Social Security: A Loser and a Scam

First, a simple question: At retirement would you rather have a million dollars or social security benefits?

The answer to that one should be pretty simple. What boggles the mind, though, is that the former is not altogether impossible; in fact it may be more likely for those in Generation X or younger to save a million dollars than for social security to still be solvent when they retire.

Social Security has been a tremendous source of debate recently – an issue that becomes one of contention from time to time – particularly with the Republican candidates for the 2012 presidential election. Rick Perry has taken plenty of heat for referring to social security as a Ponzi scheme.

Since Social Security was created in the 1930s it has been a controversial issue; becoming only more contentious as the federal government borrowed against the trust to finance other government programs. The idea that it is a Ponzi scheme is certainly nothing new – Charles Ponzi having perpetrated his fraud that coined the term before the Social Security Act was ever passed.

The argument over whether Social Security is a fraud, heated though it is, is quite frankly overdone and irrelevant – not that it is near its end. No offence to Tea Partiers, but the odds of successfully seeking charges against the United States federal government for fraud seems somewhat low.

What can’t be argued about the United States Social Security System is whether it is a good investment plan for Americans. It is absolutely apparent to anyone who does the math that, fraud or not, Social Security is a loser from an investment perspective.

Supporters of social security, due to their lack of investment knowledge and ignorance of time value of money, often argue that Social Security is a profitable system for its participants. They point out that under the current system, Americans are repaid all their contributions in just 5 or 6 years, and that everything paid out after that is a gain to the contributor. This completely ignores the time value of money; and how it grows over time. So let’s do the math:

The average American salary is roughly $50,000 per year, with social security taxes equaling roughly 12.4% of that salary (between employee and employer contributions). With the average working career (over which social security contributions are made) totally roughly 30 years, that means that over the average American’s working life, that American contributes a total of $186,000 to Social Security (12.4% of $50,000 times 30 years = $186,000).

If this American retired at 66, their monthly benefit from Social Security would, by our calculations, come out to $2,841 per month, or $34,095 per year. Going back to the argument made by social security advocates, this American would be repaid their total contributions ($186,000) in just fewer than five and a half years. Can the private sector do better?

Now let’s assume that Social Security doesn’t exist (wishful thinking, we know). To keep this comparison as fair as possible, let’s assume that this same American saves the same portion of their same salary over the same period of time. This time it’s just an in a private investment account.

So, this ‘heartless’ American who is saving in a world without such a benevolent Social Security program saves $6200 every year (12.4% of $50,000) for 30 years, ending when they retire at 66 (just like the last example).

But remember, this savings is done in an investment account, which means that those savings are being put to work in stocks, bonds, mutual funds, ETFs, or some combination of various securities. For a conservative estimate of average annual returns on stocks, let’s use 9%. That’s a good estimate considering the long term historical average returns on the S&P 500 Index, and certainly not impossible if an investor employees a good, competent money manager.

Over their 30-year working career, this second American would have contributed the same amount to their investment account as they would have to Social Security – approximately $186,000. However, this time their contributions would have been growing continually over that period at 9% per year, and compounding. Now it’s time to look at the miracle of compound interest at work.

[For those to whom this term “compound interest” is foreign, the term describes the phenomenon whereby interest builds on itself. For example, consider an average annual return of 10% on a starting investment of $1. $1 plus 10% equals $1.10. $1.10 plus 10% equals $1.21. $1.21 plus 10% equals $1.33. The interest has risen from 10 cents to 12 in just three years. While this may seem negligible, it adds up considerably with larger amounts over longer periods of time.]

This second American, at the end of the 30-year contribution period, have earned an average annual return of 9% (reasonable for a good money manager) on their total contributions of $186,000, would have an investment account worth a total of $987,116.88. Almost a million dollars.

Now, here’s where things get really interesting. This second American could, by extending this scenario, withdraw roughly 9% of their account value EVERY YEAR without depleting the principle, since they’re replacing it with another 9% in earnings during that period. In other words, this investor could withdraw $88,840 every year, or $7,403 each month, and still have $987,116 in their account at the end of each year.

So, while our American on Social Security gets $2,841 every month, our private investor is getting more than two and a half times that amount. Plus that private investor has close to a million dollars in liquid cash if they ever have an emergency.

Before we drop our comparison, there’s just one other point to consider. When American #1, with his or her Social Security benefits sadly but inevitably passes away, their heirs get roughly $0. They don’t inherit a thin dime in residual social security benefits, no matter how much their ascendant received in benefits over the years.

When American #2 passes, on the other hand, their heirs inherit whatever is left unspent from the private investment account – which started at $987,116 at their predecessor’s retirement.

The point is this: Why can’t Americans opt out of social security? There is an argument, and perhaps a valid one, that not all people are sufficiently responsible to save on their own without Social Security. That’s fine; those who want to use the system should certainly be able to do so. Those who don’t want to should certainly be allowed to opt out if they are so inclined.

Granted, in order to institute some sort of opt-out program, there would need to be a transition period. Far too many people have built their retirements totally around social security. To immediately abandon social security would be irresponsible and, quite honestly, unfair. For people over the age of 50, social security was the system they were given, and they made the most of it. Most don’t have enough time to accumulate any kind of significant savings, and pulling the plug on Social Security would leave them with nothing.

Assuming some out-out feature is created, there will certainly be some younger Americans who opt out and prove themselves unfit to govern their own financial future. This has been the argument that has been used for decades to justify the Social Security System. Unfortunately, few politicians have the gumption to state the obvious: Those who opt out of Social Security and don’t save for their future… don’t have one.

Dock David Treece is a discretionary money manager with Treece Investment Advisory Corp ( and is licensed with FINRA through Treece Financial Services Corp. He has appeared on CNBC and numerous radio programs, and also serves as editor of financial news site Green Faucet ( The above information is the express opinion of Dock David Treece and should not be construed as investment advice or used without outside verification.


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