Re-blogged post: How much Social Security will you receive?

[Practice Good Theory Blog]

How much Social Security will you receive?:

Ever wondered if you will receive any social security at all? Not the country, not some others in some unknown future, but you yourself? If you're preparing for the worst, good for you; but, what's the most likely way in which this will unfold?

How are "benefits" calculated? Social security was always a Ponzi scheme by design, but was made to resemble the structure of an actual pension scheme where people save money and then draw out their savings in retirement. Actually, the money "put aside" is paid out to current retirees, and anything that remains is used for general government expenses. Secondly, what you put in is not proportional to what you are promised. The payments by the Social Security administration (called "benefits") are "progressive". Here's a rough calculation: first, estimate your average annual salary over your lifetime (up to the max. of about $100K, after which payroll taxes are not deducted). You are promised $90 for each $100 of average earning, but only for the first $9000. Then, for the next "slab" you are promised 30% of your average earning. And, for anything over $55K, it is 15%. (Benefits are indexed to CPI. These numbers assume 2010-equivalent dollars.)

Sample calculation: Suppose you just retired, having started working in the late 1960s. Your peak earning years were probably around 1990. Let's say you earned an average of about $ 32,000 per year. Adjusting for inflation, that would be about $60,000 per year in 2010 dollars.

Look at the blue line in this graph. For an average of $32,000, which becomes $60,000 after inflation adjustment [x-axis], you are promised a benefit of around $25,000 a year [y-axis]. Notice that while the $60,000 person gets $25,000; someone who earned $100,000 gets just $30,000 in benefits.

Simpson Bowles (Dec 2010): A bi-partisan congressional group proposed changes in social-security, in order to extend its life. The red line in the diagram above shows their proposed benefits. If passed, the person who averaged $50,000 is promised about $18,000 instead of $21,000 a year. The person who averaged $80,000 is promised $20,000 instead of $26,000 per year. Simpson-Bowles makes the benefit-schedule more progressive, which is why the person with the higher average earnings will "lose" a larger amount. Depending on your level of income, instead of the current promise to pay you 30% - 42% of your average salary, the new promise will be to pay you about 20% - 35%. [Note: These changes are phased in gradually. The promises will be lowered a bit each year.]

Other Simpson-Bowles recommendations:

• Raise retirement age: under current law, it will rise to 67 year. They propose it keeps rising, linked to life-expectancy. They expect the retirement age to be 68 year in 2050.
  
• Raise the maximum salary cap that has to pay payroll-tax, from the current $107,000 to the equivalent of about $170,000. This means that people earning above $107,000 in salary will pay a 13% tax when they otherwise would not.
  
• Use a "chained-CPI" cost-of-living formula that increases benefits at a rate that is slightly lower than the standard CPI (Consumer price index).
  

Paul Ryan's proposal: GOP Congressman Paul Ryan also proposes to raise payroll taxes (without changing the rate) as a side-effect of making employer-provided health-care benefits a part of income for social-security calculations. He will also lower promised benefits for those 55 and below today, particularly higher-earners. He proposes raising the retirement age. In addition, there is a minimum payout for those at the lowest end, somewhat analogous to the minimum wage.

Free-market proposal: Paul Ryan's proposal also contains something that Republicans might see as a free-market component. It allows retirees under 55 to save one third of their social-security taxes in a savings account. This would be something like an IRA, but it would come with a government guarantee that the account will not lose money. The only way the government can make such a guarantee is if it limits the types of investments in such an account. This is definitely not a free-market solution. The government should not be ensuring that people save. Further, the government should not be choosing where we can invest our savings. The danger is that investment vehicles vie for whatever government certification is required. We've seen what a poor job the FDIC has done ensuring the safety of bank deposits. We've also seen how poorly the government-approved credit-rating agencies performed. Given this history, a pseudo free-market system versus a fully and honestly government-run system is a a poor choice of options.

Rand Paul's proposal: Representative Rand Paul, who positions himself as a libertarian-leaning GOP politician has a proposal too. He would increase the retirement age and means-test the benefits.

What will become law? Currently, no concrete plan has substantial support, but the proposals above give us some idea of how things will transpire. Simpson-Bowles was a bi-partisan commission. Paul Ryan and Rand Paul are seen as more "pro-freemarket" than the average Republican. All three of these proposals have two common themes:

• Cut benefits in some "progressive"/means-tested way
  
• Raise the retirement age
  

Though there is no political will to tackle the issue of social-security today, it is almost certain that these two ideas will dominate any plan that evolves when voters finally want Congress to act. In addition, it is quite likely that payroll taxes will be increased at least for higher-earners, by raising the max. salary to which payroll-taxes apply. Slower cost-of-living increases are also likely.

How much will you receive? Go back to the diagram and see what you are promised under the Simpson-Bowles proposal. I suggest that anybody who is 50 or younger should not expect to receive any more than this. If you just started working, and if you will retire in 40 years, I have no guess as to what's in store for social security.

The context of the Federal budget: Entitlements are the really serious threat to the U.S. Federal budget. However, within entitlements -- believe it or not -- Social Security is the easy problem to tackle. Mathematically, Medicare -- with its sky-rocketing costs -- is the bigger problem by far. That'll have to wait for another post.

Means testing and lowered-benefits are coming: If there is enough pressure from voters, we will probably end up with something like Bowles-Simpson, which will kick the issue many decades into the future. Don't bank on any promise that is more than 20% of your average life-time income: you might get less than the Bowles-Simpson proposals, but its hard to see how you could get better.

Blog cross-posted with permission. See link at top of post for original.