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How to Get Rich Investing in Stocks by Riding the Electron Wave

Social Insecurity

Politics / Social Issues Aug 13, 2010 - 12:31 PM GMT

By: MISES

Politics

Best Financial Markets Analysis ArticlePaul Cwik writes: Oh joy, oh joy! It has finally arrived! You wouldn't believe how excited I was to receive a letter from the Social Security Administration. In the letter, they dutifully showed me how much taxable income I have ever made. (Is it me, or is there something really creepy about that?) They showed me how much I have paid in taxes and how much my employer also "paid." Then they showed me how much my payment would be if I retire at full retirement (67 years old — not 62 or 65 like you may have heard) and if I delay "collecting" until I turn 70.


It is no secret that I turn 40 this year. That means I have another 30 years of work in front of me. I have (for fun) just taken an online life-expectancy survey, and it says that I will live until the age of 86. So let's assume that these numbers are correct. I will work for another 30 years and then have 16 years to spend it all.

According to the Social Security Administration, I will receive $2,522 a month during those 16 years. The value of that money when I turn 70 is a present-annuity-value calculation. For the purpose of this example, let's pick an easy interest rate of 5% per year. So the value of the Social Security payments (compounded monthly) for 16 years at annual rate of 5% is $335,444.57. In other words, for me to privately do the same as Social Security, I will need to have $335,444.57 in cash when I turn 70 and deposit it in a security that has a 5% annual return.

To take this example a step further, how much money would I have to set aside each year at an annual compounded rate of 5% to hit this target? Using some "quick math," we see that I would have to set $5,048.91 aside each year. Well, this does not seem too unreasonable. One might think that this is equivalent to putting away the maximum of $5,000/year in an IRA, and one would not be wrong for thinking that way.

Unfortunately, there is a larger point that has been missed. I have already been taxed for all of the previous years that I have worked. The Social Security Administration informs me that I have currently sunk a little more than $80,000 into this governmental pyramid scheme. Setting aside any interest I could have received over the past 21+ years, let's assume that they give me a lump sum payment today of $80,000.

Suppose that I take that $80,000 and put it into a security that gives me an annual return of 5% and I do not add another single cent. How much would I have when I turn 70? $345,752.00! I have already exceeded the target needed for the Social Security Administration to fulfill its "promise" to me.

Alas, I do not think that it will do me any good to write a letter to the Social Security Administration explaining that I have reached my target and that they no longer need to tax me. In fact, the letter states, quite explicitly, that I must maintain my current earning rate to collect the stated numbers. So at this point any additional taxes that come from me are just wealth extractions with no benefit to me.

You may think that this is a bad deal for me, and it is, but it is going to be much worse for those who are younger than I. At least I am still making a positive rate of return, somewhere between 2% and 2.5%.

A person born in 1988 making $30,000/year can expect to receive $1,539/month in the year 2058. The Social Security Administration says that he is expected to live until the ripe old age of 87. So that's another 17 years after retiring at the age of 70. The annuity present value of $1,539/month for 17 years at an annual rate of 5% is $212,938.88. In order to hit that target, he would have to set aside $1,132.50/year in a 5% security. This amount is only 3.775% of his $30,000 annual income.

Social Security and Medicare taxes are 15.3% of his income. If he invested that 15.3% of his income instead, he would be investing $4,590. Supposing that this annual contribution was invested each year for the next 48 years and the principal was collecting 5% interest, instead of the Social Security value of $212,938.88, he would have $863,036.55! That's a little more than four times the return that Social Security is "promising."

Or, to drive the nail home, he is paying $4,590 a year and is getting a future value of only $212,938.88. If he simply took that money and buried it in the dirt, he would have, after 48 years, $220,320! The bottom line is that, for today's 21-year-old, Social Security is a negative return.

Paul Cwik is associate professor of economics at Mount Olive College. See Paul Cwik's article archives.

© 2010 Copyright Ludwig von Mises - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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