SOCIAL SECURITY REVISITED

In January Allan Sloan, senior editor at large of Fortune magazine wrote about privatization of Social Security:

If your year-end 401(k) statement made you feel like barfing, I have one consolation for you: it could be worse. How's that possible, given how horrible last year was for investors? Simple: If you're not close to retirement, you've got time to recover.

If, however, you were forced to buy a lifetime annuity with your current balance - when you buy such an annuity, you trade your cash for a series of guaranteed payments for the rest of your life - you'd be making your loss permanent.

Sloan argues that’s bad, because

Social Security benefits, of course, are set by a formula that isn't affected by markets moving up, down or sideways.

Those quotes interest me, since I first wrote about privatizing Social Security here. In that post I used my own FICA tax history to show that I would have gotten a much better return on the FICA withholdings if they had simply invested in the stocks comprising the Dow Jones Industrial Average (DJIA) and the accumulation annuitized on retirement.

In a later post, I looked at John and James Doe, identical twins with the same minimum wage history, one invested in the DJIA and the other invested in Social Security over a 50 year period. On retirement, James, who had invested in the stock market, had a retirement income 31% greater than that of his brother.

Both of Sloan’s statements above are true, of course, but they are beside the point. The real question is this: Even if the market goes south – way south – just before retirement, are you still better off than you would be under Social Security?

The question isn’t academic to me; I’m in exactly that position. So I reopened my original investigation using today’s market drop to see what happens. Here’s the methodology.

I first calculated my Social Security income starting in January 2011, the year following my 66th birthday. I used the detailed ANYPIA calculator available from the Social Security website with my FICA contribution history. It’s accurate to within a few pennies.

I then calculated what the growth of my FICA contributions would have been had they been invested in DJIA stocks in the year the FICA contribution was made, dating from the first contribution in 1962 through the 32% market drop in 2008.

For 2009 and 2010 I used FICA contributions based on current salary, and assumed that in 2009 the market will drop an additional 16% and recover in 2010 to grow at a modest 6%.

These assumptions are roughly equivalent to market conditions during the recession of 1973-74.

I then converted the accumulated growth to a joint life with 10-year minimum payout annuity to get the equivalent Social Security payout. An annuity calculator is available here.

The results? If only the employee half of the FICA contributions had been invested in the stock market, in 2011 I would take home 20.6% more than my predicted Social Security income. If both employee and employer contributions were invested, my take-home in 2011 would be a whopping 41.2% more than Social Security.

But, you say, Social Security benefits will always be there. Sorry, not so. Social Security is already in trouble; it’s running out of money and the demographics are wrong for a tax-increase solution. I’ll probably be okay, but my children and grandchildren will not.

The truth is that the stock market will always be there; Social Security may not.