking the Economic Policy Institute report from March 2016 to report “news” over a year later. This time it’s average and median retirement savings for people in their 50s.

Age Average Median
50-55 $124,831 $8,000
56-61 $163,577 $17,000

Note how low those medians are. I used the age 32-37 median (< $500!) on the back cover of Basic Personal Finance. These numbers show that over half the population is not prepared to support themselves in retirement. Don’t let that happen to you. The key is to plan ahead and establish financial discipline early in your life to save for the future. That’s rule #1 in Basic Personal Finance: Pay yourself first!

The original report is here. The table below is their summary chart that was featured in the CNBC story.