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Social Security Rate of Return

February 8, 2010

I recently analyzed the rate of return on social security. Now for most people, this isn’t really interesting. But as a business person interested in numbers and investing, I care how much of my money is being paid in, and how much of it I’m getting back, and at what rate of return (particularly if it’s a negative rate of return).

The formula for benefits used to be very opaque. Nowaday, if you’re good at math and patient, you can calculate your expected benefits at home. The formula makes inflation adjustments and takes the 35 highest wage earning years and averages them to determine your “average annual wages.” Then the government creates three “wage zones” with differing benefits levels. For “average annual wages” from $0 to $9,132 social security will payout benefits equal to 90% of that per year. Above that, from $9,133 to $55,033, benefits drop to 33%, and from $55,034 to $106,000, the benefit drops to 15%. This means that the more you pay in, the worse (by far) your benfits becomes. Above $106,000 there is no required pay-in to social security. (The raw formula is available at here or more clearly here.)

Here’s the graph that shows exactly what this means for you and how much you pay in:

Note the points where the graph bends is where you see a different “wage zone” start/end.

There’s lots of ways to look at the money paid into social security. I don’t like to think of it as giving the government money and hoping they take care of me. Instead, I prefer to think of it as a forced government retirement plan which, after that money is paid in, has a rate of return. I calculate this ROI the way a bank does with an amortized loan. A bank loans me money and I pay principal plus some interest rate. That’s how these investments work.

My Rate of Return

If you click into this graph (I can’t get the silly thing to display any better inside this blog), note the highlighted column. This is the rate of return I receive on my social security pay-ins!

Note that for the first 9k, it’s ok (4.8%), after that, it’s actually highly negative (-13.7%), and not shown is above 55k (remember the other bend point?), the rate of return is substantially worse: -25.5%.

Can this ROI number be different? Definately. For example, this ROI assumes you are a 31 yr old male (me) who lives to an average life expectancy of 76 years old (actuary tables). However, since I have my grandparents genetics, which are ridiculous for longevity, I may well live much longer. The effect of this is a better rate of return. Which makes sense. After I hit the retirement age, the amount paid in is fixed. However, my pay-out amounts depend on how long I live. If I die early, I get screwed, if I live longer, I get more checks from the government, increasing my ROI! Which leads to…

Rate of Return by Expected “Live to” Age


This is a table shows the rate of return depending on how long you live. It breaks into wage zones and then how long you expect to live.

The ROI on wages less than $9,132 is pretty good, particularly as you age. But one has to live until almost 90 before any money paid in on the second wage zone even has a rate of return above zero. For wages paid in the last zone (above $55,033), your return is so negative that you will not see a zero ROI until you’re very old (115 years old).

The Short in Six Sentences
Social Security is a government required retirement plan. Benefit payouts are calculated using three wage zones with three different benefits rates. Calculating the rate of return on your investment (the money paid into social security) depends on how long you live and which wage zone you’re in. The formula provides that: The less you pay in, the better the ROI; the longer you live, the better the ROI. For the wage zones where most people fall, the rate of return is negative, or substantially negative.

Postscript: I am not writing this to thrash social security. My intention is to look at the formula and analyze the numbers objectively and see if there are ways to optimize for my retirement.

Postscript #2: Later, I will add a few more article exploring how if you and your spouse run a business together, the way to increase your Social Security ROI (based on a wrinkle in the payout formula not discussed yet), at what age do you “break-even” (get all your principal back with no interest) , and other details related to this retirement plan.

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One Comment
  1. SS is screwed as an institution because of some fatal flaws: lifespan is increasing but working lifespan isn't increasing as quickly. That means people are drawing on social security longer and longer, and not paying into it at a correspondingly increasing rate. Also, it only works if the population is stable and the people paying in match the people being paid out. If you have unemployment problems, not enough money is going into the pot and you're screwed. If you have growth, then you have to keep growing or stay large in order for the supply of SS to meet the demand, and that's not sustainable.I never figured I'd get SS back when I retire. I'm treating it as a government-issued insurance policy so that if nothing works out for me and I end up with no retirement funds and in big financial trouble, I'll still be provided for when I get old. I think the stats you have that show that the more you make the less advantageous that SS is support that idea, because the more you make the more you should have saved up for your own retirement.

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