By Dale Coberly



A reader asked what interest does Social Security pay on your “investment”?  I think it is important to realize that this is not the important question about Social Security.  Social Security is an insurance program and it doesn’t make any more sense to talk about the “interest” you earn on your “investment” than it would to ask what interest you earn on your car or home insurance. Or grocery budget.

However a person should know what he is paying for his insurance and whether the insurance is worth the premium.  In this sense it might be useful to make an estimate of Social Security’s “return on investment.”  But such an estimate can be dangerously misleading if you do not keep in mind that you are paying for insurance.

By using the 2013 and 2009 Trustees Reports, I have calculated some “returns” reasonably associated with the “premium”… the “payroll tax”… “invested.”  My results compare fairly closely with some standard estimates of SS “return on investment” in the “average” case, and diverge widely in the case of lower earners and what I regard as a more likely pattern of earnings.  Because SS is intended as insurance, the “earnings” of the “average worker” are not as germane to the task of Social Security as are the “earnings” of those who earn less than average.

By taking the “Average Wage Index” as an “average wage” over the 35 years that SS counts  wages (and therefore taxes paid) for purposes of computing your contribution and benefit…

and assuming the one tenth of one percent increase in the tax, per year, that would be required to pay for the scheduled benefits  (discussed at some length in other papers by this author)…

and taking the tax as the premium, and calculating the interest (at a steady rate over the 35 years) on that premium that would be required to generate the amount of money that would be needed, if invested in an annuity at the same rate of interest, to generate an income equal to that of the benefits that Social Security would provide, based on that record of earnings and taxes paid on those earnings, for the life expectancy that the Trustees project for the eventual retiree… the person paying the tax…

The necessary rate of interest would be…

For a low lifetime earner… 45% of Average Wage, about 18,000 dollars per year in today’s terms:

7.23% if you count the tax paid by both the worker and the employer, to pay benefits for for the worker, or

8.74% to pay benefits for the worker plus wife.

If you consider… as i do… that the low income worker would NOT get the employer’s share if the government did not require the employer to pay that share,  the worker would have to earn from his share of the tax…

10.9% to get the same benefit for himself (without wife).

These are “nominal” interest, and assume an inflation rate of 3%, so the “real” interest translates to about

4.3% if paid by both the worker and the employer, with no benefit for wife

5.7% if paid by both worker and employer, with benefit for wife

7.9% if paid by worker alone, without wife.

For an average worker… best 35 years at the Average Wage

6% (nominal, 3% real), if paid by worker and employer, no wife

7.5% if paid by worker and employer, with wife

9.9% if paid by worker alone, without wife

For a high lifetime earner, 160% of average earnings, about 64 thousand dollars a year today

5.2% nominal (2.2% real) if paid by worker and employer, no wife

6.8% if paid by worker and employer, with wife

9.2% if paid by worker alone, without wife

And for someone who earns at the cap for the best 35 years (equivalent to over 110 thousand dollars today)

4.5% nominal, if paid by worker and employer, no wife

6%.. with wife

8.6% if paid by worker alone…. in this case it would probably be fair to consider that the employee has enough leverage to get paid the “boss’s share”, if he is not the boss himself, so the “combined” rate above would be more realistic.

There is some room to complain about these results. For example I only count the taxes from the “best 35 years.”  On the other hand, I think that assuming someone earns at the cap.. or even “high” wage… or for that matter “medium wage”… every year from the day they turn 22 until they retire at 67…  is unrealistic.  Even the low earner is likely to have many years of unemployment, for which he pays no tax, so it would not be reasonable to assume “forty five years of taxes” to get a benefit based on thirty five years of taxes.

What is worse for the calculators of “rate of return” is that they ignore the insurance value of Social Security.  I have personally known people who were high earners until their business failed, or their skills became obsolete, and by the time they retired their lifetime average earnings were not much better, if at all, than medium or even low earners…. in which case they get the “interest rate” of those lower earners;  that is they get a higher interest rate than they would if they had stayed lucky.  That’s why it’s insurance.

So it may come down in the end to an “ideological” dispute between those who are sure they can drive a hundred miles an hour “safely,”   and enjoy the thrill,  and those people who are reasonably sure they can’t… or that not everyone can… and therefore prefer to have speed limits on the public roads. As well as require insurance to drive on them.

At the end of the day, the high earner is not out any money… he gets benefits fully equal to what he paid in, adjusted for inflation, and with a small but not unreasonable effective interest on top of that…..  and he gets to where he is going in just about the same time as it would have taken him if he drove the speed limit.  Maybe faster, considering the time taken by traffic jams cause by wrecks.  And without Social Security there will be wrecks.  (sorry if this metaphor is incomprehensible to you. it makes perfect sense to me.)

I calculated the “Present Value”  of those taxes and those returns.  I found that the present value is critically dependent on the “discount rate” that you choose.   A lower rate will get present values of benefits higher than present values of taxes.  A higher rate will get the opposite.

This leaves it up to the present value people to explain just where in the real world the Social Security “taxpayer” can get an interest rate that will without fail yield the return he gets from Social Security.  Plus the insurance he gets from Social Security, against inflation, against market losses, against his own failure to make enough money over a lifetime to save enough … even at the Magic Present Value Bank… to be able to afford to retire.  That way they don’t have to explain why present value is a useful measure for an insurance program,  or a grocery budget… which is what Social Security is.  Or how the Magic Present Value Bank is going to avoid attendant unpleasant social costs… that is, personal costs to many or most people…. that will follow from large numbers of people reaching old age without enough money to retire.  And remember, it’s their own money.  It’s not welfare. They paid for it themselves.

For those who haven’t figured it out… the “interest” comes from growth in the economy so that, in principle, each generation can pay the same payroll tax rate and yet provide more money to the retired generation than that generation paid in.  This is not theft. The younger generation will get the same deal.  And it works exactly the same as ANY investment.  Except that the Social Security “stock” is invested in “The United States of America,”  the prosperity of which you have something to do with.

I would not take my interest rate calculations too seriously.  But I hope you take the lesson not to take “their” interest rate calculations too seriously either.  There are too many variables for any calculation to be very useful in the end.  What matters is what other “investment” plan will guarantee that you will have “enough” to live on if all else fails?  At a rate that most sane people don’t even notice.