Return on SS "Investment"

[Gone4Good]

I'm curious if there's a simple source or rule of thumb regarding what kind of benefit increase one might expect from Social Security for paying one additional dollar in Social Security taxes (assume no other income taxes apply.)

I know I can go to the SS website and play around with their calculator. I also know it's probably supper specific to each person's age, marital status and work history. Still I'm wondering if anyone has already thought this through?

Alternatively, if you could choose to pay into the system, would it be a good investment to pay more in SS taxes in exchange for the increased benefit?

 

[MichaelB]

I'm curious if there's a simple source or rule of thumb regarding what kind of benefit increase one might expect from Social Security for paying one additional dollar in Social Security taxes (assume no other income taxes apply.)

I know I can go to the SS website and play around with their calculator. I also know it's probably supper specific to each person's age, marital status and work history. Still I'm wondering if anyone has already thought this through?

Alternatively, if you could choose to pay into the system, would it be a good investment to pay more in SS taxes in exchange for the increased benefit?

The future payout is indexed to the National Average Wage Index. You have to make an assumption how the index is going to change. From the 60's and 70's it grew much faster than inflation, but that rate of growth seems to have slowed considerably, and since the year '00 there has been little real change.

 

[Meadbh]

Not US Social Security, but here is a recent study of the Canada Pension Plan. Looks like the early birds caught the worm!

https://www.fraserinstitute.org/studies/rates-of-return-for-the-canada-pension-plan

 

[Independent]

I also know it's probably supper specific to each person's age, marital status and work history. Still I'm wondering if anyone has already thought this through?

Yes

First: Your work record may put you into the 90% band, or it may put you into the 32% band, or the 15% band, or the 0% band. That's a huge range.

Second: If you're 25, additional earnings might "buy" a 40 year deferred annuity. If you're 65, those same earnings "buy" an immediate annuity. 40 years of interest is a lot of money.

For those two reasons (plus marital status, disabled children, your health, etc) this question only makes sense for specific examples.

 

[Independent]

Getting to something relevant to most posters here, if your average annual covered wage (average of top 35 years of indexed earnings) is more than $62,000, you'll be in the 15% band.

An extra $1,000 of earnings produces an extra annual benefit of $4.28 starting at you FRA. ( .15 x $1,000 / 35 )

The SS taxes on that $1,000 are $124. But, some of that tax covers disability benefits. If you want to focus on retirement only, maybe $100 of the tax is the Old Age portion.

So you're buying a deferred annual life annuity of $4.28 for a $100 single premium.


BUT, that assumes this year's income doesn't "knock out" any prior year (i.e. that you don't have 35 years of prior earnings). If it does, and the "knocked out" year had $D of earnings, then the first $D of this years earnings don't provide any additional SS benefit. The factor above only applies to this year's earnings above $D.

 

[Gone4Good]

Getting to something relevant to most posters here, if your average annual covered wage (average of top 35 years of indexed earnings) is more than $62,000, you'll be in the 15% band.

An extra $1,000 of earnings produces an extra annual benefit of $4.28 starting at you FRA. ( .15 x $1,000 / 35 )

The SS taxes on that $1,000 are $124. But, some of that tax covers disability benefits. If you want to focus on retirement only, maybe $100 of the tax is the Old Age portion.

So you're buying a deferred annual life annuity of $4.28 for a $100 single premium.

BUT, that assumes this year's income doesn't "knock out" any prior year (i.e. that you don't have 35 years of prior earnings). If it does, and the "knocked out" year had $D of earnings, then the first $D of this years earnings don't provide any additional SS benefit. The factor above only applies to this year's earnings above $D.

Thanks for your answers. After finding this worksheet that describes how benefits are calculated I came to much the same conclusion.

Basically SS looks like a great investment if your peak average earnings over 35 years is less than $10K per year. If you're in that bucket paying an extra dollar in SS taxes nets you mid-double digit returns to your benefits. If you're above that earnings range it's tough to get a positive IRR unless you live to 80 or older.

P.S. For my IRR calcs I used the full self employment tax of 15.3%. The question I was trying to answer is whether it makes sense to claim an extra $1 in freelance income to garner the higher SS benefit. The answer seems to be "no."

 

[pb4uski]

Not aware of any rule of thumb, but I just did the following out of curiosity.

Using the SS earnings from my SS statement and historical SS tax rates, I calculated the SS tax paid by me and my employers during my career. Then I went to Vanguard and got a quote for a 100% joint life CPI-U adjusted annuity commencing at my FRA... I averaged the two premium amounts (from AIG and PFG). I used the joint life since payments would continue for my or DW's life, whichever is later. I then calculated the interest rate at which my SS tax paid (assuming it was paid on June 30 of each year) accumulated to the premium for the CPI-U adjusted annuity on the premium due date using the Goal Seek function within Excel. The calculation suggests that the "return" on SS for me is 5.02%... IOW, what my employers and I paid in to the system, accumulated at 5.02% would be sufficient to buy a CPI-U adjusted annuity that has benefits similar to my SS benefits including survivorship benefits for DW.

However, the actual return is theoretically higher in that I have ignored the value of disability and survivor insurance that is embedded in the SS taxes I have paid that would have paid disability benefits to me had I become disabled or survivor benefits to DW, DD and DS if I had died and I have no convenient way to bifurcate out the value of that insurance.

FWIW, I was a high income earner for the second half or so of my career so I would suspect that my "return" of 5.02% is probably lower than what someone in the same circumstances but with lower earnings would have as SS benefits are skewed in favor of lower income participants (not a complaint... just stating the facts).

 

[brainsqueeze]

Getting to something relevant to most posters here, if your average annual covered wage (average of top 35 years of indexed earnings) is more than $62,000, you'll be in the 15% band.

An extra $1,000 of earnings produces an extra annual benefit of $4.28 starting at you FRA. ( .15 x $1,000 / 35 )

The SS taxes on that $1,000 are $124. But, some of that tax covers disability benefits. If you want to focus on retirement only, maybe $100 of the tax is the Old Age portion.

So you're buying a deferred annual life annuity of $4.28 for a $100 single premium.


BUT, that assumes this year's income doesn't "knock out" any prior year (i.e. that you don't have 35 years of prior earnings). If it does, and the "knocked out" year had $D of earnings, then the first $D of this years earnings don't provide any additional SS benefit. The factor above only applies to this year's earnings above $D.

said another way, $2,000,000 of lifetime wage adjusted earnings puts you into the 15% range. You can earn $62,000 each of 35 years, or around the SS max for about 17-18 years or somewhere in between - either way, each additional dollar earned is benefitted at only 15% and at that point, doesn't have a large impact on your SS benefit.

 

[Huston55]

Not aware of any rule of thumb, but I just did the following out of curiosity.

Using the SS earnings from my SS statement and historical SS tax rates, I calculated the SS tax paid by me and my employers during my career. Then I went to Vanguard and got a quote for a 100% joint life CPI-U adjusted annuity commencing at my FRA... I averaged the two premium amounts (from AIG and PFG). I used the joint life since payments would continue for my or DW's life, whichever is later. I then calculated the interest rate at which my SS tax paid (assuming it was paid on June 30 of each year) accumulated to the premium for the CPI-U adjusted annuity on the premium due date using the Goal Seek function within Excel. The calculation suggests that the "return" on SS for me is 5.02%... IOW, what my employers and I paid in to the system, accumulated at 5.02% would be sufficient to buy a CPI-U adjusted annuity that has benefits similar to my SS benefits including survivorship benefits for DW.

However, the actual return is theoretically higher in that I have ignored the value of disability and survivor insurance that is embedded in the SS taxes I have paid that would have paid disability benefits to me had I become disabled or survivor benefits to DW, DD and DS if I had died and I have no convenient way to bifurcate out the value of that insurance.

FWIW, I was a high income earner for the second half or so of my career so I would suspect that my "return" of 5.02% is probably lower than what someone in the same circumstances but with lower earnings would have as SS benefits are skewed in favor of lower income participants (not a complaint... just stating the facts).

pb4-

Nice analysis.

The value of DI is pretty clear; it's 0.9% of the 6.2% (or 1.8% of the 12.4%) of the total paid in. I couldn't find a clear "survivors" portion but, a bit of digging seemed to indicate ~10% of annual payments back to beneficiaries is for survivors of one kind or another. If accurate, that would mean 10% X (12.4% - 1.8%) = 1.1% for the 'survivor' portion.

So, that would be 2.9% (1.8 + 1.1) of the 12.4% (or ~20% of it) could come out of your comparison. Applying some more of my crude math, your return would be 20% higher or, ~6%.

 

[Clone]

If you have a long work history already, then you need to understand what it takes to increase the Indexed earnings. In my case, I have 36 big years of earnings. In order to increase the adjusted monthly average, I have to earn more than the 35th highest year of earnings. Plus, I am firmly into the 15% portion of the SS calculation.

If I were to earn $118,500 in 2016 (max SS taxable), my SS payment would go up by $10 per month.

My wife, who was a SAHM, has 5 years of high income, 15 of moderate, and a few zeros in the 35 year record. Her SS calculation is in the 32% range. If she were to put in a $118,500 year, her SS would go up by $90.

We are shifting some payments to her that will incur SE tax. If she collects 6 years of payments ($35K annually), she will pay $25620 in SE tax (both the employee and employer side of the SS tax). Her calculated benefit would go up $160 per month.

To take out the effects of the SE tax, we could look at it like this. If she were to earn and additional $200,000 over a couple years, she would pay an additional $12400 in SS tax, and her monthly SS amount would go up $150 per month.

 

[samclem]

It is likely inaccurate to only count the worker's direct contribution (6.2%) in doing these calcs. Depending on various other factors (esp labor demand/ the labor market), some or all of the employer's contribution (another 6.2%, which is already included in the employer's labor costs) would be expected to be paid to workers and be available for spending or investment by the employee.

 

[pb4uski]

pb4-

Nice analysis.

The value of DI is pretty clear; it's 0.9% of the 6.2% (or 1.8% of the 12.4%) of the total paid in. I couldn't find a clear "survivors" portion but, a bit of digging seemed to indicate ~10% of annual payments back to beneficiaries is for survivors of one kind or another. If accurate, that would mean 10% X (12.4% - 1.8%) = 1.1% for the 'survivor' portion.

So, that would be 2.9% (1.8 + 1.1) of the 12.4% (or ~20% of it) could come out of your comparison. Applying some more of my crude math, your return would be 20% higher or, ~6%.

Thanks... but would DI have been 0.9% every year in the past (back to 1970 in my case)? But you are correct... if I assume that 20% of amounts paid were for disability and survivor's insurance then my rate of return is 6.12%.

 

[Huston55]

Thanks... but would DI have been 0.9% every year in the past (back to 1970 in my case)? But you are correct... if I assume that 20% of amounts paid were for disability and survivor's insurance then my rate of return is 6.12%.

No, not 0.9% every year but, the total is also not 6.2% every year back to 1970. I didn't evaluate the proportionality of DI for all years back to 1970 but, for this high level analysis, I think your ~6% return is accurate enough.


You may be whatever you resolve to be.

 

[pb4uski]

So if I assume that my "return" is about 6%, then it is as if my taxes and employer's were invested in a 10% stock/90% bond mix given that the 1926-2015 historical return for 0%/100% was 5.4% and for 20%/80% was 6.7%. Could be worse!

 

[Independent]

Not aware of any rule of thumb, but I just did the following out of curiosity.

Using the SS earnings from my SS statement and historical SS tax rates, I calculated the SS tax paid by me and my employers during my career.

The original question was the marginal value of one more year of work.
You're calculating the average value of all years. The tiered benefit formula typically makes the average quite a bit higher than the marginal.

If you're interested in the SSA actuaries' take on this, they occasionally do calculations: https://www.ssa.gov/oact/NOTES/ran7/an2012-7.html

 

[cathy63]

If you use the anypia calculator from SSA, the last page of the output gives a table showing taxes paid for OASI and DI. It does not break out the survivor portion and does not include the employer portion.

Here are the actual rates for the years in which I have earnings. The weighted total percentages will vary depending on which years you hit the max and which you didn't and when you started/stopped working. My overall percentages turned out to be 5.17% of SS taxable earnings went to OASI and .82% to DI.

year oasi% di%
1980 4.52% 0.56%
1981 4.70% 0.65%
1982 unk unk
1983 unk unk
1984 4.93% 0.47%
1985 5.20% 0.50%
1986 5.20% 0.50%
1987 5.20% 0.50%
1988 5.53% 0.53%
1989 5.53% 0.53%
1990 5.60% 0.60%
1991 5.60% 0.60%
1992 5.60% 0.60%
1993 5.60% 0.60%
1994 5.26% 0.94%
1995 5.26% 0.94%
1996 5.26% 0.94%
1997 5.35% 0.85%
1998 5.35% 0.85%
1999 5.35% 0.85%
2000 5.30% 0.90%
2001 5.30% 0.90%
2002 5.30% 0.90%
2003 5.30% 0.90%
2004 5.30% 0.90%
2005 5.30% 0.90%
2006 5.30% 0.90%
2007 5.30% 0.90%
2008 5.30% 0.90%
2009 5.30% 0.90%
2010 5.30% 0.90%
2011 3.60% 0.60%
2012 3.60% 0.60%
2013 5.30% 0.90%
2014 5.30% 0.90%
2015 5.30% 0.90%

 

[pb4uski]

The original question was the marginal value of one more year of work.
You're calculating the average value of all years. The tiered benefit formula typically makes the average quite a bit higher than the marginal.

If you're interested in the SSA actuaries' take on this, the occasionally do calculations: https://www.ssa.gov/oact/NOTES/ran7/an2012-7.html

Good point. I recall before I retired checking to see how retiring early ($0 earnings from when I retired onward) vs continuing to work (at max SS) affected my benefit. As I recall the impact was very small... on the order of $25/month or something like that. However the impact is easily determinable for each individual from the SSA website tools.

 

[kcowan]

Not US Social Security, but here is a recent study of the Canada Pension Plan. Looks like the early birds caught the worm!

https://www.fraserinstitute.org/studies/rates-of-return-for-the-canada-pension-plan

Wow thanks. I see that I began contributing in January 1967 and stopped in May 1992. I started collecting in January 2004. Looks pretty optimal!

 

[Ed_The_Gypsy]

Having had a long, fairly well-paid career, I saw that we were close to the maximum family SS benefits when I went to work in Canada years ago. My payments to Canadian Pension Plan were a lot smaller than my payments to SS would have been. I learned that because of the tax treaty between the US and Canada, I would not have to pay a 'social tax' in the US if I had already paid one in Canada, but SS would credit me with earning years. Since we were at the maximum benefit level already, the less I paid from there was to my benefit, even if I never saw any CPP benefits (which I won't). This worked for me again in Azerbaijan, which collected a social tax. I have to pay twice as much SS today when I consult but we will never see additional benefits from that.

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