More Abuse of Social Security Statistics...

Making reference to the average Social Security benefit is an often used - and misused - characterization that won't go away.  Chuck Saletta of the Motley Fool writes the following at MSNBC.com:

The average Social Security payment to a retired worker currently sits around $1,234 per month -- or about $14,808 per year. For comparison, a full-time minimum wage job would currently pay $7.25 per hour -- or around $14,500 per year.

From there he goes on to argue that with such a low average benefit, the importance of savings to augment the benefit is all the more important.  Fair enough.  I am all for more savings for retirement.  However, for those nearing retirement there is limited time for the magic of compound earnings to pump up their savings.  By contrast, there is a sure-fire way to increase your guaranteed Social Security benefits: find a way to claim later!

Let's unpack the loaded 'average benefit around $1,234 per month'.  More than half of claimants start benefits at 62, the earliest possible age.  Most of the rest start within a couple more years, long before the latest claiming age of 70.  Let's suppose this $1,234 is typical of people claiming at 62 (and it is if you have a look at this data from the Social Security Administration, p. 352).  That benefit is reduced about 25% from what it would have been at age 66, Full Retirement Age currently.  If the same person waited to that age to start, the benefit would be $1,542, an amount that would be typical of an earner who made about $44,000 a year during their working career.  If the worker waits to age 70 to start, the benefit is 32% higher, or $2,035.  Now, suppose a married couple both earned that amount and are entitled to the same benefit.  Claiming at 70 their income would be $4,070 or $48,840 per year.  Harly makes them wealthy, though there are places you can live on that kind of income, especially since it would be tax free if you have little other income.  Of course, you need to get to age 70...

Social Security rules give this couple a little help to get there.  At age 66 the younger spouse can file a "spousal" claim based on the other spouse's work record and receive 50% of what that other spouse was entitled to receive at age 66 (even though both are waiting to age 70 to claim on their work records).  That's 50% of $1,542, or $762 for 48 months: an extra $36,576!  Waiting has its own reward!

Getting the Most Out of Your Social Security Investment

The Social Security Administration periodically updates its analysis of the real rate of return that benefits generate for workers, male and female, at various income levels.  In its most recent report, from July of this year, the calculated rates of return are considerable, especially for low to moderate income earners whose returns range between around 3% and 6%.  Interestingly, even if benefits are cut in 2033 (when the Trust Fund is exhausted and assuming the only payments are from current payroll tax collections, a cut of about 25%), the range of returns for these earners is 2% to 6%.

In general, the returns go down for more recent generations.  Those born in the 1920s and 1930s have by far the highest rates of return.  Also, the returns for women are higher in all categories because on average they live longer and therefore collect longer.  Still, even high earners get real rates of return above zero under all scenarios.

I became aware of this analysis from an article by Steve Vernon writing at CBSNews.com.  Mr. Vernon writes often about Social Security and excels at explaining some of the intricacies of claiming strategy.  As he points out in the article, "Looking at all the various combinations, large numbers of hypothetical workers received estimated real rates of returns of 2, 3 or 4 percent per year."  Considering there is a near zero risk on this "investment", that's not bad!

One assumption used in their analysis deserves special notice from our vantage point: all calculations are based on the beneficiaries retiring at age 65.  Our own analysis shows that most of these claimants would enjoy far greater cumulative lifetime benefits if they claimed later, closer to age 70.  The result for most couples would be an increase in benefits approaching or exceeding $100,000, an amount that would increase the rate of return considerably.  Make the most of the investment you made in the Social Security system by adopting a smart claiming strategy.

Retirement in the Age withOUT Defined Benefit Pensions

A new study from the Center for Retirement Research at Boston College by Alicia H. Munnell, Rebecca Cannon Fraenkel, and Josh Hurwitz reveals just how poorly baby boomers are positioned for retirement in light of the shift to defined contribution pension plans (401(k)s principally).  According to this research, in the model a worker who reaches peak earnings of about $65,000 at retirement, and who put away 6% per year with an employer match of 3%, would accumulate about $363,000; a two-worker household with both earning the same would have double that.  Yet the Federal Reserve's Survey of Consumer Finances indicates that in 2010 a typical household close to retirement age only had about $120,000 in 401(k)s and IRAs - enough to purchase an annuity of about $575 per month.  (Presumably this is not an inflation-adjusted annuity like Social Security.)

Why the discrepancy?  First, there are a large number of businesses that don't offer 401(k) plans in the first place.  Second, of those that do off plans the participation rate of 79% is not as good as might be hoped.  Further, workers don't always maximize their participation.  For these reasons, overall only 42% of the private sector workforce participates in such a plan.  (The public sector workforce effectively has 100% coverage.) 

This data further underscores the importance of finding a strategy for waiting to claim Social Security benefits until age 70 when they are typically 76% higher before adjustment for any inflation).  Locking in the higher benefit level for life is undoubtedly the single biggest step to take to ensure greater financial security.  This is particularly so for those who are near retirement age and have few other options for accumulating financial wealth.

How Urgently is a Fix Needed for Social Security?

Charles Blahous is a public Social Security trustee.  He recently wrote a lengthy article, Is it Becoming Too Late to Fix Social Security's Finances? posted at Economics21.org, that emphasizes the necessity of acting sooner rather than later to shore up Social Security.  He points out that assuming there is plenty of time to act since the Trust Fund is not forecast to be exhausted until 2033 is a dangerous illusion that lulls too many into inaction.  If we fail to act soon, then the steps needed to right the program will be overwhelming.

He argues that the magnitude of the long run shortfall is close to 4% of the tax base (worker wages).  To put this in context, right now the tax base is taxed at the rate of 12.4% with 6.2% withheld from the employee's check and 6.2% paid by the employer.  Increasing the tax rate 4% would bring the total tax up to 16.4%.

He also compares this shortfall to the 1983 shortfall and concludes that it is about twice as severe. Moreover, he points out how politically difficult it was to agree to the changes made to fix the program at that time.  Such a degree of compromise in the current climate in Washington, D.C. seems highly improbable, in his view.

Dale Coberly responds at Business Insider to Mr. Blahous's article by arguing that such an increase (4%) isn't as mathematically implausible as it seems.  With real wages forecast to increase over time at roughly 1% per year, a 20% gain over 20 years could absorb the 4% (net real gain slightly under 16% instead of 20%).  If such an increase were implemented gradually, it might hardly be noticed.  This of course assumes the politics are overcome in order to get there from here.

I hope Mr. Blahous is incorrect about the politics and that some alignment of the stars will force the politicians to act.  However the issue is resolved it is as unlikely to be all tax increases as it is to be all cuts.  (The default solution is to cut benefits across the board around 25% in 2033.)  Simpson-Bowles had a mix of the two built in; you can view a PDF of the evaluation of the Simpson-Bowles proposal by the Office of the Chief Actuary at the Social Security Administration at a link provided in the Charles Blahous article.  I expect something along the lines of Simpson-Bowles to be closer to the eventual solution.

Social Security Privatization: Good Idea or Bad?

Writing today in the Detroit Lakes online, Donald A. Johnson makes an interesting case against privatization of Social Security, arguing that it is "...the worst idea ever imagined."  He contrasts the longevity of this program with that of many prominent banks:

"What do Drexel Barnum Lambert, Lehman Brothers, Madoff Investment Securities, Wachovia, Washington Mutual, CIT Group, Merrill Lynch, Bear Stearns, AIG, and Citi Group, all have in common? They were all highly regarded private investment firms that were incorporated after the Social Security Administration was established in 1932 and went bankrupt or were bailed out before going bankrupt, in the last 30 years. "

He also points out that the fees and overhead of the banks that remain in operation are considerably greater than those at the Social Security Administration - no fees and overhead less than 1%. 

While I am inclined to agree with his premise - Social Security privatization is not a good idea - I think his arguments are apples to oranges.  Social Security is not an investment program designed to generate a nest egg.  Rather, it is an insurance program intended to provide a guaranteed annuity that adjusts for inflation each year.  In fact, Mr. Johnson inadvertently makes this case very well in pointing out the inherent risk involved in the financial markets, risks that have paid off rather poorly over the last ten years or so.  On the other hand, you won't find many that argue that the returns on the money paid to Social Security are very good, and they are certainly worse than they were a generation or two ago, as was reported recently in this Associated Press article.  The point is that Social Security is insurance.  For instance, it includes benefits for disability that you will not receive if you are fortunate enough to avoid becoming disabled.  It also likely won't pay off if you don't live long enough to start collecting retirement benefits (might still pay off for survivors in this case).  And, if you happen to live long enough, it might actually turn out to be a good investment after all - that's when you need it to have been a good investment, a kind of longevity insurance.

Prospective retirees of modest to moderate means need to plan their Social Security claiming strategy coupled with any other guaranteed cash flows they may have (e.g., a pension) to ensure enough income to cover basic needs no matter how long they live.  Then the other savings in the markets can be used judiciously for those activities that may enrich their lives, like travel, entertainment or leaving a legacy - uses of money that are not essential to getting by.

I came across this unusually thoughtful article on the state of the Social Security system from the editorial staff at Fisher Investments and only wish everyone would read it.  It does an excellent job of putting the numbers associated with the system's viability in context.  To wit, take them with a big grain of salt.  Due to the nature of any program providing retirement benefits, the Social Security actuaries forecast decades into the future.  Yet any such forecast is inherently unreliable and subject to enormous fluctuations over time.  As they note, "You can see this in past long-term governmentally produced forecasts, which are frequently wide of the mark—like federal government surplus projections for the next decade minted in 2000."  Don't we wish...

Yet politicians pick up on the latest projection, promote it wildly if it happens to suit their agenda, and the press often picks up their lamentations, treating them without offering much perspective.  For instance, the report of the actuaries this spring moved up the expected date of the Social Security Trust Funds exhaustion by several years, to 1933.  Only a few years ago the date was around 2049.  How could the funds be so diminished in just a few years?  Every year the actuaries update their assumptions based on recent economic developments.  Key factors this year were a reduction in long term earnings growth over the next 75 years due to (1) higher long term energy prices and (2) slower growth in work hours coming out of the recession.  In a future year (perhaps during brighter economic times) these trends could be reversed, or other trends such as unanticipated productivity gains could cause the forecast of Trust Fund exhaustion to recede once again further into the future.

In sum, a forecast indicating a shortage in the Trust Fund in 20 years should be little more than a red flag that if something isn't done, we will eventually encounter a problem.  On this score everyone is in agreement and the question is when will it be politically feasible to make the fix.  Fisher Investments is pessimistic on this score, thinking there will have to be much more of a crisis to bring this all to a head. Indeed that was the case in 1983, when the fabled Greenspan Commission did the last big fix - within about six months of system becoming insolvent!  I am more optimistic.  In the grand debt bargain that Obama and Boehner almost reached last summer to lop around $4 trillion off the long term debt, Obama put a major concession on the table as part of a broader package: move the COLA adjustment to a chained CPI basis.  That coupled with an increase in the tax cap or gradual increase in the rate and another longevity adjustment could do the trick and bring balance to Social Security for another 50 years or so.  Both parties would endure shrieking from their bases, a reasonable price to pay for Social Security security.

New AP Poll Favors Shoring up Social Security

Those recently polled by Associated Press/GfK support raising taxes over reducing benefits by 53% to 36%.  Similarly, 53% were in favor of raising the retirement age as opposed to 36% who would rather cut benefits.  As the article points out, raising the retirement age is effectively a benefit cut.  However, people are living much longer than they did when the first benefits were paid in the 1940s and Full Retirement Age was initially set at 65.  Today Full Retirement Age has only moved to 66 and won't get to 67 for another 15 years.  Life expectancy back in the 1940s was closer to 65.  Today a 62 year old male has a median life expectancy of 82 and for a female it is 85. 

The poll, conducted in August, found that majorities of all parties (including Independents) favored raising the retirement age over cutting benefits.  Majorities of Democrats and Independents preferred raising taxes over cuts, while a majority of Republicans wanted the opposite.  Interestingly, similar results ran across different generations with one exception: younger people were far less likely to be confident that Social Security will be there for them (20% of voters under 35) whereas those older felt it would be there (55% of those over 65).  Overall only "...30 percent said it was very likely or extremely likely they will be able to rely on Social Security." 

Sadly, this low level of confidence in Social Security is not so surprising given the number of politicians on both sides of the aisle who are prone to make hysterical comments about the system, arguing it is a "Ponzi scheme" (Republican Governor Rick Perry) or that it's going to "fall off a cliff" (Democratic Senator Dick Durban).  Hopefully the attitudes reflected in this poll will give politicians of all stripes the backbone to step up and fix the system while such a fix can still be implemented gradually over many years, even decades.  The solution will undoubtedly lay in a set of modifications that combine benefit preservation and modest cuts - something we used to call compromise.  The sooner the better if it means that the public will come to realize that Social Security will be there for them; not just for seniors entering retirement but also for those just entering the workforce.