Recently I’ve taken something of a closer at Social Security. I was inspired to do so by an article insisting young people shouldn’t plan on getting any money from the program The article talked about how the program was “bankrupt” and “doomed”. Basically it was the kind of sensationalized diatribe that makes me go “hmmm, is that really true?”
Like most people under 60, I had no understanding of Social Security. I still don’t really, but I googled just enough to feel confident it’s not going away. Since this is a blog and I need to write things, I’m going to share a bit about why it exists and how the formula for benefits is calculated. It’s really dry stuff, so I’ll split it into 3 separate posts. By no means will they be comprehensive or even enlightening, it’s just some words I made.
At any rate. Part 1 of 3:
While you’re reading this I think it’s helpful to keep in mind the broadest definition of the federal government’s purpose – to support its citizens.
An Aging Problem
Let’s start anecdotally:
It’s 1935, and we see a 65 year old man slumped on the corner with a “homeless and hungry” sign. Americans have always been very boot-strappy, believing we’re responsible for our own successes and failures. Essentially we think it’s this guy’s own fault he’s broke, but that doesn’t mean we’re ok with him starving.
To sprinkle a little context on our old man – 1935 is the middle of the Great Depression, though we don’t know it’s the middle, to us it feels like the new normal. In previous generations the man’s children would care for him, as he likely did for his parents, but the landscape changed during the roaring ‘20s and his children moved away from home to settle in cities. He relied on a wage for support most his life, but now jobs are scarce and no one wants to hire a haggard old man.
This situation becomes a national problem, and the federal government decides it needs to intervene for two reasons:
- To provide basic human rights (food and shelter) for it’s citizens and
- To protect society from the burden of supporting people who can’t support themselves.
Two programs are started to address these problems – Welfare and Social Security. Welfare is an answer to (1) people starving in the streets, and Social Security is an answer to (2) protecting society from the costs of supporting the destitute.
The First Thing to Know about Social Security
It is not a welfare program; it’s a mandatory retirement and insurance program. Basically people were doing a really bad job saving for when they wouldn’t be able to work anymore, so the government stepped in and forced people to start saving. That’s the system: you pay in a portion of each paycheck now and receive monthly payments later. You’ll hear it referred to as an “entitlement program”; if you make contributions, you’re entitled to benefits.
Social Security is funded with payroll taxes. In 2018 the tax is 12.4% of the first $128,400 of income. You pay 6.2%, and your employer pays the other 6.2% on your behalf. If you’re self-employed you get to pay the whole 12.4% yourself. Lucky you. Most people don’t realize the extent of the tax because it’s deducted automatically.
To manage all of these payments, two giant accounts, The Social Security Trust Funds, were established to facilitate contributions and disbursements. One fund is used for the retirement component and the other for insurance. Individual records are kept to track how much each person has contributed and the benefit they’re entitled to.
Social Security Evolves
As mentioned, Social Security was originally designed with two components, retirement and insurance. Retirement meaning the monthly checks you get after you’ve worked long enough and had a big enough birthday. The insurance portion is designed to support people who lose their ability to work for a reason other than age, like disability, even if that disability occurs outside of the workplace.
A third component was added 30 years later, in 1965, called Medicare. Medicare fits with Social Security because people were also failing to adequately save for future medical costs. Under Medicare you pay a percentage of your wages now (1.45%, plus your employer pays 1.45% on your behalf) so you can have health insurance coverage later in life.
Waiting to purchase insurance until you need it is either incredibly expensive or completely unavailable. As a result, the people who need health insurance the most often didn’t have it.
Remember also that a directive of health professionals is to treat sick people regardless of their ability to pay. That doesn’t mean the treatment doesn’t cost money, it just means the patient isn’t paying. Instead the cost of caring for the destitute is covered by everyone else (society).
Medicare tries to alleviate this problem by forcing people to pay for insurance in advance while they’re healthy and working.
How the “Retirement Age” was Determined
When Social Security began, the full retirement age was set at 65. Why 65?
- It’s what Germany was using (Germany’s social security system began in 1889)
- It was the age used by the Railroad Retirement System
- It was the age used by about ½ of state pension funds.
Initial analysis showed the system could be self-supporting with a minimal payroll tax – 1% of the first $3,000.
Yeah, read that again, Social Security taxes were designed to be 1% of a small portion of your paycheck. It’s currently 12.4% of (probably) all your pay. I’ll dig into it more in the next installment, but suffice it to say ours is not the first time Social Security has faced a shortfall.
An Incredibly Important Note
Do not be thrown by the Social Security Administration’s use of the term “retirement age”. You DO NOT have to work until you’re 65! 65 is just the year you’re able to start receiving “full” benefits. There is a very important distinction here that I think people miss: Social Security is not social law – it’s a formula.
Sixty-five was chosen because it’s kinda-ish when people were retiring in 1935 and some mathematicians closed one eye, made small circles with their outstretched thumbs and said “that’ll about do it”. You can retire whenever you are financially able, you just can’t get full Social Security benefits until you’re disabled or 65*
*The full retirement age for people born after 1959 is 67.