Social Security Privatization Made Easy

Privatization of Social Security is still a hot topic in the Combs house. I started drawing Social Security at my normal full entitlement age, in my case 65 years and 10 months (I was born in 1942). However, Alice waited  until she was 68 before starting.

Both of us knew that Social Security wouldn’t pay me much, even though I earned above or near the maximum for FICA contributions for almost all of a working life now approaching fifty years.

Over the years Alice and I have heard Democrats putting down Social Security privatization, saying that it wouldn’t pay as much and was too risky. As a test, I thought it would be a good idea to use real income and contribution amounts to get an accurate estimate of how a person would have fared if Social Security had always been privatized. Fortunately for my project, Alice had “Your Social Security Statement” in one of her voluminous files (she never throws anything away) and I copied her Social Security income by year onto an Excel spreadsheet, beginning with the $40 she earned in 1959.

The next part, calculating how much Alice contributed to Social Security each year, took a little research. Happily, such research in the Age of Google is the essence of simplicity, and I immediately found a Social Security page on JustFacts.com that provided a table of Social Security tax rates:

Year Social Security Tax Rate
1950 3%
1960 6%
1970 8.4%
1980 10.2%1990 12.4%
2000 12.4%

By multiplying Alice’s Social Security earnings each year by the tax rate for that year I calculated how much Alice contributed each year. Since Alice earned more than the Social Security ceiling since 1977, I projected her income and contributions through the end of 2008 and found she had contributed a total of $220,254.56 from 1958 through 2008.

The next part was simple, but a bit tricky since it required me to select a table of values for stock market investments covering at least a half century. I selected a table of the Compound Annual Growth Rate (CAGR) of the S&P 500 for two reasons. The CAGR gives about a one percent lower rate of return than using simple averages, but avoids the valid criticism that a simple average method mechanically distorts the effects of year-to-year fluctuations. The other reason I chose it was that an index of the S&P 500 reflects a simple, inexpensive mutual fund investment option that has been available for a long time.

I used the date range calculator for each of the fifty years 1958 through 2007 (I valued 2008 FICA contributions at face value). It was laborious work, but now you don’t have to do it, because I’ve done it for you.

(For example, a dollar invested in the S&P 500 in 1958 is worth $32.57 today. Multiply your FICA contribution in 1958 by $32.57, and you would have its value now.)

Year Compound Annual Growth Rate
1958 $32.57
1959 $24.78
1960 $23.22
1961 $24.19
1962 $20.18
1963 $22.88
1964 $19.28
1965 $17.06
1966 $15.65
1967 $17.98
1968 $14.97
1969 $14.05
1970 $15.87
1971 $15.85
1972 $14.37
1973 $12.43
1974 $15.00
1975 $21.29
1976 $16.23
1977 $13.63
1978 $15.37
1979 $15.42
1980 $13.71
1981 $10.90
1982 $12.12
1983 $10.53
1984 $8.98
1985 $8.85
1986 $7.01
1987 $6.07
1988 $5.92
1989 $5.27
1990 $4.14
1991 $4.43
1992 $3.51
1993 $3.36
1994 $3.14
1995 $3.18
1996 $2.37
1997 $1.97
1998 $1.51
1999 $1.19
2000 $1.00
2001 $1.11
2002 $1.27
2003 $1.66
2004 $1.31
2005 $1.21
2006 $1.17
2007 $1.04
2008 $1.00

Now all you have to do is post this to your Excel spreadsheet, and multiply your contribution each year by the CAGR value for that year. When you’re finished, just sum the total and you will find how much your contributions would be worth through 2008 if they had been invested in an S&P 500 index fund. (This fund would be much larger if you assume that dividends are reinvested.)

Alice would have had a fund worth $765,722.90. If she drew on it now, at the rate of the $2,000 per month Social Security would pay if she started now, it would last her 32 years, or until she was 98 years old, even if she never re-invested a penny. That’s a good thing, since Alice, then at age 66, had a life expectancy of another 18 years to the age of 84. If she only made it to 84, by drawing out $2,000 a month she would still have about $333,000 left to pass on in her estate.

(Unfortunately, in our current government-run system, as soon as you die, your Social Security disappears unless you have the unlikely situation of a spouse who does not qualify in their own right, or unmarried minor children.)

Alice, being a very successful businesswoman, would of course re-invest her privatized Social Security funds, and would probably just leave it in an S&P 500 index fund.

The average rate of return for all holding periods beginning in 1926 (the year the S&P 500 was actually founded) is 11.0%. The average rate of return for all holding periods beginning in January 1945 is 11.6%, and since January 1980, the average rate of return for all full-year increment holding periods is 13.9%.

Let’s keep it simple and say that the market can only do 10.0% per year, so in each month of 2009 Alice leaves the principal alone and only takes out as income the average monthly increase of $6,380 ($76,560 per year), which is about 3.2 times larger than she would have been paid under Social Security.

Don’t forget, Alice can keep drawing on her funds at this rate for years and still have over $765,000 untouched to pass on tax-free one day to her heirs (assuming that politicians don’t get greedy, as they usually do, and levy an exorbitant Death Tax on these previously taxed funds).

So why don’t we have privatized Social Security? To answer this question, ask another question. Why aren’t there any funds in the Social Security Trust Fund?

There aren’t any funds in the Social Security Trust Fund because Democrat politicians realized that historical Social Security surpluses could be diverted to finance current spending through the simple device of replacing the Trust Fund surplus dollars with special Treasury Bonds (or government IOUs).

In essence the government said, “I’ll borrow from myself, spend the money, and when Social Security goes into deficit spending in 2010, I’ll increase payroll taxes plus borrow from the General Fund – excuse me, sell back the IOUs, causing the General Fund to borrow and increase taxes to make up the deficit - while pretending the whole time that Social Security is solvent until 2035. By then I’ll be long retired, and some other poor suckers will have to try to clean up the mess.”

Our government has always trusted that we are primarily too stupid, and secondarily too greedy, to privatize Social Security. Too stupid to realize Social Security is a horrible investment for workers, but a great cash cow for politicians to tap for funds to spend to buy our votes. Then we have to be too greedy to stop them from buying our votes and to phase in privatization to pass down a better system to our descendants.

As a final point, and one deserving of a post all its own, if we all had been paying into a privatized account, an S&P 500 index fund (the S&P 500 contains 70% of our stock market capitalization), instead of a government deep in debt, we would have an economy awash in capital. All of our contributions invested in our economy instead of frittered away by politicians would be powering economic growth, and high levels of research, development, and innovation.

As an incidental consequence, the high level of economic activity would also be generating high tax revenues, especially at reduced tax rates.

We would have universal health care through personal Medical Savings Accounts, not a bankrupt Medicare system and Medic-Aid that has been cut so much that doctors are refusing Medic-Aid patients.

We have seen the future, and it works, but only if we can take back control of it from the politicians.