With all the media attention on the approaching fiscal cliff and the need to reduce entitlement spending along with increasing revenue, there has been expanding information about Social Security taxes paid and benefits collected. Most recently I received an email on Social Security titled "Federal Benefit formerly known as Social Security". In the widely circulated message, the writer states " If you averaged $30K per year over your working life, that's close to $180,000 invested in Social Security". In my earlier post of May 23, 2011 on the subject of Social Security and costs per person, I too discovered that an average person pays into Social Security about $198,000, so no argument about this part of the email.
However, later in this same email the writer states: "If you calculate the future value of your monthly investment in social security ($375/month, including both your and your employer's contributions) at a meager 1% interest rate compounded monthly, after 40 years of working you'd have more than $1.3+ million dollars saved! This is your personal investment . Upon retirement, if you took out only 3% per year, you'd receive $39,318 per year, or $3,277 per month . That's almost three times more than today's average Social Security benefit of $1,230 per month, according to the Social Security Administration " Note that this 3% withdrawal rate implies that the average person lives 33 years after retirement to consume the entire amount which means about 98 years old.
This email said this average person could actually have done nearly 3 times better than "investing" this money with Uncle Sam. My "data radar" went off since this was vastly more that my previous post suggested. So I started with the $375/month an average employer/employee paid into SS. I can confirm that this is in the ballpark. Next I had to look at the $375 monthly payment invested at a "meager 1% interest rate compounded monthly". First, compounding an investment at 1% compounded monthly becomes 12.7% annual growth rate (1.01 raised to the 12th power). I would not consider this "meager". Also, if you used this 1% compounded monthly, your $375 monthly payment becomes $4.4 million over this 40 year work career which is very different than the $1.3 million stated in the email.
So maybe the writer meant that "meager 1%" was an annual rate but compounded monthly. If this is the case, then the monthly compound rate would be 0.082954% (1% to the 1/12 power). Compounding $375 per month for 40 years at this 0.082954% rate leads to a final account balance of $220,995 at retirement. If you withdrew 3% a year from this account, that would yield $6,629 / year or $552 / month. This is half of what this average person would get from Social Security.
So, what would the interest rate need to be so that this same $375/month would deliver $1,200/month at retirement after 40 years of employment. Assuming the same 33 years in retirement, this would be 4% annual investment rate, but compounded monthly. This seems about right for a conservative investment rate over 40 years. (Please note that these calculations are all in 2012 dollars and assume that the 40 year invested amount does not continue to earn interest in the 33 years of retirement which seems to be assumption my email writer made)
So, what is my take away from this encounter?? If you get an email from anyone that has been forwarded from someone else and it has math involved, assume it is wrong until you confirm the arithmetic, including this posting! Maybe this is also a indictment of the math education we receive in the US.
