Very few people buy life annuities. There’s something about giving an insurance company our hard-earned cash in exchange for a lifetime of monthly payments that gives us the willies. It causes us to look for the door.
There are lots of reasons for this: We don’t like giving up control of our money; we think it might be better to spend our money sooner rather than later; and we fear something weird happening, like being hit by a bus before we get our first payment.
And that’s just the irrational side.
The rational side is what economists call the “money’s worth” problem. We’re afraid we’ll get a lot less back than we put in. And we’re right. M.I.T. economist James M. Poterba and other researchers have found that people who bought annuities got back the equivalent of only 85 cents on the dollar. They also found that life annuity offers varied greatly between companies, often by 20 percent.
Well, we have the same problem, in spades, with the life annuity we all buy: Social Security retirement benefits. If we work, we pay the employment tax and Social Security promises to give us an inflation-adjusted life annuity when we retire. Whether we get our money’s worth depends on things like our income, sex, marital status, and when we were born.
Some of the differences in benefits are expected. As I pointed out in a recent column, Social Security isn’t a pension plan. It’s an instrument of government social policy. Lower income workers receive higher benefits for their contributions than higher income workers.
But here’s the rub. The differences may be too great. Worse, while Social Security has always compared well to private annuities in the past, many future retirees will do a lot worse than they would do if they had been able to buy a private annuity.
A recent research note from the Office of the Chief Actuary for Social Security examined the annuity provided by Social Security. The findings show that some people get far more than their money’s worth. Some people get far less.
How much less? Here’s an extreme example. A very low income single female worker who expects to retire next year at 65 will receive $1.51 per dollar paid in while a high income single female worker will receive only 68 cents. A maximum income worker will receive only 55 cents on the dollar. The low-income worker, in other words, receives 2 to 3 times as much as a higher income worker. More important, higher income workers would be better off if they bought a private annuity.
The differences in payouts don’t stop with income. Women get a better deal than men because they live longer.
Then there is the “Leave-It-To Beaver” advantage. Couples with only one earner do lots better than two earner couples because non-working spouses are entitled to a benefit without paying any employment tax. Too bad the trend has been toward two-earner couples since the end of World War II. (For more figures see the table below.)
The figures I’m using, by the way, all bask in the benign assumption that everything will be paid out as scheduled under present law. The ratios will be lower if the employment tax is increased to cover the current revenue shortfall. They will also be lower if benefits are lowered to an amount that is covered by ongoing revenue. More important, the younger you are, the greater the reduction in the money’s worth ratio.
And that isn’t all. The effective benefit payment is also being reduced further by two additional burdens not considered by the Social Security actuaries. First, Medicare premiums are rising faster than Social Security benefits so younger people will pay a larger proportion of their benefits to Medicare. Second, the number of workers whose Social Security benefits are subject to income taxes is increasing because the taxation formula isn’t indexed to inflation.
What’s the bottom line here?
Simple: The squeeze on the American middle class isn’t over. It is just beginning.
Who Gets a Good Deal From Social Security? Who Doesn’t?
This table shows the Money’s Worth ratios for people born in 1949 and retiring at age 65 in 2014. Ratios for earlier years were generally higher and ratios for later years are likely to rise somewhat if scheduled benefits are paid. Future ratios will be lower if the employment tax is increased or if benefits are reduced to meet available revenue. Figures in italic represent money’s worth ratios that are lower than the ratios for private life annuities.
|Career Average Income||All males||All females||Two-Earner Couple||One-Earner Couple|
|Very low ($10,413)||1.36||1.51||1.52||2.70|
Scott Burns is the retired Chief Investment Officer of AssetBuilder, the creator of Couch Potato investing, and a personal finance columnist with decades of experience.