Monday, April 23, 2012

Social Security system is inefficient


Ah.. Social Security… It's wonderful program that takes 12.4% of your income each year in order to secure you your future. Let's analyze Social Security a bit, shall we?

The purpose of Social Security is to help the average American save money for retirement. Although the funds average annual yield is 5.3%, it's backed by the United States treasury, meaning it's a guaranteed investment. 5.3% may seem acceptable when compared to the national average savings account yield of approximately 0.54%, but the truth is that many competitive money market accounts yield upwards of 5.4% without locking up your investment until retirement, or jeopardizing your retirement savings, as nearly every reputable bank is a member of FDIC and have lengthy histories of customer satisfaction. When was the last time you went to your local bank and they didn't allow you to withdraw your money?

Now let's compare Social Security to a safe investment in the stock market. History has proven that the safest investment in the market is the S&P 500 index. This index tracks 500 of America's most prestigious blue chip companies and is a sound investment, with minimal risk. The S&P 500 average annual return on investment is approximately 10.4% (This figure is based on a 78 Year average). The difference may not seem much, but it's gargantuan on a long term basis. See my calculations below:

Scenario: Let's say you begin working at the age of 25, and earn $40,000 a year. The government takes 12.4% of your income every year on social security alone. This is the actual percentage that they withhold from your income. (Your employer will adjust your salary in order to cover his side of social security without spending additional money. The employer pays ~6.2% for your social security and you pay ~6.2% this will be explained below.) Let's also assume you retire at age 65. That's 40 years of contributing to social security. Let's see how much you'll get back in social security when you retire, and how much you would have gotten back if you invested the same 12.4% each year in the S&P 500 index instead.

Social Security: *$696,699.17
S&P 500: $2,702,720.36

*The social security total is actually higher then it should be, because I used today's social security yield, instead of the 50 year average, which is LOWER the today's yield.

You may be confused about where the 12.4% was derived from. The way social security functions is that you, the employee pay 6.2% on each paycheck, and the employer pays 6.2% on the wages he pays you, the employee. You may think to yourself that, the 6.2% that the employer pays has no effect on your salary, but you are mistaken. Your salary is adjusted (decreased) to cover the employer's end of social security. This doesn't apply to all employees, but Milton Friedman, Nobel Peace winning economist, got several large employers to admit to using this practice. Let me provide you an example. Let's say, as an employer, you want to spend a total of $100 on your employee for his services. But you know that an additional $6 will be added on top of the base $100 salary to cover the employer's portion of social security. Instead of paying out a total of $106 (100$ to the employee and 6$ to the government, the employer will instead, pay the employee 95$ as a salary, and pay 5$ on top of it for the employer's portion of social security. Now the employer spent his intended 100$ on the employee, instead of the $106 he would have paid if he set the employees base salary at $100. Now the employee must also pay a 6.2% tax on the $95 he earned through wages. If Social Security did not exist, the employee would have received the full $100 in wages, instead of $95 minus social security taxes.

Don't assume that I don't agree with the general philosophy of Social Security. The purpose of Social Security is to provide for the elderly once they retire so that they may sustain themselves. I am not against its purpose, but I am strongly against the way it's forced down our throats. If the money is intended to be spent on your future, why can't the government allow you to save it on your own? The only way for social security to function in an honest fashion is for it to be voluntary. If an individual wants to invest their money elsewhere, that individual should have the option to opt out of the Social Security system. The government simply cannot spend your money in a better fashion FOR you then you can for yourself. An individual should have the liberty to decide how he chooses to invest his own money, instead of the government forcefully taking it and investing it in their place.

The S&P 500 is not a guaranteed investment, but history has proven it to be the safest investment in the market, and has a proven track record of 75+ years at an average annual return of 10.4%. Ultimately, an individual should have the choice of opting out of government run social security. Countries like Chile, Mexico, Britain, and Australia have already transitioned from failing government run social security type programs to healthier systems based on individual retirement accounts.

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