You're Paying for Someone Else's Retirement, And Hopefully Someone Will Pay For Yours

It's Monday, August seventeenth. My dad sent me a text this morning with some math on Social Security. He said: if you took $1,000 a month, invested it at 8 percent interest compounded quarterly for 30 years, you'd end up with about $1.5 million, which could pay you $6,000 a month in retirement and still leave the $1.5 million as an inheritance for your kids. Then he compared that to Social Security, where a similar contribution over the same period doesn't even pay $3,000 a month and leaves zero capital behind when you die. His conclusion was that the government must be quietly using the money. And his math isn't wrong, the investment returns really do dwarf Social Security payouts. But when I looked into why Social Security exists in the first place and how it actually works, the comparison breaks down in a way that I think is worth understanding, because Social Security was never designed to be an investment. It was designed as insurance, and the distinction between those two things changes the entire conversation. In 1934, during the Great Depression, over 50 percent of elderly Americans lived in poverty. There was no federal safety net for people who couldn't work anymore. If you didn't have savings, or if the bank that held your savings had collapsed, which happened to thousands of banks in the early 1930s, or if your family couldn't take care of you, you were on your own. Old-age poorhouses were common, essentially institutions where destitute elderly people lived in grim conditions because they had nowhere else to go.

President Roosevelt signed the Social Security Act on August 14, 1935, and when he did, he said something that I think frames the whole program well: "We can never insure one hundred percent of the population against one hundred percent of the hazards of life, but we have tried to frame a law which will give some measure of protection to the average citizen against poverty-ridden old age." He didn't promise wealth. He didn't promise returns. He promised a floor, a minimum level of income that would keep elderly Americans from starving, and the program has delivered on that promise more effectively than almost any other government program in history. The poverty rate among Americans over 65 has dropped from over 50 percent to about 10 percent, and Social Security is the primary reason.

Today, roughly 70 million Americans receive Social Security benefits. Nine out of ten people over 65 get a check every month. For about a third of elderly Americans, Social Security represents over 90 percent of their total income. It's the largest single program in the federal budget, accounting for about one-fifth of all federal spending, and for millions of people, it's the only thing standing between them and poverty. The biggest misconception about Social Security is that your contributions are sitting in an account somewhere with your name on it, growing over time, waiting for you to retire. They're not. Social Security is a pay-as-you-go system, which means the money coming out of your paycheck right now is going directly to someone who's already retired. Your contributions aren't being invested on your behalf. They're being paid out to current beneficiaries this month, and when you retire, the workers at that point will fund your benefits with their paychecks.

Right now, workers and employers each pay 6.2 percent of wages into Social Security, for a combined 12.4 percent on income up to about $168,600. If you're self-employed, you pay the full 12.4 percent yourself. The average monthly benefit for a retired worker is about $1,900, and the maximum benefit if you retire at 70 is about $4,873. You can start collecting as early as 62 at a reduced rate, full retirement is 67, and if you wait until 70 you get about 8 percent more per year for waiting, which is why most financial advisors say delay as long as you can afford to. Even if you never worked, you can collect up to 50 percent of your spouse's benefit, though unlike an investment account you can't pass Social Security to your kids when you die, which is exactly your dad's point about leaving nothing behind. And most people don't realize that Social Security income is taxable: up to 85 percent of your benefits can be taxed depending on your other income. Those numbers are adjusted for inflation annually, which is something the stock market doesn't guarantee.

My dad's math assumes 8 percent consistent annual returns for 30 straight years. The S&P 500 has historically averaged about 10 percent annually before inflation, so 8 percent isn't unreasonable as a long-term average. But averages hide a lot of pain. The market dropped over 50 percent during the 2008 financial crisis. It dropped 34 percent in three weeks during COVID. If you needed to withdraw money during either of those periods, or if you panicked and sold, your 30-year average could be dramatically lower than 8 percent. The average investor significantly underperforms the market because of bad timing, emotional decisions, and the inability to stay invested during crashes, and study after study has confirmed this. Social Security doesn't care about market timing. It pays the same amount every month regardless of what stocks did that day, which is what insurance does: it removes variability in exchange for a lower expected return. This is the question everyone my age asks, and the answer is almost certainly yes, but probably at a reduced level unless Congress acts.

The Social Security trust fund, which holds the surplus that's accumulated over decades of payroll tax collections exceeding benefit payouts, is projected to be depleted around 2033 to 2035. When you hear "Social Security is running out of money," that's what people are referring to. But depletion of the trust fund doesn't mean Social Security stops. It means the program can only pay out what it collects in real time from current workers' payroll taxes, which would be enough to cover about 77 to 79 percent of scheduled benefits. So benefits would be reduced, not eliminated, and the program itself would continue to function because workers would still be paying into it.

Congress has a few options to close the gap: raise the payroll tax rate, raise or eliminate the income cap so that higher earners pay Social Security tax on more of their income, gradually increase the retirement age, reduce benefits for higher-income retirees, or some combination of all of these. They've known about this problem for decades and have chosen not to fix it yet because every solution involves either raising taxes or cutting benefits, both of which are politically painful. One detail worth knowing: undocumented immigrants contribute an estimated $13 billion per year in payroll taxes to a system they'll never be eligible to collect from, which actually helps keep the fund solvent longer than it would be otherwise. But the program is too large and too important to let it default. Almost every economist and political analyst expects Congress to patch it before the trust fund actually runs out, because letting 70 million Americans take a 20 percent pay cut is not something any politician wants to be responsible for.

My dad's point that you'd be better off investing the money yourself is mathematically correct for someone with the discipline to invest consistently for 30 years, never panic sell, never raid the account for an emergency, and retire during a period when the market isn't crashing. That person exists, but most Americans aren't that person. About 55 percent of American adults own stocks, and the median retirement savings for households approaching retirement is around $134,000, which would generate maybe $500 a month in income. Social Security's $1,900 average monthly benefit is three to four times what most people have managed to save on their own, which is why the program exists: not because the government thinks it can invest better than your dad, but because most people don't invest at all, and without a mandatory floor, millions of them would retire into poverty the way they did before 1935. My dad's math makes Social Security look like a bad deal, and for a disciplined investor, it is. But Social Security was never trying to compete with the stock market. It was trying to make sure that a 75-year-old who didn't invest, or whose investments got wiped out, or who got sick and spent everything on medical bills, doesn't end up in a poorhouse. Before it existed, more than half of elderly Americans lived in poverty. Now about 10 percent do. That's what insurance looks like when it works.

Stay informed, stay curious, and we'll see you tomorrow.