Thursday, March 26, 2009

Social Security - I wish I had been wrong.

Today marks an important day for those who have faith in Social Security. The trustees announced that the social security surplus may be gone this year instead of in 2017. The increase in unemployment has greatly reduced payroll tax revenues while the high inflation of 2008 increased current benefits by 5.8% and the reduced rate paid on US Treasuries has decimated the income from the Social Security Old Age (SS-OASI) trust fund.

The Social Security Administration’s spoke person put a spin on a negative day by say the trust fund balance is quite large and is able to pay benefits for decades to come. Is this two decades which is just 20 years and then the trust fund is gone or is it three decades or thirty years and the and the trust fund is gone.

I presented this before and I will attempt again to in another way. A 20 year old has 47 years to save for retirement which is equal to age 67 or full retirement age under Social Security. A person making $30,000 a year can expect to receive $12,600 a year in Social Security OASI benefits at age 67. Based on 6% return, 3.5% wage growth, 3% inflation and living to age 90, this worker would need to save 8.2% of their pay each year to duplicate SS. If they were to wait till age 30, they would need to save 11.9%, at age 40 they need to save 18.7%, at age 50 they need to save 33.85 and at age 60 they need to save 93% of their wage each year.

It is quite obvious the longer you wait to save, the greater the percent you need to save. I do not think anyone finds this to be new information. Under the 2008 SSA trustee report, SS-OASI would be able to pay full benefits till 2041. This is 32 years away. This means a person who is now 35 will reach age 67 when SS-OASI has trust fund is exhausted. Therefore, we as a nation have 32 years to fix Social Security or some might say save it. In simple terms, this is no different than a person who is now 35 and has not begun saving for retirement. This means they would have to save 14.8% of yearly wages to duplicate SS-OASI at age 67. However, there is a problem with this method of thinking. It assumes there are no workers older than age 35. A 36 year old will collect one year’s benefits before the trust fund is exhausted. This means the 36 year old needs to save 15.4% to duplicate SS-OASI benefit.

What we have ore 47 cohorts working paying SS-OASI taxes, but very little of it will be used to pay them benefits because this year the payroll taxes paid will be insufficient to pay the SS-OASI benefits. So what is the average age of these 47 cohorts? The average age of the cohorts subtracted from age 67 (full retirement age) provides us with a good approximation of how many years WE collectively have to save social security. There are a total of 4,687,715,596 man-years for the ages 20 through 67. This group numbers 191,101,992 individuals. This means the average man-years to save is 24.5 years. However, we have a problem. This assumes those under the age of 35 have more the 32 years to save when in fact we as a nation have 32 years. This means the weighted average man-years to save is 21.9 years. But wait, we still have another problem. The trust fund only has enough funds to pay four years worth of benefits. Another way to say it is the SS-OASI trust fund can pay full benefits to all age 83 and over. This means we need to add in the average weighted man-years to save for those currently 67 to 83. Because this group is not paying payroll taxes, their weighted average man-years to save will be negative. The weighted average of years to save for those over age 67 is -10.8 years.

When combined, we as a country have less than 11.1 years to solve the social security mess. To put it in terms of an individual, it is no different than a person who is 55.9 years old who has saved nothing for retirement and is now attempting to duplicate the SS benefit. The payroll tax to do this is 55.8%.

So when people say they are in favor of saving social security, do they actually comprehend the magnitude of the problem? Sure 32 years sound pretty far away, but I ask you to think about it in terms of an individual who has not saved and is now 56 years old. Can you set aside 55.8% of your wages each year for 11.1 years? If not, then it is time to seriously rethink saving social security.

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