Can we count on Social Security?

This is a perennially popular topic among Americans, and as I recently completed the “vesting” requirement of 40 quarters, a germane one for me. Our beloved Encyclopedia Americana (aka Wikipedia) explains vesting as follows:

In law, vesting is to give an immediately secured right of present or future enjoyment. One has a vested right to an asset that cannot be taken away by any third party, even though one may not yet possess the asset. When the right, interest or title to the present or future possession of a legal estate can be transferred to any other party, it is termed a vested interest.

Powerful words, but do they apply to our Social Security rights? If Social Security is an “intergenerational contract”, as a former U.S. President put it, why can’t I count on reaping benefits from it as I have fulfilled (and continue to fulfill) my obligations to serve the previous generation of beneficiaries? From what I have heard, financial planners run the gamut on this issue. There are those who count 100% on promised Social Security benefits to those who completely write it off for younger clients. Before we try to project a meaningful estimate of what we can get, if any, from Social Security, we have to start with obvious limitations of this exercise.

First, any commentary on social security’s solvency requires some level of assumptions on the U.S. political enterprise and economic growth. Divining the will of politicians is about as certain as predicting the tropical hurricanes twenty years hence. However, much as the future of individual stocks is uncertain but the collective stock market’s future is reliably tied to corporate earnings as a whole, I will make a bold assumption here. While individual politicians will be as unpredictable as individual stocks, the collective political will – over the long term – will reflect the interests of the population. At least, that’s the premise of democracy, with all its attendant privileges and real life absurdities.

I will start with my prediction that vested workers at or above the age of 50 in 2008 will receive their Social Security benefits as promised. The basis for this assumption is that when they become eligible to receive benefits in about 12 years, the current system has enough resources to sustain them for the rest of their retired lives. Moreover, reducing their monthly benefit check after they start receiving it is political suicide for any U.S. administration so, I think it is highly unlikely. Even strong welfare states like France and Germany with a more burdensome system than the U.S. have not cut benefits. So at worse, annual raises may be frozen in the distant future but still, on a nominal basis, those 50 and higher can count on both the vested social security benefits and annual COLA increments. In considering any future scenario, we should not forget that already elderly Americans form a formidable vote bank (and generally, are more likely to vote). Also, this “AARP segment” (i.e. over 50 group) of the population is only going to rise for the next 40 years in the U.S.

The categories of interest are those in 40s, 30s and 20s. Even with the trust fund declining and as current estimates put it, the system starts to draw on their surplus from 2020 or so, by the time the 40-something group reaches mid-60s, most of their projected benefits can be counted for at least half of their retired lives (assuming they live up to mid-90s). In making this assumption, I am considering that the surplus does not fully deplete until 2042 as SSA actuaries estimate using reasonable assumptions. By this time, the youngest of this group – the 40 year olds - will be 74 years old. Beyond that, going by the ‘political reality’ assumption we made earlier that no cut in benefits will be made to those already receiving benefits, at worse, this group will sail through the rest of their retirement years at the nominal value of their benefits, though inflation will reduce the real value of their benefit check every year. It is appropriate to point out here that monthly benefits I cite in this post are all in today’s dollars (estimated from the online calculator in SSA’s website)

For people in their 30s, the situation is more complex. Many people, especially professional immigrants, reach their minimum vesting eligibility in this age group, having worked for at least 10 years by this time. Those who started to work in their lives earlier (say younger than 20), would reach eligibility before their 30th birthday, but they are not a group that can I relate to so, I will exclude them from my analysis. The ‘political reality’ assumption we made earlier for 40s and 50s starts to become less reliable for the 30s set because the distant political will is even more uncertain, unless U.S. becomes a welfare state like much of Europe is (who knows, that may happen too!). However, another political reality assumption is called for here. For those at the lower end of the vesting spectrum, i.e. those whose presently estimated benefits are in the range of say, $400-$1000 a month, there is a definite political ramification to cut benefits compared to those who are slated to receive higher benefits (over $1000 a month and more likely those at $2000 or higher). Now, if you think that is unfair, let me remind you that no matter what is done (or not done) to the ailing Social Security system, some constituency will always get the shaft. In making this assumption, I also considered that Social Security’s primary goal is to prevent elderly Americans who have earned the right to be vested from falling into abject poverty. It is not meant to provide a ‘cushy’ retired life. Also, those whose benefits are less than $1000 a month most likely have earned relatively low wages throughout their working career or possibly have significant periods of unemployment or have fallen out of the SSA net in some other fashion. Imagine a U.S. politician demanding a benefit cut for this constituency. He may never get re-elected or worse, he may not even reach home safely that evening. AARP may offer a supari on him or at least, they will join forces with every human rights group worth its 3-letter acronym to protest. So, I see this set as a reasonably protected segment of beneficiaries.

Into the above protected segment falls a small sub-group, namely high-earning professional immigrants who return to their home countries after minimum vesting in the Social Security system. For those with or just over the minimum 40 credits of vesting, their estimated monthly benefits are likely to fall in the $400-$800 range, below my arbitrary ‘at risk’ criterion of $1000+ per month. While it may be unfair to group the truly disadvantaged people with these high-earning professionals who just decided to work outside the SSA system, I believe eliminating this relatively small sub-group from the large protected segment is impractical and at best, is of questionable value to SSA’s sustainability. There are bigger fish to fry elsewhere! Similarly, limiting these benefits to U.S. citizens and disenfranchising vested foreign nationals has marginal value to SSA’s sustainability and such a move may have some ‘image problem’ for the U.S. as a leading free market democracy whose equal opportunity law covers ‘national origin’. Therefore, I believe this sub-group will see most of their social security benefits intact and at worst, will receive at least 73% of projected benefits from 2042 as SSA currently estimates.

The highest risk group is clearly the 20s. They are unlikely to be vested today and given the long line of people ahead of them in the beneficiary queue, are unlikely to see nearly as much benefit even after vesting when they reach their 60s. Even for this group, going by the ‘pay as you go’ philosophy of social security, there will be some benefit if the projected 2:1 ratio of workers to beneficiaries continues beyond 2050. Note that even if the projected ratio becomes 1:1 (i.e. one worker supporting one retiree), at the current payroll SS tax rate of 12.4% and annual average wage of at least $36,651 (2006 SSA data), an average beneficiary will get a $340 a month in present dollars (assuming a ~10% frictional cost allowance for administration and other systemic costs) adjusted at wage inflation rates in perpetuity.

All the above scenarios assume a future U.S. GDP annual growth of at least 2.5% as considered by SSA’s own trustees, which is lower than the 3.4% that the U.S. has seen over the last 50 years. This assumption is significant because had the U.S. grown at 2.5% instead of 3.4% over the last 50 years, the U.S. economy would be nearly 40% smaller than it is today. So, the future projection does consider a significantly bleaker economic growth picture for the U.S.