Social Security

I often refer to social security with a grain, or, perhaps a full dose, of salt.  This isn’t because I don’t think it’s a good system – to the contrary, I’m all for keeping and even expanding it.  The reason for my perhaps cynical view is that it’s difficult to predict future entitlement to benefits, as well as a lack of confidence as to what social security will look like in a few decades.  

As I often stress, it’s important to calculate your future net worth and cash flow to assess whether you have enough money to retire early.  And while social security would appear to be a bonus future income stream, I’m not so sure it’s reliable enough to count on.  Let’s talk about why and consider whether there’s a compelling case that I’m (hopefully) wrong.

Before we delve in too far, this post will only be relevant to those who live and work in the United States.  Other countries have a variety of different retirement programs, but in this post I’m specifically talking about the U.S. Social Security system and those who have a Social Security number.  That is, the ten digit identifier that you’ve been told both to memorize and to guard with your life.

When you first started working, you probably noticed a deduction from each paycheck for social security.  The US Social Security system gets its money from a payroll tax that workers pay when they earn wages.  Each year, the social security tax is about 6.2% of an employee’s wages, up to a ceiling that changes each year.  Basically, the social security tax only applies on income up to a certain amount, and then not to income over that amount, meaning you might see your paycheck go up after you’ve earned more than the threshold each year.

The money deducted from your paycheck ends up in a trust fund administered by the Social Security Administration (SSA).  The money administered as social security funds several different types of social programs, but for our purposes, we’re discussing the retirement portion of social security.

How much you’re entitled to receive in social security when you retire comes down to a formula, that, when you first look at it might seem complicated, but in reality is actually not too bad.  Essentially it depends on how much you contributed and for how long, as well as when you start requesting to receive benefits.  Over time, social security benefits are also updated to account for things like cost of living adjustments. 

As of the time of writing, the minimum age to be eligible for social security payments is 62.  The minimum age has risen over time, and it wouldn’t be unreasonable to expect that it will continue to do so.  The minimum retirement age is, as you might expect, one of the more hot button issues associated with social security.

You can actually get an estimate of your anticipated social security benefits on the Social Security Administration’s website: https://www.ssa.gov/benefits/retirement/estimator.html.  But be forewarned, the estimate tool is of little utility to anyone with variable income or who wants to retire at an age other than 62, 67, or 70.  It’s not of much use for a FIRE investor or really any retiree who plans to stop working at a non-traditional age.

So why do I discount social security as a source of income for a FIRE retiree?

Let’s start with the basic point that you might have deduced from the overview above: it’s difficult, if not impossible, to calculate how much you might be entitled to when you reach the eligibility age.  You can go to the SSA’s website and enter your current income, but the projection it gives you assumes that you continue to work and earn the same income until the ages of 62, 67, and 70.  There’s no way to estimate how much you’ll be entitled to if you work until age 45 and then claim benefits in the distant future.

What this means is that if you’re projecting your future income and net worth, any amount you put in for social security is based almost entirely on speculation.  Now, it’s not as if every other projection you make is based on exact science (i.e., the estimated 6% annual return), but those are at least based on historical returns.

You could always put in an extremely conservative estimate of future income from social security.  Say, a few hundred dollars per month.  What’s the harm in that?  Likely you’ll be receiving more, though you can’t really know, but at least you’re factoring in something, right?  Ok, valid point, subject to the coming discussion.

On to the main concern about the social security system.  Now, I’m not going to use the term Ponzi scheme to describe social security, but many others have – seriously, look it up.  While there are many differences between a Ponzi scheme and social security (namely, support of the government and greater knowledge about how it operates), there is one parallel that has probably contributed the most to this unflattering comparison.  And that is that social security payments are funded by contributions to the system by current workers.  When your paycheck goes into the social security trust, it’s not held in an account for your benefit in the future.  Rather, your money goes to pay out current beneficiaries, which is, more or less, how a Ponzi scheme operates.

Social security therefore relies on continued funding from workers.  For some time in the past, up to about 2009, there was actually a surplus of funds in the trust.  So great!  But, changing demographics have put this into doubt.  For one, starting in about 2009, waves of baby boomers started to hit retirement age, and hence started to collect social security money.  At around the same time, the work force itself started to shift, with fewer workers actually paying into the social security trusts.  So you can see where the problem is.  Fewer contributors plus a greater number of beneficiaries equals a decline in the funds available. 

Now, it’s tough to estimate how long the social security trust might last, as there are just so many moving parts to it.  Not to mention, the government has options to keep it afloat if necessary.

But, that brings me to my next point, which is that there are those in the government, and those who support them, who argue that social security should be privatized.  As in, stop requiring contributions from payroll and allow people to invest money themselves.  The argument goes that individual investors could achieve a much greater return on investment than what they get by paying into and collecting social security.  Essentially, the theory is that personal investing vehicles like IRAs and 401(k)s are better than the government handling retirement – similar to what happened to pensions.  Invest on your own and do better, they say.

Now, I won’t argue against the merits of personal investing; obviously, this whole site is dedicated to personal investing.  But I will say that shifting the entire risk of retirement to individuals is not the way to go.  While I definitely think there’s value to be had investing what we can afford, balancing risk is just as important and social security is an excellent balance of risks.  After all, there are many people who wouldn’t be able to afford saving for retirement without social security, and there are many people for whom investing continues to remain a mysterious topic.  And it’s impossible to blame anyone who feels that way – read the news and it seems that all you see are alarmist reports about how risky it is to invest and that the market is seemingly always one day away from complete collapse.

Ultimately, having a government-run program is an important safety net to ensure that people have money to live off when they’re older, whether retired or because they can no longer work.  Shifting that burden to individuals runs too much of a risk that people will be left destitute and without the ability to work, which adversely impacts the people who need it the most.  In fact, it wouldn’t take too much work to demonstrate that privatizing social security would bring the most benefit to those who are essentially already well off enough that they probably don’t even need social security in the first place.

So with that, you have my opinion that social security is a vital program that protects the ability of people to retire and/or to receive income in the later years of life when they can no longer work.  Unfortunately, not everyone agrees with that sentiment and that’s the source of my warning not to rely on social security as part of your projections of future income.

Undeniably there is a potential liquidity issue in the future for social security insofar as there may come a point when beneficiaries would be drawing more funds than are being paid in to sustain the balance in the trust.  And that will require some kind of solution if social security is to continue without a drastic reduction in benefits or its complete elimination.  

The fact that something needs to be done is the potential source of the issue.  Obviously, there is plenty that can be done to keep social security in place, such as, for example, requiring greater contributions from those with higher incomes (i.e., a more progressive tax), reducing benefits to those who don’t need it as much, and guaranteeing social security from other revenue sources.  But as you may recognize from these options, they’d require the federal government to take action to alter how the social security system functions.  And some of the options may just be politically infeasible unless there’s a drastic change in how the US government functions.

Now, I don’t think social security is doomed.  Like any major government program, there’s some inertia that would very likely keep it in place.  Even if the options to sustain it might be a political challenge, allowing a major program like this to expire, particularly one on which so many people rely, is equally unpalatable.  But something does have to happen to avoid a liquidity crunch, and it could very well depend on what the government looks like when the time comes.

If anything, the main takeaway here is that the future of social security is somewhat unpredictable.  First, even assuming no drastic changes to the system, predicting future entitlement to social security payments is at best a highly speculative exercise, especially for someone who expects to retire early.  

Second, it’s difficult to say what the future of social security holds.  Without some sort of adjustment to the way the system works, it would appear that it may be unsustainable.  And while I certainly hope that the government keeps social security in place without reducing its benefits (and even enhancing them to those who need it), it’s extremely difficult to predict whether this will happen given the political discord over how this would be accomplished.  While I doubt that social security would be eliminated or fully privatized, it’s simply impossible to know what the future will bring.

Without a doubt, investing toward FIRE depends on planning.  When your goal is to give up, or significantly reduce, your income from wages, it’s vital to ensure that you have a reasonable chance of covering your living expenses.  To do this takes a good understanding of how much you need to save, how much your investments should return, and how much you’re going to spend.  

The social security part of this equation just doesn’t fit nicely into the planning needed to accomplish FIRE because it’s simply too unpredictable.   If part of your FIRE planning includes a cash boost from social security when you hit 65 or so, you may be a bit off-course.  If you read this site, you can probably tell that I tend to add cushion to everything to reduce my risk.  But even if you’re more of a risk-taker, relying on social security down the road really thins your margins.  It would definitely appear, given the discussion above, that a more prudent strategy would be either to save more while you’re working or work for a little longer so that your invested assets are more likely to carry you as long as you need them.

For the sake of all retirees and those who need it otherwise, let’s hope that social security continues to remain the way it is, or even gets better.  For the FIRE investor, however, give good consideration to whether to include social security in your long-term retirement plans.