Following up on this post (see especially the excellent comments), let’s take a look at why the Social Security program exists. As I said in the post cited, in part it’s aspirational (in part, of course, political): we want a society in which people who are too old to work can maintain a reasonable lifestyle and that produces an acceptable level of economic growth. Let’s think about the implications of the Social Security program ceasing to exist and people living solely on what they’re able to save over the course of a lifetime.
Using the retirement calculator here, I’ve been able to produce a baseline scenario, the results of which are in the graph above. My assumptions are a base income of $50,000 (median income for a family of four), the ability to realize 4% on savings for the whole term, paying principal down to zero over the term, working fulltime without hiatus from age 20 to age 67, realizing an income of $30,000 per year after retirement, inflation at 3% (its average for the last 300 years here), and wages incrfeasing slightly slower than inflation. I recognize that there are any number of ways in which these assumptions are unrealistically rosy, for example, a good part of the interest you’d realize on savings would be taxed away or eaten up in fees but you’ve got to start somewhere.
I also assume that Medicare continues to exist, at least for people age 67 or older.
As you can see in order to achieve the target retirement income you’d need to save 25% of your gross income. That alone should be enough to convince you that people with average or below average incomes just aren’t able to save enough for their retirements but we’ll continue with the experiment.
Note that the result isn’t robust: it is extremely dependent on the rate of return that can be realized. At a 3% rate of return:
the rate at which you’d need to save rises to 35% and at 2% return (much, much more realistic in my view):
the rate at which you’d need to save rises to a whopping 50%.
Is it practical for people of average (or below average) income to save 25% of their income? Saving 25% leaves 75% or $37,500. Let’s make some more assumptions and construct a budget:
| Rent | $15,000 |
| Healthcare insurance | 10,000 |
| Taxes | 4,000 |
| Food | 5,000 |
| Utilities | 2,000 |
| Transportation | 2,000 |
| Everything else | 1,000 |
| Total | $39,000 |
Here in Chicago I think that’s pretty realistic. A decent two bedroom apartment in an okay neighborhood will run at least $1,200 per month. Two CTA passes every month will cost about $2,000 a year (you won’t be able to buy a car, pay its insurance, put gas in it, and maintain it for $2,000 a year). I suppose you could scrimp a bit on food and utilities. Maybe someone more knowledgeable on shopping for healthcare insurance than I could comment on what it costs to insure a family of four. Note that if you assume that the job includes healthcare insurance you’ve got to assume it for everybody which is not a realistic assumption.
But it’s extremely frugal. Clearly, a family earning the median income can’t save enough for retirement and that’s even more obvious at lower levels of return.
There’s another monkey wrench. Look at that “everything else” figure. That’s most of the economy. We can’t maintain a growing economy when people are saving at that ferocious rate. Another monkey wrench: at that low level of personal consumption state and local governments couldn’t fund themselves with sales taxes. Income taxes and property taxes would need to rise and that will lower the amount of money available for saving even farther. I submit that for people below the top quintile of income earners, 80% of the people, there is no realistic way for them to save for their retirements and doing so would be too injurious to the economy to contemplate doing.
We need the Social Security program. If it didn’t exist, we would need to invent it. If we dismantle it, it will only to replace it with another program that does much the same thing.
Let’s stop telling fables about eliminating Social Security and, instead, produce realistic strategies for salvaging it. We need it.
I wonder if there’s been any study on what people expect from social security. Do people see it as an actual safety net designed to provide minimal income in order to keep the elderly from sleeping under bridges? Or do they see it as something more?
Dave –
Your case is indisputable because of the assumptions you’ve made. No, nobody making $50K can save 25% of their income.
But don’t you think its time we call bullshit on the entire system? Under your assumptions its a welfare program; let’s get on with it.
I have said many times here and elsewhere that people like me need to be means tested, and obviously wiped out from receipt of a nickel from the program. (Of course, all politicians in this ENRON scheme should also be thrown in jail…….but that’s just my personal pipe dream.) The system a fraud? Yes, for years. But is this a practical reality that needs to happen? Yes.
Keep redoing your math until you solve for what level of income you think should become ineligible for SS payments. $60K? $80K? $100K? Then ponder graduated eligibility, and then a value judgment: is the guy who buys a 50″ flat screen TV or spends money on beer and 4 tickets to a ballgame rather than save the money for retirement an irresponsible parasite?? And should we feel sorry for him/her?
And now we’ve come full circle to what the politicians know. Better to keep alive an “all pay” “all receive” system that is structurally unsound, kick that can as far down the road as possible, and perhaps mine “the rich” for more subsidy as opposed to apply political leadership and sound actuarial fiscal policy.
I don’t disagree with the conclusion, but I can’t help but find problems with a couple of the points.
Housing — According to the 2000 census, the median value of a home in the U.S. was $120,000. Assuming a 30 yr mortgage rate of 8%, and a 20% downpayment on a $120,000 house, that would yield a $734 per month mortgage payment. One has to figure in property taxes (if any) and maintenance, but that suggests to me that in many parts of the country, its quite possible for most people to enter retirement owning a modest home that has both resale value and a savings from rental expenses. Indeed, I think in a world without SS, the value of home ownership for retirement would reinstate itself.
Retirement annuity. An unstated assumption here is that people need to save for the risk of longevity, when that is an insurable risk through an annuity. Looking at the Vanguard website for an example of costs, I see that at age 70 “Fred” can buy a $1,400 per month annuity that adjusts for inflation for $400,000 with a guaranteed 20 yrs of pay-outs. (Assuming “Fred” dies at age 80, the annuity keeps paying an heir for 10 yrs) Assuming that scales proportionately, $1 million should buy $42,000 a year income. I don’t know if I’m capturing the ins and outs of annuities, but if everybody is expected to save on the assumption they will live until they are 102, a lot of heirs will benefit from someone else’s savings.
OTOH, I can see some rosy assumptions like level income and savings through life, and I don’t know if a $50k presupposes some college and thus delayed entry into the workforce and student loans.
You have an endogeneity problem. That is current savings maybe too low because of programs like Social Security. Or to put it differently, when people are making decisions about how much to save for the future vs. current consumption the fact that Social Security is there will lead most people to shift more towards current consumption vs. future. Especially considering that for many people Social Security eats up a significant chunk of their pre-tax income. People are taxed at least 6.2% and possibly as high as 12.4%. That last one depends on how competitive the labor market is. If it is quite competitive then it is most likely the case that the employee is paying the full 12.4%. And lets not factor in deadweight loss either.
In short, there is alot more work that needs to be done before I’d even consider this project complete.
Current grade: C (for the effort).
Sorry.
Andy is touching on the very point I’m trying to make. SS has been cloaked in a “preventing the elderly from living under a bridge” package when convenient – they need to pull on the heart strings. However, when elsewhere convenient its packaged as “everyone pays in,” “everyone gets a benefit out commensurate with what you paid in” package – they need to make you think you are not about to be frauded our of your contributions.
Balls.
Dave was making the point last week on SS that “a smidge here and a smidge there” and “we can cope.” My response was quantify it, because bills don’t pass with the term smidge.
More fundamentally, money is fungible, and the elephant in the room is Medicare. So you can operate in a wunderworld where SS is “fixed”…….. but they will just be reaching into your pocket for Medicare. Is anyone that shallow?
The transfer payment system is broke. To Andy’s point, if we are humane, we will want to take actions to prevent “under the bridge dwellers.” But politicians have a need to fool the public into thinking they will get money back, or at least a portion. But that ruse has run its course.
Its time to make official what I call the “latent fraud,” have some transparency for the majority to make them wake up, and halt the notion that once again we can raid the bank accounts of the top 3% so that politicians can prance around as heros while continuing the ruse.
PS –
So Steve V swooped in and made the point that makes me so angry about this fraud that has been perpetuated: people make consumption/savings decisions based upon a false notion that transfer payments will be there for them later in life. No they won’t……………………….unless we want to do a double fraud/rape: “hey rich guy, you don’t get SS payments, and open up your bank account!”
I haven’t found a single study that quantifies all of the different approaches for extending Social Security’s solvency out for the full 75 year actuarial period.
I did find a study that found that by returning the proportion of income eligible for FICA to what it was in 1983 you extend the solvency period by about 5 years. That’s not much but it’s something. They also found that if you make all income susceptible to FICA solvency is extended indefinitely. IMO that touches on the fairness issue I mentioned yesterday and I also suspect it would have adverse impact on investment.
I didn’t find what I was looking for: the impact of extending the minimum Social Security Retirement Age to 65, moving forward the point at which normal SSRA is 70, and pushing full SSRA back to 72.
I also didn’t find an estimate of changing the formula for calculating COLAs. IIRC the CBO did such a study but I haven’t been able to put my hands on it.
Steve V.:
Obviously, there’s an endogeneity issue. The Chinese aren’t more virtuous than we are. They just don’t have much of a choice. Since there is no system of general social insurance there, for 95%+ of the people the only retirement plan they have is to save and have their children support them in their old age. If China’s economy is to grow, they need a lot more domestic personal consumption, for that they’ll need to reduce their savings rate, and for that they’ll need a system of social insurance among many other policy reforms.
That’s the key point that I think is being missed here: without Social Security our economic growth and income growth for everybody at all levels would be a lot smaller.
I continue to believe what I’ve been saying all along: we need to raise FICA max a bit, increase SSRA a bit, and means-test a bit (the mechanism that the system has used for means-testing is by adjusting the benefits formula). IMO raising FICA max so that it covers the same proportion of income as it did in 1983 is fair and would extend the system’s solvency by another five years. I think you can expand the solvency period by another five years by pushing back SSRA, and get the remainder of what we need by tinkering with the benefit formula.
I don’t think that abolishing the present system, going to a system of personal accounts that only the top quintile will put much into, and implementing a brand spanking new transfer system that does very much what the present system does is much of an improvement.
One more thing. For half or more of the population it’s not just that they’re unwilling to save. Even if they were to start saving at 10% or 15% a) it would be taxed away and b) it wouldn’t be enough. It’s not a virtue thing. It’s a mathematics thing.
PD –
I’m no annuity guy, but your example makes me intuitively cringe.
$400,000 over 20 years – just depletion of principal – is $1667 per month. And on whatever principal balance you have you can make, say, 4%? That’s $1,333 out of the gate, and declines. An annuity makes sense how?
But to an earlier discussion, it sounds like without SS a person needs about $500K in savings at age 65. How do I get there? Same math. $500K amortized over 20 years is $25K per year, and at 4% on your remaining principal balance you make $20K out of the gate, declining over time, which you have to prepare for. So you have $45K/yr.
Can you save $500K in a lifetime? Well, I put together a back of the envelope excel sheet and if you average $50K in a 30 year career (start at $30K and end at $70K), save 10% a year (6% SS proxy plus 4% for your own account) and make a 4% return real……….yes you can.
I know this will get me in trouble. But I don’t know people who only make $50K per year throughout their lifetime. What is the poverty rate these days? But it seems – admittedly crudely calculated – that SS is obsolete for prudent family financial planners, if you make more. Imagine.
It gets back to my point. I have no problem with safety nets. But I’m thinking this scheme is not right at avg lifetime income over $50 – $60K.
First, here is a link to a calculator that lets you factor SS in or out. I would not start at age 20. That is incredibly rare.
http://www.calcxml.com/do/ret02
Next, you can certainly make a case that you can get a much better return for your money through private investments. But, as Dave points out, it is pretty difficult for many people to achieve that kind of savings level. It then goes back to political feasibility. Can you really convince those at the top to pay in when they will receive no benefits? I am not so sure. As I have looked around at retirement systems around the world, there are nearly all universal. The fact that everyone else has the same problem and solves it the same way says something.
We also need to decide ahead of time what we will do when someone who supposedly makes enough loses big due to a market collapse and ends up with inadequate funds. Do we let them die? If not, why bother saving?
Steve
$50,000 is MEDIAN income for a family of four. The income of the TOP QUINTILE starts at about $90,000. The top 1% starts at about $300,000. The top .1% is over a million.
That’s the point I’m making about private accounts. Most of the people won’t put much into them because they don’t have much to put in and, if we need a supplemental system anyway, what’s the point in abolishing the current system?
Drew, the referenced annuity would continue to pay $1,400 per month until you die, whether its 20 years or 200 years after retirement. (This one just guarantees that if you die before 20 years is out, a designated heir will receive payments up to the 20th year.)
My slight experience with annuities is that they have high expenses and some tricky language. Caveat Emptor.
The life expectance of a 67-yr old man is just under 83 yrs of age (15.77 yrs). I just don’t know that its an adequate baseline scenario for everyone to assume they will live another 20 yrs. That’s an insurable risk that can be valued through an annuity, whether you buy one or not.
Dave, I did look at Kaiser on healthcare insurance on the individual market, and they’re reporting a $215 per month average premium (including both adults and children), which for a family of four would be $10,320. Seems close enough to me.
http://www.statehealthfacts.org/comparemaptable.jsp?ind=976&cat=5
“They also found that if you make all income susceptible to FICA solvency is extended indefinitely.”
This is basically my point. If you have a funding problem, its always solvable if you start from the point of view that you just go get more revenue. Impossible in the private sector, and an path available only to the state.
“For half or more of the population it’s not just that they’re unwilling to save. Even if they were to start saving at 10% or 15% a) it would be taxed away and b) it wouldn’t be enough. It’s not a virtue thing. It’s a mathematics thing.”
Perhaps. I admit I live in rarified air……..by design. But I also have eyes. I watch what people buy in grocery stores and restaurants. In Best Buy. The cars they drive. The implicit notion here is that the vast majority of people are hanging on for dear life. I travel the country for a living. From Maine to Florida and Arizona to Washington State……….oh, and “flyover country.” I don’t see the “hanging on for dear life.” I see people spending, enjoying………..and I suspect spending beyond their means. Think of that what you will. But in my business I probably cover the entire country every three years. This is what I observe. Further, why do we view taxing as sacrosanct. WTF?
“$50,000 is MEDIAN income for a family of four. The income of the TOP QUINTILE starts at about $90,000.”
Since its Dave, I take this as fact. And you can’t ignore it. But it probably substantiates my point that SS should be for those below the median. But it gets more complicated. The last couple years my family has spent alot of time in Michigan. Our daughter was up at Interlochen Arts etc. For those not familiar with the territory, think God’s country, but barren and low cost. So driving through these areas I often mused “what is the real cost of living??”
The point: is that median statistic worth the paper its written on? In downtown Chicago……..no effin way. In Saugatuck? You tell me, Dave. In Boyne, MI? No effin way.
So I admit I’m a bit at sea on this whole debate. Quantifying it is a real birtch.
I have thoughts on the folly of not collapsing SS and medicare – its bad analysis – but I’m tired.
PD –
“Drew, the referenced annuity would continue to pay $1,400 per month until you die, whether its 20 years or 200 years after retirement.”
I understand. Just a friendly hint: their actuaries will beat your actuaries. And if not, the law of large numbers will. I gaur-on-tee.
Be careful, man.
er, Sauganash….
Median household income for Chicago in 2009 (the latest year I could find) was around $46,000. Where I am in Sauganash it’s higher. I don’t know how much higher but since this is about as good as it gets in single family housing in Chicago, it’s higher.
I don’t know about that Dave, it is really just another type of savings, but this kind is government mandated with a deadweight loss. Further, the government then borrows the savings (vs. private sector) that then spends the money. It isn’t like there is free money in here somewhere. Really, what I think China needs is another China, i.e. another country to take over the investing that China will need while it simultaneously increases consumption.
And everybody seems to either have missed my point about the FICA tax or didn’t quite get it….
Currently I contribute around 12% to my 401k. If the labor market is competitive, I’m paying all of the FICA tax. Combine those two together: 24.2% of my pre-tax income is being siphoned off before I see it. A bit under half for my future consumption, the rest for current consumption in one form or another. Of course I can’t save 25% of my pre-tax income because I paying the FICA tax.
Now, would most people save like that if there was no SSA? I don’t know, I imagine at the lower income brackets the answer is, “No.” I imagine that for people in the lower income brackets the marginal value of consumption today is far higher than the marginal value of consumption 25 years hence.
And making sound investment decisions are a problem as well. Many people will likely fail (probably around 50% maybe more).
But the point still remains, when the point is raised, “You need to save at least 25% of your pre-tax income”….uhhh, we are already out 12.4% due to FICA. Everybody can save at least 12.4%, right now, today and they wont miss it if they are forced to do it, and at least you’d avoid the deadweight loss.
It’s the guarantee not just the amount that’s the key.
Here in the U. S. the issue is the lower 80%, not the top 20%. And savings and consumption are in a trade-off position. All of those people saving 25% of their incomes won’t be buying cars or houses.
We can’t make that difference up with exports. Some, yes, but not all. The numbers just aren’t there.
If we change the incentives for businesses, something that I favor, we can make up some of the difference with business consumption. But, again, not all. We’ve got to maintain a high level of PCE.
Steve V, I understood the point about FICA. As I recall, the CBO believed that if you decoupled health insurance from employment, that over time the employer’s health care costs would become the employee’s wages. Based upon this recollection, I think its fair to assume that the employer’s share of SS payments when discontinued would also over time become wages.
Part of the problem is that young peole do not save, they borrow. There seem to be rational reasons to do so, but they won’t get the benefit of a full 47 years of voluntary contributions.
Related to Steve V’s comment, the median family COMPENSATION is closer to 90k:
http://douthat.blogs.nytimes.com/2011/04/18/a-note-on-median-income/
“Now, would most people save like that if there was no SSA?”
I think not. IRAs were made universal in 1981. The Roth IRA was created in 1997. From 1981 to about 2007, personal savings rates dropped. The Roth IRA in particular is a great deal. In a society that is, supposedly, tax averse, this is odd.
Steve
steve,
Personal savings and retirement savings are not the same and are dependent on a number of other factors. While we’d expect the introduction of additional and even superior ways to save for retirement, other factors would make a casual comparison somewhat dubious.
For example, when did SS increase its tax rate under Reagan via the Greenspan Commission and the subsequent legislation? 1983. Could savings have decreased as a result of that increase in taxes? All other things being constant I’d argue yes.
Dave,
But we already have people missing out on 12.4% of their income to pay for current consumption, plus whatever else (if anything) they manage to save. And under a system that is currently heading towards insolvency along with its huge brother Medicare.
Fixing simply will not happen, at least not in a way that will prevent damage to our economy or enhance our future prospects. All of the suggested fixes make sense to do right now, this very month or next, or even within the next 6 months. Will we do any of them? Hell no. In fact, if Barack Obama is re-elected we wont see any meaningful change to Social Security until after 2017 at the soonest. And Medicare you and completely forget about.
You might as well just sit back and try to enjoy whatever is left of the nice ride before things get bumpy.
So where are we? Are we to conclude that the bulk of the population cannot retire w/o SS?
Something is wrong. Some things just don’t pass the snicker test.
BTW, I just used steve’s link and using the same parameters in your base case Dave I find that the retirement savings rate required is 8.7%. Now lets add on the 12.4% so we get 21.1%. That is not that far off from the 25% your base case needs and we have no idea what the costs are in terms of deadweight loss associated with the FICA tax.
The simulation is also extremely sensitive to changes in the age or retirement. A mere 2 years of additional work reduces the amount require to 5.1% or a 41.3% drop in the amount of savings required.
FWIW
That’s one possible conclusion but it’s not the only one and it’s not the conclusion I’m trying to nudge people towards.
Other possible conclusions are that wages are too low or that rent and healthcare are too expensive or that we have too large a proportion of the population earning minimum wage or any number of other possible conclusions, singly or in combination.
The conclusion that I’d like to see people make is that Social Security is a device that, in addition to aiding the poor, enables the economy to grow more robustly than it otherwise would. I gather that Steve V. and, possibly, you think that it’s a bad thing. I think it’s necessary for some proportion of the population and useful for a larger group.
However, I’m well aware that incentives matter. How do we incentivize more saving, do so without bringing the economy to its knees, and do so without completely uprooting the Social Security system? That’s a question. I don’t have a ready answer for it.
One factor about household income is that it varies greatly with the type of household. I’m looking at 2010 census figures for median incomes:
All households: $49,445
All Family households: $61,554
Married Couple households: $72,751
Female Head of Households: $32,031
Male Head of Households: $49,718
Nonfamily households: $29,730
More support for the advice to finish high school, avoid having kids before finishing high school, and getting married.
Trying to pull swome comments and concepts together….
If the predicate is that a majority of people need a SS system because they cannot save enough, we’ve got a real pickle on our hands.
We all send money into a system, get a miserable investment return, and then syphon it back? That doesn’t make any sense.
And if individual payouts exceed what an individual puts in, then there are only two ways to make the system “sound”: 1) have an ever increasing ratio of those paying in to those receiving payments (this is where the “Ponzi” argument comes in, and demographically just won’t work) or 2) acknowledge that this is just a transfer payment scheme from those taxed on a bigger base of income to those taxed on a smaller base of income. But then why not just throw in the towel and call it what it is? A welfare scheme, my original point.
This is the usual point where someone comes in and tells us how the “rich” have stolen from the poor or destroyed the middle class. Hence, we need income redistribution – call it SS, through the tax code, whatever. But I don’t know of the better off stealing or being advantaged such that they can hive off money from the poor or middle class except through government sanctioned subsidy or monopoly power. So if you are a health care provider you have benefitted from the third party payer system and fleeced the middle class. If you get ethanol subsidies – same. If you get “green” subsidies – same. If you are a capital provider to a bank that got bailed out – same. And so it goes.
From where I sit, the SS mess is the canary in the mine illustrating structural problems in our economy and government intervention that are coming home to roost after decades of being ignored or denied. I doubt I’ll get concurrance here.
Drew,
You really have an ability to finesse numbers and finances. It was illuminating, to say the least, reading all your posts on this thread.
To be honest I have not paid much heed to SS, as I never anticipated having it be a part of any retirement plan. It has mainly seemed more like a safety net, than a bonified program that the masses could realistically depend upon.
While I don’t have anything to offer, as you do, to this discussion, I do find that SS, being so pronounced now in partisan debates, is a healthy turn of events. And, it causes one to reflect more on how it could be changed, rather than it can never be changed, as has been the circumstances before the dialogues that have errupted this year.