February 11, 2014 6:00 AM
The question of whether Social Security is a good deal is getting more visibility. And it is a question that deserves even more attention.
There is no short answer, but that doesn’t mean that people will not try to give you one. Some say that Social Security is a good deal, and some say that it is a bad deal. When you get a short answer, you have to understand that the answer likely does not apply to you as an individual, and it is likely scripted.
The data is real. It comes from the Social Security Administration (Moneys Worth Studies) and the Urban Institute (2013 Update). The results compare what you would have had if you had invested your contributions (including the employer's portion) to the amount of money it would take to buy the benefits that you expect to collect over time. The point here is to allow you to compare what you give to what you get on an apple to apple basis.
Through the magic of mathematics, the research computes what you would have today if you had invested the past contributions in an investment account. The research uses the same process to calculate the value today of your expected future benefits. If you expect more in future benefits than you pay, then Social Security is a better investment than the one applied in the math.
Better should not be confused with good. For example, almost all cars are faster than mopeds, but that does not mean that all cars are fast. The math compares Social Security to an alternative investment. In the case of most research about Social Security, the benchmark investment is an extremely poor one that few people would match on their own.
The “discount rate” determines the lifetime value of your contributions as if those contributions were invested into an account that earned interest. The Urban Institute uses 2% above inflation. Even with the financial crisis, the lowest 45 year rolling return of the S&P is between 3 and 4%. The rolling 45 year return of the S&P500 is normally 5% or more. So the "lifetime-value-of-contributions" is likely to be greatly understated.
People can argue about what the correct rate should be. There a number of things that you can’t argue:
2% above inflation is an express way to poverty. It is insane that the government created a leg of a retirement stool that delivers a hopeless level of poverty on its citizens.
A low discount rate will make the what-you-have-contributed lower. It will make poor returns look great.
A low discount rate will make the what-you-get higher, much higher.
Is Social Security a good deal? Maybe, but it is much less of a good deal than the research suggests.