Social Security - Part 2

This is a continuation of my previous entry on Social Security.

I have received some comments, via my blog, e-mail and also directly from those know me in real life, questioning whether the rationale expressed in my previous post holds even considering the massive 'baby boomer' retirement. Some wrote saying that the demographic tidal wave that contributed to the economic growth over the past few decades in the U.S. is now going to 'sink' into retirement, implying those who were propping up the U.S. economy over the past few decades will soon be in need of being propped up themselves.

This point appears powerful at first glance, yet it does not seem to hold up to a basic analysis of current data. The millions of baby boomers who are set to retire from this year on out till early 2020s, are not going to drop off the map. Let's examine this from investing and consumption perspectives separately. If one agrees that a retiring boomer needs at least 60% of his/her pre-retirement income, a basic analysis shows that this money is not going to come from Social Security or personal savings. Let's examine the savings scene first.

Based on Federal Reserve statistics on net worth (2004 data), the situation is grim (median and mean data):

Under 35 years old = $14,200 ($73,500)
35-44 years old = $69,400 ($299,200)
45-54 years old = $144,700 ($542,700)
55-64 years old = $248,700 ($843,800)
65-74 years old = $190,100 ($690,900)
Over 75 years old = $163,100 ($528,100)

In analyzing data like the above table for the entire U.S. population, the median values are far more meaningful than the mean values, which inevitably skew up due to the high wealth disparity among every age group in the country. After all, U.S. is the country with the world's largest number of millionaires and billionaires. It is known that the top 10% of the U.S. is estimated to hold over 70% of the country's wealth and even across the world, the richest 2% hold half of all global wealth. So, let's forget the mean and focus on the median values.

About 50% of the people at or nearing retirement have a net worth below the $150-250K median range for the age groups from 45 till over 75. For the sake of simplicity, let's take the midpoint of this range ($200K) and consider, based on recent data, about 46% of this median net worth is in home equity. Taking this portion away (as housing is required even during retirement), the median investable net worth for this group is about $108K. When I plug this figure into an annuity calculator assuming a 6% moderate growth rate for a 30-year payout period, I get a fixed annual payout of $7,400 (not adjusted for inflation). An inflation-adjusted annuity may only start at about $5,200 a year (I got this for a 65-year old male using Vanguard's annuity calculator while making a few other assumptions).

The average personal income (2006 data from Social Security Administration adjusted for inflation till 2008) is about $41,000. Even if an average retiree needs only 60% of this pre-retirement income, the income needs during retirement are $24,600 on a post-tax basis for the first year, which will rise with inflation in subsequent years. The average beneficiary (May 2008 data from Social Security Administration) receives about $990 in monthly benefits or $11,880 in the first year of retirement. So, SSA benefits and the annuity payout (inflation-adjusted) yield about $17,000 in annual income. This still leaves a 30% shortfall compared to the $24,600 expense requirement and likely a 35-40% short-fall when you consider Medicare premiums (which will be deducted from the SSA payment) and maybe a 45% shortfall if one considers taxes (modest but still has some impact) at these income levels. The shortfall grows further if more than 60% of the pre-retirement income is required during retirement. Remember that all of this applies to the median case, so 50% of U.S. residents will fare even worse than this scenario.

What's the implication of all this? Even for the "median" baby boomer case, staying employed during his/her 60s and possibly into 70s is going to be required to maintain a reasonable standard of living. Guess what happens when the boomers continue to work till say, 70, instead of withdrawing from Social Security at 62 when become eligible? Those 8 years of extra employment generates 6.2% of taxes paid into the SSA system (~$2,500 of SS taxes at 2008 median income levels). This is a double-benefit for SSA. Instead of paying out benefits for 8 or more years, the system is now taking in taxes to shore up its fund. Even if some of the boomers opt for Social Security benefits in their 60s, they will need to supplement it with earned income as the median case example shows. Under current rules, every $2 of earned income reduces SS benefits by $1. All this can only mean that the SSA will have more to payout for those in the queue later.

Staying employed into their 60s and possibly into early 70s is the only option I can see for the current generation of 45+ year-olds with the median net worth figures cited above. So, contrary to being a strain, I see this as a strengthening of the Social Security system. I suspect this may be one reason why the trustees keep extending the year when the trust fund is expected to be fully depleted. I remember the first projection as 2030 about a decade ago, then they adjusted it to 2035, then 2038 and now they project 2041. I believe this will continue to be extended as people are forced to extend their employment horizons and delay taking their social security benefits.