How good or bad is the Social Security retirement benefit? How does it compare with a hypothetical 401(k) plan with identical contribution rates? How does the Social Security retirement benefit compare with the retiree's immediate pre-retirement annual earnings? Is Social Security a welfare program or just another regressive tax that bears more heavily on low income folks than it does on high income folks?
Experts know the facts upon which answers and opinions can be premised. Most people do not. So here we go. I supply a few facts. You can form an opinion. To make things a little bit simpler I have stated everything on an annual basis because annual amounts are easier to relate to one's personal situation. The Social Security Administration deals in monthly amounts.
1) Social Security retirement is a defined benefit retirement plan. If, instead, Social Security had been structured as a pure 401(k) program with identical contribution rates, most participants reaching the full retirement age of 67 in 2010 would have received a much higher monthly pension than that which they receive under the present Social Security formula.
For example, an individual who retired on January 1, 2010, would have received a Social Security pension ranging between about 45 percent and 90 percent of what would have been received from a hypothetical 401(k) plan with identical contribution rates, depending on how much he or she earned while working.
2) The spousal provision raises the benefit by up to 50 percent. An individual with a spouse of the same age whose annual 35-year earnings just happened to coincide with each year's Social Security earnings limit (the level of annual earnings above which the Social Security tax rate drops to zero) would receive a combined (individual and spousal) Social Security benefit that is approximately 70 percent of what a comparable 401(k) plan would have delivered.
3) Only the lowest of low earning recipients can replace pre-retirement annual earnings with their Social Security benefit. This is so because Social Security's defined benefit formula greatly favors lower earning recipients. Those who retire in 2010 receive a basic benefit equal to 90 percent of the first $8,928 of what is called 35-year "average inflation indexed annual earnings." For those with average earnings above $8,928, the fraction drops off rapidly, reaching 15 percent for earnings in excess of $53,796. The spousal benefit pushed replacement over 100 percent for a husband and wife.
For this reason it is difficult to categorize Social Security as regressive based solely on a comparison of tax rates.
Although the tax falls more heavily on lower-income earners, the benefit formula compensates. Almost no one would have done better under Social Security over the past 35 years than under a comparable, hypothetical 401(k) plan, but low earners would have done relatively better than high earners.
4) Social Security's main plus is that it forces people to save for retirement, albeit at actuarially unfair rates.
5) The fact that Social Security benefits continue until the beneficiary dies is only a partial plus. Again comparing Social Security with a hypothetical 401(k) plan for an individual who retires in 2010, the majority of 401(k) holders could have purchased a lifetime annuity at retirement that equaled the Social Security benefit. In most cases they would still have had something left over.
Caveat: The facts provided here are in part determined by assumptions that I believe to be reasonable. They include assumptions about past and future rates of return on a 401(k) plan, life expectancy, lifetime employment and unemployment, retirement age and spousal age. I would be happy to provide details upon request. An informative article can be found in the October 2008 Social Security Bulletin available at www.ssa.gov.
David M. Reaume is a Washington state-based economist who was based for many years in Juneau. His opinion column appears every month in the Anchorage Daily News.
DAVID REAUME
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