Some readers and I have been discussing some aspects that surround retirement planning from people who seek to voluntarily exit the workforce at a premature age in order to enjoy the finer things life. I’ll start out by stating that I may actually do some of these harmful things myself, but I think it is important to acknowledge the negativity of what we do, and perhaps even find ways to plan around it to avoid impact. At the very least, even if you don’t change your ways, it is wise to be mindful of such threats to your retirement plan should your actions cause something to fail, such as the social security system no longer being able to offer sustenance to you in your golden years.
I draw corollary to the impact of our actions on the environment, it is common thinking now to consider our carbon footprint, or ecosystem destruction in calculating the value and viability of a particular course of action. The logic behind this is the same from a financial ecosystem, it is easy to take the approach that a system so large cannot be harmed by our influence, but perhaps it is more prudent and evolved of us to instead consider the impact of our actions on all things, and continue to leave the world a better place for future generations.
For the sake of brevity I will focus on social security in this post, but the same could be said for all aspects of social welfare, where the system conceptually is designed where the strong will support the weak, the rich will support the poor. Fundamental to my perspective is that in order for a person to consider early retirement that they are wealthy, and able to earn good money, by consciously deciding to not only cut off that fiscal pipeline, but to add to the burden of the system by demanding support they are causing serious harm to the longevity of the system for all.
A Background on Social Security
Social security was signed into effect in 1935 by President Franklin D Roosevelt, it came into effect during the Great Depression in America, which peaked in 1932 with unemployment rates of 25%. The purpose of the program was to support the elderly generation in retirement as a social insurance program. The social security program in America is already in financial trouble, and the Social Security Administration has already made changes in order to help preserve the system, they have changed the terms of what is considered ‘full retirement age’ from 65 to 67. Attempting to take benefits prior to full retirement age will result in a reduction of payments. However, despite best efforts it assumed the the Social Security Trust in America will be depleted at some point between 2033 and 2041, for the details of this calculation please see this document.
The social security system in America is funded by taxation from FICA, which is paid by both the Employer and Employee. The FICA tax also funds Medicare, the breakdown of this is as follows:
- Medicare 1.45% (Both for Employer and Employee)
- Social Security 6.2% ( Both for Employer and Employee)
Self employed people are responsible for paying both sides of the employee/employer equation so their tax is effectively doubled, though is operated by a different administration on the collection side. Finally, it is worth noting that due to caps on taxes collected the Social Security Tax can be considered a Regressive taxation system, in as much as that, after a certain salary threshold, the tax is no longer applicable. For 2014 the salary level is $117,000, people earning in excess of this will not pay any more than 6.2% on that first $117,000. The effect of this is that as a percentage the Tax reduces as salary increases above that level.
Why the system is broken
The problem with Social Security solvency can be calculated in the same manner as any retirement plan, the equation for which is fairly straightforward time value of money calculation, in a nutshell you need to figure out how much you put in over time, add on interest rates and compound interest, and then work out how much to take out over time once you hit ‘retirement’.
It is a two step process, on the inflow side we consider:
Inflows
- Payments (Made by Individual)
- Interest Rates (earned after inflation adjustment)
- Time (years of saving for compounding of interest)
This creates a Net Present Value, which is then used as a fund or ‘pot’ that is in turn withdrawn from.
Outflows
- Payments (received in retirement)
- Interest Rates (after inflation adjustment)
- Time (years of drawing from the plan)
The system fails on several levels, likely the most critical is that Social Security (theoretically) doesn’t run out of money. What that means is that when they price out how much you should receive in retirement with a personal plan if you outlive your estimation you run out of cash, but within social insurance if you outlive the expected life span your payments continue, this social safety net is causing massive problems to the system since there are more people collecting payments for more years than ever before, and that trend seems to be continuing.
There is a lot of data out there on Life Expectancy, and data is constantly manipulated to support theories, and agenda’s. I disagree with Politifacts approval of Glenn Beck’s sentiment that when Social Security was implemented in 1937 it was never intended to be claimed. Mr Beck stated that the average life expectancy at that time was 58 for men and 62 for women. The flaw with this data is that it includes infant mortality rates, and dates back to the turn of the century.
A more relevant statistical mix comes from this chart from the Social Security Administration, which instead looks at the life expectancy of the group of people who have already lived to 21 years of age, thus making it much more relevant from a ‘money in, money out’ equation. However, whilst the numbers are a lot less inflammatory than proposed by Mr Beck, the concept he presents is valid, as the nation ages more money is coming out, and less going in. The equation is unbalanced.
Interest Rate Restrictions
Further to requiring more payments from the system, the rules regulating the Social Security Trust Account where the collected revenue resides restrict investment options to special fixed issue government bonds. Due to the low rates of interest available at this time that means the current average growth of the Social Security Trust fund is limited to an average rate of 1.875% in 2013, a year where the DJIA rallied some 26%.
Summary
From a very high level, the problems facing Social Security are simply that there is too much money on the outflow side, and too little on the inflow side. Furthermore, this can be broken down to the system not appropriately tracking the increasing graying of the nation. Restrictions placed upon the investment options for the plan, rightly or wrongly restrict the capital appreciation, and when considered in tandem with inflation rates many years the Social Security Trust loses money purely on the equation of actual interest rates. The Trust has run in deficit as follows for recent years:
- 2010 – $49 Billion USD
- 2011 – $45 Billion USD
- 2012 -$55 Billion USD
It is likely that changes will be made in order to preserve social security and it is likely that they will include austerity measures. Unfortunately governments are averse to implementing taxes raises for fear of losing the popular vote, and social security as a social insurance is very unpopular with the younger generation who already feel that they are funding something that may or may not exist in their own retirement years. Eventually this will be addressed, but in the interim and likely in tandem, the most likely course of action will be to find ways to taper payments in order to rebalance the Trust.
What it means to you
If you are currently factoring in social security to your retirement planning you might want to run some scenarios where it was removed altogether as a worst case event. Would your plan survive? I would say this is particularly useful for people who are planning well in advance, currently in their 20’s or 30’s. Understand that in doing such a plan your costs of living can increase in these years due to healthcare costs.
The Early Retirement Movement
The increased desire to retire early and exit from the fiscal collection program had put further strain onto the the system. When one considers the money in/money out of a person who retires at 35 rather than at 65, a conscious decision has been made to exit the funding system for Trust Inflows. This puts further strain on an already fragile system. It may well be that finding a way to leave the sinking ship is the most financially savvy move from an individuals perspective, but it does raise questions of civic responsibility.
Perhaps it would be better for the system, that if people are planning to break away from the societal mold that is retirement around the age of 65, and willingly leave the workforce where they have the potential to earn an attractive salary that they consider doing so without taking from the pot that they opted to stop filling up. However, I realize that is unlikely to be of interest to people so I would instead something that perhaps should benefit everyone.
Craft your early retirement plan to include multiple situations, including a worst case one where you cannot access the Affordable Care Act, Social Security, or other welfare in the interim. Because it is more likely that such things will actually go away if you opt to unplug yourself from the system, make sure that you have a plan where you can afford to reap what you have sown.
Conclusion
This post attempts to tackle two separate issues, one of them is to explore the Social Security system as a whole and the the second is to consider accountability of your actions within a system. It is clear to me that finding a way to extract oneself from Social Security is a better financial move for the individual, as if we were to invest the funds ourselves in a more sophisticated manner we would be able to ensure more outflows from our personal plans, however, when considering societal impact of our actions it is equally clear that making choices for the individual are harmful to the masses. In many ways I encourage such thinking, but I feel that if you are ‘opting out’ of paying into the system you probably should opt out of taking from the system too.
While I don’t disagree with the general concept here of general civic responsibility, I don’t see how we can logically draw any moral line here other than at the extremes. It’s gotta be either “follow the spirit of all government programs and don’t use any loopholes” or “follow the letter of government programs and use every advantageous loophole.”
Everything you just said about the moral implications of social security apply completely to all taxes. Taxes fund welfare, food stamps, Medicaid and many many other programs. By using the credits and deductions that everyone agrees we should (including you in a previous post), aren’t we shirking our moral duty to help the people who need these plans? And isn’t the us government running a huge deficit partly because of us shirkers just like social security failing?
Why draw an arbitrary line somewhere between loopholing out of your taxes and “opting out completely as much as possible”
And no, tax loopholes are not “incentives” for people like us. They’re incentives for some people, but not for people who read websites like this one.
Frankly, I don’t know. It is something that I am wrestling with, and the dilemma enters all sorts of very complex areas, and perhaps is Orwellian in many ways.
My current position is that I am comfortable with playing a tax advantaged game, rationalized by the notion that the Tax Code itself is broken, and the ‘loopholes’ rebalance the equation. Further to which once I have optimized my income whilst I am still part of the earning/producing side of money I have the ability to make conscious positive decisions from a financial perspective, such as targeted charitable giving.
However, extracting myself fully from the tax system is something that is a real possibility – due to my personal situation I can exit simply via immigration rules when I chose, but when doing so I have a strange feeling that it should be from taxed by the US to not taxed by the US, rather than taxed by the US to supported by the US. I think the conscious choice to exit the payment side of things and instead draw from the system to challenge my moral compass.
Matt,
With respect, you’re moving further and further away from the truth with each post on this subject.
You said in your previous comment section that you like to mix it up, so here goes:
1. The issue with Social Security funding in the future is the whole scale aging of the population driven mostly by the aging of the baby boom generation.
The effect of a small number of people retiring early is so insignificant, it is not accounted for in any Social Security Administration calculations, nor should it be.
2. You ignore the fact that retiring early affects both Social Security inflow and outflow.
Your Social Security payment is determined by the average of your highest 35 years of earning, so if you retire early your SSI payment is much less.
With an increasing life expectancy (which you allude to in your Glen Beck quote) this effect would make early retirement a net positive for the Social Security administration (A profoundly longer period of diminished outflows following a moderately shortened period of inflows .)
3. Soccerdad22 Nails it in his comment above.
There is no ethical distinction between legally avoiding taxes and legally accepting benefits that you are entitled to. Both benefit the individual at cost to greater society.
4. A final point: And I think this is really the most important one.
Social Security is almost completely irrelevant to early retirement planning.
It cannot be drawn by a healthy individual until he is at least 59 1/2.
Accessing social security at 59.5 means a lifetime of lower payments. This is why it is generally considered most economically advantageous for the individual to draw social security at age 70.
So painting the early retirement community as moochers is just a complete non sequitur when it comes to Social Security.
Let’s be honest: none of us work in order to contribute to social security. We work to enrich ourselves. That is neither good nor bad. That’s just a fact.
Keep up the provocative posts! They are lots of fun.
-MD2
OK first of all start adding your website so people can link through to you, you can do that in the comment section. You have a lot to offer and I would like to see more people click through to your site.
Now, to start with, where exactly am I going from the truth? I think I did some good research on your social security program, the facts seem to be accurate to me? After I explain the system, I go onto say why it is broken, and I cite the following criteria:
The Graying of the Nation (which is your point 1)
Restrictions on Asset Appreciation
In a nutshell, the system is such that there is not enough inflow, there are restrictions on capital appreciation, and outflow has outgrown expectations with the increase in life expectancy.
A large part of this post is to highlight what Social Security is, and to raise awareness that it may not exist when my generation retires. After that, well here’s the thing…
If you appreciate that social insurance is a collectivist ideal, then ensuring its solvency is the role of the healthy, employed segment of society. If you bail on the idea of helping out society in a broken system, then you are turning your back on society, and becoming very self centered.
I am not necessarily against such thinking, but I think that if you take that route it should be that you become your own island, and don’t go further on the extreme to start making demands that society should now start supporting you.
Matt,
Your analysis of Social Security is spot on.
You did a really nice job of explaining why it’s solvency is in question 20 years in the future.
I have my own thinking on how to make Social Security solvent, but that’s not particularly germane to this discussion.
I don’t see Social Security as collectivist. I see it as social insurance that everyone pays into and withdraws from in proportion to their contributions.
Where I see the flaw in your analysis is in jumping to the conclusion that because early retirees are not contributing to Social Security during their retirement, years they’re contributing to the problem.
The point I make in #2 of my first response is that early retirement is likely net neutral and possibly a positive for Social Security as a whole because of the greatly diminished outflows, and moderately reduced inflows.
The other big oversight, that I point out in point number four, is that Social Security is quite simply not something that most early retirees include when calculating how much money they need to save for retirement.
The crucial number is saving 25 times your yearly spending, so that you can live indefinitely off of 4% withdrawals from your investments.
You will notice that Social Security payments play no role in this calculation.
Given this, classifying early retirees as sponges, because of their effect on the Social Security trust fund seems nonsensical to me.
A much better line of attack, would be to point out that early retirees do not pay their fair share of taxes.
In fact an early retiree can make up to $70,000 of income from his investments without paying a dime of income taxes or social Security taxes.
As always, I do not comment on blogs that I do not deeply admire, so please take my criticism as a compliment.
Long live “Blog Wars” indeed!
Alexi
http://www.milesdividendmd.com
Hey dude did you not get my reply ?
I guess not- will check spam
You got buried in my Akismet folder, filled with Beats By Dre and Viagra ads, what a rough time finding your post! I love discussion and debate and welcome it here, hopefully I will revise my own view each time we exchange perspectives.
The reason that social security (in my opinion) is collectivist is twofold:
Firstly, social security doesn’t end, if a person outlives where their own outflow should have ended, it is picked up by the system.
Secondly, it requires social funding from the workforce to survive. If you cancelled every inflow from the people aged between 30-65 today then it would become insolvent remarkably quickly, it is support (undersupported) by the people working today.
That’s a big problem. It doesn’t have enough money in the system from the people who paid in to sustain itself, it needs to tap into present day money to remain buoyant – why that is I haven’t explored, but the inflow/outflow balance per individual is not correct, which is why it is losing money.
There are 3 ways to change this:
More inflows
More interest
Less outflows
Since the first (more inflows) is being hurt by early retirement they are harming the system. The second is not allowed, perhaps for good reason, and the latter comes to your point of where it it is something that
“I see it as social insurance that everyone pays into and withdraws from in proportion to their contributions.”
Clearly it is not, in order for it to be sustained unfortunately people need to put more into it than they get back out.
If everyone opted out of paying it would crumble – I guess this is because we are playing catchup for the people who retired in the 30’s and could draw from the pot without putting in.
Matt,
You are making the mistake of considering early retirees only in terms of their input to the system. You must also consider what they will take out.
Put another way, If the baby boom generation had been comprised entirely of early retirees, would we be better or worse off than we are now?
While we undoubtedly would have a smaller trust fund surplus, we would also have dramatically diminished future obligations. And the longer the lifespan of the baby boomers, the more favorable this equation becomes for the trust fund in the early retiree scenario.
“Clearly it is not, in order for it to be sustained unfortunately people need to put more into it than they get back out.
If everyone opted out of paying it would crumble – I guess this is because we are playing catchup for the people who retired in the 30′s and could draw from the pot without putting in.”
This is just wrong. What you get out is determined by what you put in. Early retirees are simply not the problem (particularly when there is high unemployment!)
The reason there is an issue now is the same reason that we currently have a large surplus. There simply are more boomers. They contributed more (hence the current surplus). They will have even more future obligations due to life span prolongation. (hence the current and projected deficits.)
It’s that simple. It really is.
So there are any number of things we can consider to make SSI sustainable.
Raise the cap on SSI taxes. (more inflow)
Liberalize immigration. (more inflow)
Raise the age for SSI. (Less outflow)
Decrease benefits levels (Less outflow)
But early retirement just isn’t a big player here. It might even be helping long term. But whatever the effect is I can guarantee it is a small one.
AZ
milesdividendmd.com
I may have been spammed again….
Don’t click on the penis enlargement adds.
It doesn’t work. (I heard from a friend)
AZ
Matt,
I think my response may be in your akismet folder again.
AZ