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Sunday, March 06, 2005

Testing the President's Plan

I decided I’d put the Bush Social Security program to a numbers test. That means setting aside four percent of gross income in an individual account where interest accrues on an annual basis. At retirement, that money is then used to purchase an annuity which pays out benefits. This gives us two parts to look at: the investment and the annuity. Sorry, but you have to follow the math to do this.
As far as the investment goes, I worked with an annual rate of return of 5%. This is actually a pretty ambitious rate of return, but it works to illustrate the point. If you worked for forty years at $6.50 an hour, you would end up with an investment fund that held $65,956.68. If you worked the same amount of time for ten bucks an hour, your investment is worth $101,471.81. If you maxed out your Social Security contribution, which means you made ninety grand per year then you would have an account worth $456,623.15.
Now, let’s see what that investment gets you. There are many kinds of annuities, some that allow the money to be inherited, some that don’t. Some pay out over a specific period of time, some pay out over your entire lifetime. If we are comparing this investment to Social Security, then you have to look at a guaranteed payment for life with no inheritability.
I found a website that calculates the amount of money you would have to invest to make an annuity work for you (http://www.totalreturnannuities.com/). To get a payment of $1000 per month guaranteed for your lifetime (in the state of New Jersey) you would have to invest $152,870. This can easily be seen to be more than anyone who earned less than an average of ten dollars an hour would be able to afford. In fact, you would have to earn an average of $15.15 per hour over a career of forty years.
To actually get what Mr. Bush is promising, an annuity with inheritability, then the same $1000 per month would require that you invest $172,331 to get twenty years of inheritability for your designated beneficiary. To get that in your retirement account, you would have to earn $17.13 an hour for forty years. According to the Bureau of Labor Statistics, the current average wage for production and non-supervisory, non-farm employees is $15.88. This would then be enough for the average worker to pay for the non-inheritable annuity, but not the inheritable one. This falls short of the promises made by Mr. Bush.
At $15.88 an hour, for a standard two thousand hour week, annual income would be $31,760. This would put this single earner at better than almost forty percent of all American households. The median income, the point where half of the people are above and half are below, is only $26,911. That means that fully half of the 151,880,000 workers in the country are at least $5,000 a year shy of the average worker’s gross pay. These workers would only be able to buy an annuity that provided fifteen years of guaranteed benefits. This is not good news for anyone who might live over the age of 80.
But wait – the news gets worse.
This experiment pretended that you worked for the exact same wage your entire life. This is, obviously, not true. All of us start earning very little and most of us see our earning power slowly rise throughout our working lives. If you work five years at $10.88, five years at $15.88, and five years at $20.88, your average earnings over the fifteen year period is $15.88. This would change the figures above drastically.
I next ran a scenario where a person’s hourly wage is $6.50 for five years, $10.00 for ten years, $18.00 for ten years, $25.00 for ten years, and $27.50 for five years. Social Security contributions were calculated and the resulting personal investment account was worth $138,426.57, rather than the $172,331 had the same flat wage been applied to every year of employment. This is actually enough to guarantee a $1000 benefit for fifteen years.
But wait, it still gets worse.
None of this factors in inflation. Over the last ten years, inflation has varied between one percent and slightly more than three-and-a-half-percent. This is exceptionally low, as the average rate of inflation since 1913 is 3.49%. This means that our five percent rate of return would have to jump to eight and a half percent to give us a constant-dollar return of five percent. If the rate of return were held constant, then we would gain only 1.5% on our investment account. This has a dramatic effect on even the rosiest predictions. The person making $90,000 and maxing out his contribution just saw the amount available to buy an annuity drop from $456,623.15 to $198,294.88.
Don’t feel too sorry, because he can still get the lifetime annuity with 20 years of inheritability. However, the $20.00 an hour wage earner just saw his retirement account drop to $88,131.06. The $10.00 an hour guy now has only $44,065.53. The poor guy slaving for $6.50 an hour has only $28,642.59. The only annuity the $20.00 an hour guy can afford is the five year benefit, and the rest can’t even afford that.
But wait, it gets worse.
Proponents of this system will be quick to point out the Dow average has yielded an average of better than eleven percent. However, this neglects the fact that the 1980s and 1990s were a time like no other in the history of the stock market. While the Dow trades today at around 10,000, it was only during the last twenty years that it saw anything close to it. The Dow broke 2,000 on Jan. 8, 1987. It had taken 14 years to grow a thousand points. On November 14, 1972, the Dow broke 1,000 for the first time – 76 years after it was formed. It would fall below 1,000 within months and not rise above it again until 1976, when it would hover in that vicinity for a few month before plunging. The Dow ended the 1970s trading less than fifty points above where it was traded a decade earlier.
The 1980s and 1990s were fueled by rapid advances in technology – like the personal computer. They were also a time of historically low oil and gas prices. They were a rare historical quirk and it would be prudent to not hope for another period like that one. This is especially true now when the economy is anemic, neither booming nor busting, but just limping along in all directions at once. It is also important to note that oil prices are regularly breaking historic high marks, which means that inflation will begin to rear its ugly head.

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