What is your rate of return on Social Security contributions? Many people believe that it is very low - are they correct? Let's try to provide an answer.
By `rate of return' we do not mean the investment results of the Social Security Trust Fund. Whether the Fund's investments (which are Treasury bonds) have a good year or a bad year, your benefits don't change. Instead we mean: If I had put all my FICA contributions into an investment account over the years, what rate of return would that account need to earn to give me the retirement check that Social Security provides?
We will choose a near `worst case' example: someone whose wages have been at or above the maximum subject to FICA taxes for their entire working life, which we assume began at 22. Our worker was born in 1940 and begins his retirement on Jan 1, 2005.
He received
$1,874 per month ($22,488 per year) from Social Security when he began retirement four months ago. That benefit will increase each year to keep up with inflation. If he had a private account instead of Social Security, he would need have needed an
account balance of $344,500 to fund
an annuity providing that inflation-protected monthly benefit. (The annuity calculator is provided by the Thrift Savings Plan, which President Bush uses as a model for personal accounts. We are assuming that our worker is single.)
We have a complete history of his wages subject to FICA taxes here, courtesy of the Social Security Administration, which also provides a history of FICA rates over the years. I used this data to construct a spreadsheet, whose results follow.
When he started working in 1961, our high wage worker made at least $4800. He and his employer paid $288 to Social Security that year. This rose each year, reaching $10,900 in 2004. He and his employers paid a total of $187,270 over his 43-year career. About half of that $187,270 was contributed in the last ten years.
If he had instead taken the entire amount that he and his employer paid to Social Security each year and put it an a private account, what rate of return would he have needed to receive in order to make his $187,270 grow to $344,500? The answer Excel gives me is:
5.16%.
Social Security benefits are structured to be somewhat progressive: people earning less get back more relative to their contributions. So, workers earning less over their careers will get a higher rate of return.
Is 5.16% a good return? Well, I take more risk and shoot for a higher return in my 401-K and IRA. But, without the floor of benefits that my Social Security contributions provide, I would be much less comfortable risking that money - I would shift it to more conservative investments with lower potential earnings.
In my view, 5.16% is a very attractive return, especially when I consider that I get protection for family if I die young or become disabled.