Social Security is no longer a good deal for working people. Even if the program could pay all of its promised benefits, those benefits would represent a low, below-market rate of return on the huge taxes workers and their employers pay into the system.
Workers would get much higher returns and benefits if they could save and invest their payroll taxes in their own personal savings and investment accounts.
The average monthly Social Security benefit today for a single retiree is only $920. For most workers, even if Social Security manages to pay all promised benefits, the real rate of return under the program will still be 1% to 1.5% or less. For many it will be zero or even negative.
By contrast, the long-term real return on corporate stocks has been at least 7% to 7.5%. The long-term real return on corporate bonds has been around 3.5%.
This large difference in returns adds up to an enormous difference between the benefits offered by Social Security as it is and the benefits that could be earned over a lifetime if Social Security were reformed with personal retirement accounts. In a study for the Institute for Policy Innovation, I showed how much the difference would be based on the Ryan-Sununu bill.
The bill would allow workers on average to invest 6.4 points of their 12.4% total payroll tax in personal retirement accounts.
Take a middle-income couple. The husband, age 40, earns an average income of $40,000 this year, and the wife, also age 40, earns an income of $30,000, which is consistent with Census Bureau data regarding the average income of two-earner married couples. They each started working at age 23, with the husband earning $20,202 that year and the wife earning $15,152. They also each earn only the average salary increase each year.
With a diversified portfolio invested half in bonds and half in stocks, and earning the standard, long-term market investment returns discussed previously, the couple would reach retirement with a total fund of $668,178 in today’s dollars after adjusting for inflation. That fund would be able to pay them about 60% more than what Social Security promises, $4,987 per month compared to $3,133. Remember this results from contributions to the accounts of only about half of the total payroll tax.
Now suppose the couple invested two-thirds in stocks and one-third in bonds over their lives, which is actually the default option under the Ryan-Sununu bill. The couple would then reach retirement with $829,848 in today’s dollars. That would be enough to pay them over twice what Social Security promises, $6,605 per month to $3,133.
Now, look at the potential benefits for a low-income worker, age 40, who earns only $20,000 this year. This worker did not go to college, entering the work force instead at age 19 and earning only $8,600 that year. He also earns only average wage increases each year, which leaves him in the same position relative to other workers each year as a worker earning $20,000 this year. Assume again he is able to exercise the Ryan-Sununu personal account option from the start of his career.
With a portfolio of half bonds and half stocks earning standard returns, the worker would reach retirement with a trust fund of $271,505 in today’s dollars. That fund would pay the worker 84% more than Social Security promises, $2,156 per month compared to $1,172. With a portfolio of two-thirds in stocks and one-third in bonds earning standard returns, the worker would reach retirement with a personal account fund of $347,827 in today’s dollars. That fund would be enough to pay him more than twice what Social Security promises, $2,762 per month compared to $1,172.