An Update on Annuities vs. Social Security

About a month ago Disqus commenter “Pnwgy” noted an error in my analysis comparing private annuities vs. Social Security. Unlike some conservative writers who compare Social Security with a fixed income annuity, I did play fair and compared SS with an inflation adjusted annuity, which is what Social Security is. But what I failed to realize is that FICA taxes pay for more than annuity; they also include disability insurance, which uses up .9% of the 6.2% FICA tax rate. That is, I should look at how much you would save if you contributed 5.3% x 2 = 10.6% (not 12.4%) to a diversified portfolio during your career and then purchased an immediate annuity with inflation rider with Social Security. Needless to say this makes Social Security look better than the previous edition.

But this leaves us with a mystery: how can Social Security do so well when even under adverse conditions the S&P 500 grows faster than wages? The answer: many contribute without collecting. Illegal immigrants are the obvious example. (And this may be why the federal government is lax on immigration enforcement. No NAFTA conspiracy theories needed.) Also, people who only work as paid employees for a few years (cf. housewives) don’t receive benefits from their contributions (but they do from their husband’s career). This may balance out well enough but a seller of immediate annuities doesn’t get that money.

But here is the big injustice: if you work a full career and die young you don’t get any benefits. Social Security is an annuity you make payments on starting with your first real job. I am being unfair to private sector immediate annuities since they get money only from those who at least reach retirement age. Perhaps more importantly, those who are unhealthy generally opt out of the inflation adjustment rider. Why pay a huge premium for years you are unlikely to live? Private annuities thus suffer from adverse selection.

But note what happens if people saved vs. contributing to Social Security. That smoker who kicks it at 60 leaves a big pot of money to his family. Granted, under Social Security his wife gets the benefit as a survivor, as would minor children. But consider if the wife smokes too and dies young, and the children are adults. Under a savings plan the children inherit. The working class experiences a bit of multigenerational wealth building.

Anyway, for the record we aren’t here calling for simply doing away with Social Security and expecting to save. We call for a fixed amount of free money for seniors to provide a livable, though not cushy, retirement for all citizens regardless of income history. If you want more, save as you will.

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