Approximating Social Security

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burnout454
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Approximating Social Security

Post by burnout454 » Wed Oct 28, 2015 9:44 pm

Unlike most, I have the option to opt out of social security. My question is not whether I should do so. Instead, my question is: if I were to do so, in order to match or beat what would have been my social security benefit, should I invest the approx 7% employee contribution or the full approx 14% (7% employee + 7% employer contribution)?

(I am aware that I would also need to have life and disability insurance.)

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grabiner
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Re: Approximating Social Security

Post by grabiner » Wed Oct 28, 2015 10:02 pm

The SS benefit is not proportional to the amount invested; if you have high income, your benefit is a lower percentage of your contributions. To see the cost of not contributing, you need to compare your benefit if you do and do not contribute.

In most cases, if you only have to pay half of SS, you expect to come out ahead over investing that half yourself. A possible exception can apply if you already have enough SS earnings to be over the second bend point, and are not affected by the Windfall Elimination Provision. This might happen, for example, if you worked 30 years in the private sector, and are now moving to a government job.
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burnout454
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Re: Approximating Social Security

Post by burnout454 » Thu Oct 29, 2015 10:59 am

Although it's difficult to estimate the SS benefit, would I need to invest the full 14% of my income -- the equivalent of both employee and employer contribution -- to get close to replacing SS, assuming the investment makes a 6-7% long-term rate of return?

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TomatoTomahto
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Re: Approximating Social Security

Post by TomatoTomahto » Thu Oct 29, 2015 11:07 am

SS is, for most of us, the only available inflation indexed annuity that has no credit risk. I would not opt out.
Okay, I get it; I won't be political or controversial. The Earth is flat.

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grabiner
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Re: Approximating Social Security

Post by grabiner » Thu Oct 29, 2015 9:19 pm

burnout454 wrote:Although it's difficult to estimate the SS benefit, would I need to invest the full 14% of my income -- the equivalent of both employee and employer contribution -- to get close to replacing SS, assuming the investment makes a 6-7% long-term rate of return?
No, but that's a big assumption. SS growth is risk-free; you have to take a lot of risk to earn an expected 6-7%.

In Payroll deduction on the wiki, there is an example which illustrates the break-even point. If you make HSA contributions by payroll deduction, you save 7.65% in tax (your half of SS, plus Medicare). Every $420 you contribute reduces your tax by $32.13, and your AIME by $1. If your investments match inflation, and you are above the second bend point ($4980 AIME, corresponding to an annualized salary of $59,760), you have to take SS for 214 months starting at full retirement age to break even; this is close to break-even, and may be a loss if you have a spouse or widow who gets benefits on your record. If you are below the second bend point, you have to take SS for 100 months to break even, so paying more SS is a clear advantage even if your investments beat inflation.

A separate issue with not paying SS is the Windfall Elimination Provision; you'll have to work out how that affects you if you do or do not pay SS.
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Re: Approximating Social Security

Post by rkhusky » Fri Oct 30, 2015 6:57 am

Perhaps you can estimate what your monthly SS benefit would be if you paid in. Then see what an inflation-adjusted annuity would cost to give you that monthly income. You could then estimate how much you would have to save to purchase that annuity.

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Re: Approximating Social Security

Post by TomatoTomahto » Fri Oct 30, 2015 7:08 am

rkhusky wrote:Perhaps you can estimate what your monthly SS benefit would be if you paid in. Then see what an inflation-adjusted annuity would cost to give you that monthly income. You could then estimate how much you would have to save to purchase that annuity.
Don't forget to add something for the risk that the insurance company will be unable to meet its obligations.
Okay, I get it; I won't be political or controversial. The Earth is flat.

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Re: Approximating Social Security

Post by abuss368 » Fri Oct 30, 2015 8:25 am

burnout454 wrote:Unlike most, I have the option to opt out of social security. My question is not whether I should do so. Instead, my question is: if I were to do so, in order to match or beat what would have been my social security benefit, should I invest the approx 7% employee contribution or the full approx 14% (7% employee + 7% employer contribution)?

(I am aware that I would also need to have life and disability insurance.)
Hi burnout454,

I would not opt out. OneI taking on more market risk by allocating more funds to investments. Social Security is inflation adjusted and guaranteed to be available in some way shape or form. Spread your risks.

Best.
John C. Bogle - Two Fund Portfolio: Total Stock & Total Bond. "Simplicity is the master key to financial success."

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Re: Approximating Social Security

Post by rkhusky » Fri Oct 30, 2015 8:38 am

TomatoTomahto wrote:
rkhusky wrote:Perhaps you can estimate what your monthly SS benefit would be if you paid in. Then see what an inflation-adjusted annuity would cost to give you that monthly income. You could then estimate how much you would have to save to purchase that annuity.
Don't forget to add something for the risk that the insurance company will be unable to meet its obligations.
And the risk that the government may cut your SS benefits either directly or through increased taxation, especially if you are well-to-do.

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Re: Approximating Social Security

Post by abuss368 » Fri Oct 30, 2015 8:56 am

rkhusky wrote:
TomatoTomahto wrote:
rkhusky wrote:Perhaps you can estimate what your monthly SS benefit would be if you paid in. Then see what an inflation-adjusted annuity would cost to give you that monthly income. You could then estimate how much you would have to save to purchase that annuity.
Don't forget to add something for the risk that the insurance company will be unable to meet its obligations.
And the risk that the government may cut your SS benefits either directly or through increased taxation, especially if you are well-to-do.
True. It is a trade off potentially. One risk for another.
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Re: Approximating Social Security

Post by nisiprius » Fri Oct 30, 2015 9:03 am

And the risk are very hard to assess--and don't be too quick to listen to people offering assessments of that risk, because they often have a financial stake in the matter. Very few financial institutions or advisors can make money by having you choose to contribute to Social Security.
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Re: Approximating Social Security

Post by GoldenFinch » Fri Oct 30, 2015 9:34 am

One way to look at SS is that it adds a to your overall portfolio diversification. There is some risk, but it would be different risk than the risk you have with your other money invested in equities/fixed income.

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Re: Approximating Social Security

Post by Watty » Fri Oct 30, 2015 10:00 am

duplicate post
Last edited by Watty on Fri Oct 30, 2015 10:22 am, edited 1 time in total.

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Re: Approximating Social Security

Post by Watty » Fri Oct 30, 2015 10:21 am

Watty wrote:
burnout454 wrote:Unlike most, I have the option to opt out of social security. My question is not whether I should do so. Instead, my question is: if I were to do so, in order to match or beat what would have been my social security benefit, should I invest the approx 7% employee contribution or the full approx 14% (7% employee + 7% employer contribution)?

(I am aware that I would also need to have life and disability insurance.)
Just FYI, it is usually 6.2% Social Security and 1.45% Medicare unless you have high income. I would assume that you cannot opt out of Medicare too.

Many people with solid middle class incomes will be able to structure their retirement income so that they do not pay any taxes on their Social Security so you need to take that into account too when comparing it to spending taxable money from something like an IRA.

The disability payments from a private policy are usually not adjusted for inflation and they also usually end at your normal retirement age which could be a problem. Another risk is that you could be disabled before your normal retirement age and not be able to make saving contributions since few disability policies will pay 100% of your income.

I don't have a clear answer but unless you are earning a high income and could comfortably retire on your saving alone then I would be real cautious about opting out.

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Re: Approximating Social Security

Post by burnout454 » Fri Oct 30, 2015 3:41 pm

A little more background for those questioning the wisdom of opting out:

As an ordained minister, I also have the tax benefit of a "housing allowance." In other words, part of my pay is called a housing allowance and therefore non-taxable. This saves me about 6,000–7,000 in federal taxes.

In order to get this benefit I must pay Self Employment tax (the full 15%), not FICA (7.65%). In other words, I wouldn't be getting the 7.65% employer contribution if I stayed in SS.

So in deciding to opt out of SS or not, the comparison is whether to pay the full 15% into Social Security or put that 15% into additional investments beyond what I would already invest.

Does that change things in your mind, or do you you still have the same conclusion?

I'm grateful for everyone's help.

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Re: Approximating Social Security

Post by jeffyscott » Fri Oct 30, 2015 6:17 pm

http://smallbusiness.chron.com/irs-rule ... 40233.html

Doesn't seem like you're actually eligible for the exemption, since your decision is based on what's financially beneficial, not religious beliefs.
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Re: Approximating Social Security

Post by burnout454 » Fri Oct 30, 2015 7:05 pm

Jeffyscott,

Notice my original post. My question was not whether or not to opt out based on the math. Instead it was, if/when I opt out, how much will I need to save to replace SS.

Others were questioning the practical benefit of doing so, not me. The background information in the most recent post was simply to help others understand the full context.

In light of the full context I'd still be glad to hear opinions on the question: stated a little differently, although it's impossible to determine exactly how much would be needed to approximate the SS benefit, can anyone provide an educated opinion on whether that number would be closer to 7% (the employee contribution) or 15% (matching the employer contribution as well).

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Re: Approximating Social Security

Post by Independent » Fri Oct 30, 2015 8:31 pm

If you're asking for simple math,

Suppose:
You save 10% of your gross each year and got a level return of inflation + 3%.
Your salary goes up with inflation.
You do this for 45 years.
At the end of the 45 years, you start withdrawals using a 4% "safe withdrawal rate".

Then, the 10% per year accumulates to 9.3 x your final salary.
4% of 9.3 = 37% i.e. you would be able to replace 37% of your final salary by withdrawing from your fund.

I'm using 10% because part of your 15.3% funds Medicare. I don't know if you can opt out of Medicare.
The 12.4% that goes to SS includes some that fund SS disability and young spouse's survivor benefits. I'm not sure what you'd spend for disability and term life insurance.

If you don't like the 3%, then inflation + 2%, 4%, and 6% give replacement rates of 29%, 48%, and 85%.
So you can see that the investment return assumption is huge.

You can get a quick estimate of your potential SS benefit here: https://www.ssa.gov/oact/quickcalc/
If you're young, you probably want to discount that for future reductions in SS benefits.

The key to simple math is the twin assumptions that your salary goes up with inflation and that you will express your investment return as inflation + ___. With both of those, you can ignore inflation in your future value calculation.

There are plenty of future value calculators on the web. For example: http://www.calculatorsoup.com/calculato ... ulator.php

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Re: Approximating Social Security

Post by 2comma » Fri Oct 30, 2015 11:51 pm

I find this an interesting question but I don't have the ability to answer - I liked rhusky's idea of guessing what SS would pay, price an annuity that would payout that then figure out what savings you would need to purchase an equivocal.

I hope someone comes up with an educated opinion. In the mean time you might find these two articles that are somewhat related. The first link indicates that if you saved 6.2% (the employee contribution) you'd come out better than SS, even if you invested in bonds. Mind you the Cato Institute is political (in my opinion) and not necessarily mainstream economics - I don't necessarily agree with most of their conclusions I just found the article and thought it might be related. The second link comes up with an average Joe return equal to somewhere in the 2-4% range for SS. Of course you'd also have to figure all of the added benefits of SS.

My first thought was you'd probably need something near 15% contributions to equal SS. These seem to indicate less but I really have no idea. I'd love to see someone here come up with "the number" you are requesting. Even though I am firmly in the SS camp I'm beginning to wonder if it can overcome the 15% hurdle you'd have to get over.

http://www.cato.org/publications/policy ... l-security

http://www.cbsnews.com/news/are-your-so ... nvestment/
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Re: Approximating Social Security

Post by rkhusky » Sat Oct 31, 2015 6:06 am

Found this article: http://www.usatoday.com/story/money/col ... y/1639119/
This quote gives you one data point:
Incidentally, the average Social Security payment, which bears strong similarities to an inflation-adjusted annuity, is $1,234. An inflation-adjusted annuity yielding the same amount would cost a 65-year-old $325,877 to $348,600, according to Vanguard. That's without benefits to survivors or disability benefits, which Social Security also provides.
Here is another link with a lot more data points:
http://www.freemoneyforall.org/seniors/annuities.php

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Re: Approximating Social Security

Post by jeffyscott » Sat Oct 31, 2015 7:19 am

In addition to Medicare accounting for 2.9% of the 15.3% FICA tax, 1.8% is paying for disability insurance. This leaves 10.6% that is actually funding the retirement benefits.

But, I guess one can certify that he is opposed on the basis of religious principles to acceptance of public insurance (for services performed as a minister), yet be willing to accept this same public insurance for which he qualifies based on his or his spouses other employment.
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Re: Approximating Social Security

Post by #Cruncher » Sat Oct 31, 2015 8:27 am

burnout454 in [url=https://www.bogleheads.org/forum/viewtopic.php?p=2672872#p2672872]this post[/url] wrote:My question ... was, if/when I opt out, how much will I need to save to replace SS.
This can be estimated, but the answer will vary a lot based on assumptions such as:
  • Your wages between now and retirement
  • Your life expectancy
  • The investment growth rate between now and death
I've devised a little spreadsheet which will compute an answer based on these and other assumptions. It works in constant CPI-indexed dollars so we won't have to estimate future changes in the Consumer Price Index. [*] It assumes the current method of determining the benefit for a single individual without any related benefit for a spouse. Here is a hypothetical illustration:

Code: Select all

Row                           Col B   Col C   Col D
  1  Monthly wages            7,000
  2  To 1st bend point          856     90%     770 
  3  To 2nd bend point        5,157     32%   1,376 
  4  After 2nd bend point               15%     276 
  5  Avg % & monthly PIA              34.6%   2,423
  6  Age now                   27.0 
  7  Retirement age            67.0 
  8  Life expectancy           87.0 
  9  Investment growth         3.0%
 10  PV of PIA @ age 67     436,924 
 11  Monthly investment         472 
 12  Percent of wages          6.7%
In the hypothetical case above, $472 invested each month (6.7% of $7,000) growing at 3% for 40 years will become $437,000 at the start of retirement. If it continues to return 3% over the next 20 years, this amount will allow withdrawals of the same $2,423 monthly benefit that SS would have provided. (All dollars and growth rates are in terms of constant 2015 purchasing power.)
Notes:
  • Cell B1 is assumed to be one's average monthly wages in constant CPI-indexed dollars between now and retirement. The calculation treats this as the Average Indexed Monthly Earnings (AIME).
  • Cell D5 is the estimated monthly Primary Insurance Amount (PIA) using the current formula as shown here, applied against the average wages in cell B1. It is the monthly benefit one receives at Normal Retirement Age (NRA).
  • The PIA in cell D5 is assumed to be collected during retirement years (B8 - B7).
  • Cell B9 is the assumed annual real investment growth rate (i.e., in constant CPI-indexed dollars) over the entire period from now until death.
  • Cell B10 is the present value (in 2015 dollars) of the monthly PIA at the beginning of retirement. It's computed with the Excel PV function.
  • Cell B11 is the monthly investment needed to provide the value in cell B10. It's computed with the Excel PMT function.
As I said before, the answer is quite dependent on the assumptions. Here is a table showing the effect of two of them: monthly wages and annual real growth:

Code: Select all

                           ---------------- Annual Real Growth -----------------
 Wages    PIA     Pct        0%      1%      2%      3%      4%      5%      6%
------   -----   -----     -----   -----   -----   -----   -----   -----   -----
 3,000   1,456   48.5%     24.3%   17.9%   13.1%    9.5%    6.8%    4.8%    3.4%
 4,000   1,776   44.4%     22.2%   16.4%   12.0%    8.6%    6.2%    4.4%    3.1%
 5,000   2,096   41.9%     21.0%   15.5%   11.3%    8.2%    5.9%    4.2%    2.9%
 6,000   2,273   37.9%     18.9%   14.0%   10.2%    7.4%    5.3%    3.8%    2.7%
 7,000   2,423   34.6%     17.3%   12.8%    9.3%    6.7%    4.8%    3.4%    2.4%
 8,000   2,573   32.2%     16.1%   11.9%    8.7%    6.3%    4.5%    3.2%    2.3%
 9,000   2,723   30.3%     15.1%   11.2%    8.1%    5.9%    4.2%    3.0%    2.1%
10,000   2,873   28.7%     14.4%   10.6%    7.7%    5.6%    4.0%    2.9%    2.0%
11,000   3,023   27.5%     13.7%   10.1%    7.4%    5.4%    3.8%    2.7%    1.9%
At one extreme, if he can only grow his investment at 0% in real terms, a person earning only $3,000 per month would need to save 24.3% of it for 40 years to provide the same $1,456 per month for 20 years that SS would provide. At the other extreme, if he can grow his investment at 6% in real terms, a person earning $11,000 per month would need to save only 1.9% of it to provide the $3,023 that SS would.

If you wish to see the effect of altering other assumptions, here are the constants and formulas that can be copied and pasted into an empty Excel sheet.
Paste into cell A1

Code: Select all

Monthly wages
To 1st bend point
To 2nd bend point
After 2nd bend point
Avg % & monthly PIA
Age now
Retirement age
Life expectancy
Investment growth
="PV of PIA @ age "&B7
Monthly investment
Percent of wages
Paste into cell B1

Code: Select all

7000
856
5157


27
67
87
0.03
=PV(B9/12,12*(B8-B7),-D5,0,0)
=PMT(B9/12,12*(B7-B6),0,-B10,0)
=B11/B1
Paste into cell C2

Code: Select all

0.9
0.32
0.15
=D5/B1
Paste into cell D2

Code: Select all

=C2*MIN(B1,B2)
=C3*MAX(0,MIN(B1-B2,B3-B2))
=C4*MAX(0,B1-B3)
=SUM(D2:D4)
* I'm also making the implicit assumption that average wages increase at the same rate as the CPI.

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