How the Current System Works

Social Security basically resembles a traditional employer pension. We pay into the plan during our working years and receive monthly payments during retirement. The more you pay into the plan, the more you recieve back, but the plan gives higher returns to the poor than it does to the rich which makes it a highly successful anti-poverty program. And most important, the plan is indexed against inflation and is protected from the ups and down of the economy and the financial markets. That is how it provides security for the middle class.

Calculating Benefits

The full retirement age benefit calculation is a bit complicated. You start with the amount of income on which you paid Social Security taxes each year you earned money, multiply that by an “index factor” to adjust it for inflation, and then determine your average income over the highest 35 years. In 2014, your benefits would be 90% of the first $9,792 of average income plus 32% of the income from $9,792 to $59,004 plus 15% of everything over $55,488 to a maximum of $117,000. The percentage breakpoints are adjusted for inflation each year.

The benefit is then multiplied by a percentage factor based on your actual age when you retire.

The following chart illustrates how the payout percentages are heavily weighted for those in the lower income brackets. This is very understandable because those with lower incomes really do not have the opportunity to save for retirement while those at higher incomes do.

$10,000 $8,879 $8,879 88.8% $8,000 ($879) $0 $0 $8,879 $8,538 88.8%
$20,000 $3,200 $12,079 60.4% $16,000 $3,921 $0 $0 $12,079 $3,200 60.4%
$30,000 $3,200 $15,279 50.9% $24,000 $8,721 $0 $0 $15,279 $3,200 50.9%
$40,000 $3,200 $18,479 46.2% $32,000 $13,521 $0 $0 $18,479 $3,200 46.2%
$50,000 $3,200 $21,679 43.4% $40,000 $18,321 $2,080 $312 $21,367 $2,888 42.7%
$60,000 $3,031 $24,710 41.2% $48,000 $23,290 $5,898 $885 $23,825 $2,458 39.7%
$70,000 $1,500 $26,210 37.4% $56,000 $29,790 $12,061 $1,809 $24,401 $576 34.9%
$80,000 $1,500 $27,710 34.6% $64,000 $36,290 $18,223 $3,645 $24,065 ($336) 30.1%
$90,000 $1,500 $29,210 32.5% $72,000 $42,790 $24,386 $6,096 $23,114 ($952) 25.7%
$100,000 $1,500 $30,710 30.7% $80,000 $49,290 $26,104 $6,526 $24,184 $1,071 24.2%
$110,000 $1,500 $32,210 29.3% $88,000 $55,790 $27,379 $6,845 $25,365 $1,181 23.1%

Well, that explains the first 4 columns. The remaining columns deal with the taxation of the Social Security benefit. If a person wants to retire on 80% of their pre-retirement income, they will have to supplement their income from other sources. Assuming this “other income” is taxable income from IRA’s, 401K’s, or a part time job, at some point a portion of their social security benefit becomes taxable income and they will have to give some of it back to the government in the form of taxes. The last column of the table shows how the actual retirement benefit is further reduce for higher income individuals after tax.

The negative numbers in the Delta column of this chart are accurate and need a bit of explanation. Our last page, The Hump, will explain this in more detail, but please don’t jump there just yet. Basically you are at the point where every additional dollar of extra income causes 85 cents of your social security benefit to become taxable income, you are in the hump! When you reach the 25% taxation level this can actually cause your after tax benefit to go backwards until you reach the point where 85% of your entire benefit has been taxed, you get over the hump!

Average Benefits

In order to make a reasonable model of how a new system would work, we have to start with a SWAG (Scientific Wild Arsed Guess) at the average benefit of the average American at their full retirement age. The scientific part was to use September 2013 from the U.S. Census Bureau to determine the percentage of people who fall into each income category. We then calculated the average benefit for an average 100 people.

$10,000 $8,879 18.59 $185,900 $165,061
$20,000 $12,079 19.71 $394,200 $238,077
$30,000 $15,279 15.12 $453,600 $231,018
$40,000 $18,479 11.68 $467,200 $215,835
$50,000 $21,367 8.69 $434,500 $185,679
$60,000 $23,825 6.37 $382,200 $151,767
$70,000 $24,401 4.83 $338,100 $117,856
$80,000 $24,065 3.51 $280,800 $84,469
$90,000 $23,114 2.49 $224,100 $57,553
$100,000 $24,184 1.76 $176,000 $42,564
$110,000+ $25,365 7.25 $797,500 $183,899
  100 $4,134,100 $1,673,778
  40.49%

Note: We included the percentage of people making over $110,000 in the $110,000 group since they pay OASDI on their first $117,000 of income.

40% will work well for this discussion, but, before a real plan can be implemented, we will need to get an accurate percentage from the Social Security Administration.

Now that some of the preliminaries are out of the way, it’s time to look at the 1983 legislation and see why it fixed the problem 30 years ago, then failed “again”.

Next - The Social Security Amendment of 1983