Social Security. It’s a benefit that, as United States citizen*, you take for granted. Saving aggressively for retirement and investing is nice, but at least Social Security will be there for you in the worst case scenario. Right?
A quick glance at a lot of retirement calculators reveals several issues.
- They assume that at a minimum your expenses will be 60% of what you make now. This is absurd; my expenses aren’t that even now.
- They often cap your savings rate in the 20% range. I save over half my income, and many others do too.
- They don’t let you retire early in your 30s, 40s, or 50s.
- Social Security benefits are included.
Here is a quick screen capture from the AARP website. It doesn’t have most of the issues listed above, but unfortunately, many others (Vanguard, for example) do.
That green Social Security income sure looks nice, doesn’t it?
However, the latest OASDI Board of Trustees report paints a much grimmer picture. The contents of this report should be front page news for every major newspaper, but nary a peep is heard about this shocking information. This is my attempt to wave a giant flag and bring attention to this issue. If I’m right, there are severe consequences.
What is OASDI and How Does It Work?
Before we dive in, let’s briefly go over how the Social Security program is set up and how it works.
OASDI refers to both what we know colloquially as “Social Security” as well as Disability Insurance. The graphic below shows the breakdown of Trusts and how many people they serve.
The next graphic highlights the OASDI’s income, expenses, and reserves. As you can see, in 2016 we had a $35 billion excess! Any excess is added to the trusts and invested in Treasuries, which return a yield every year. Sounds great, right?
Unfortunately, the SSA’s own projections show that this $2,848 billion reserve ($2.8 TRILLION) will be depleted in 2035.
The Report’s Conclusions
First, let’s lay out the conclusions of the OASDI report. This is not me paraphrasing or taking liberties with interpretation; this is verbatim what is written in the report. Deep breath.
Basically, if you’re on disability, you’ll start receiving 93% of your benefits in 2028 or 2029. Not good, but not terrible either right?
About that Social Security check…in 2035 or 2036, it’ll be cut by 25%!
If you’re currently under the age of 48, you will probably never receive a full social security check.
The Report states that by 2022, non-interest income (i.e. taxes) will no longer be able to cover the expense of social security and disability programs. At that point, the interest made from the Trusts’ holdings of government debt will carry cover the shortfall for 13 years or so until they no longer can.
This is a real Catch-22 situation for the government. They could increase the interest rates on the treasuries as the OASI and DI Trust Funds rollover into new investment. These increased interest rates could keep funding social security at 100%. However, raising those rates that quickly and by a good margin is likely to bankrupt the government because $20 trillion of debt (which does not include unfunded commitments like social security btw) at higher interest rates is untenable. I’ll save more of this talk for another time.
Now for the less good news.
The assumptions used in the OASDI projections suuuuuck.
ASSUME (make an ASS of U and ME)
In a previous life, I was an investment banker at a global investment bank.
At both my MBA program and on the job, I learned how to analyze companies using their financial statements and how to build models to find the intrinsic values of the aforementioned companies.
When you first start building valuation models, it’s almost like magic. You feel powerful. “My three statement model ties out!” you scream at 2 am as you feel the Red Bull wear off. The lights in the office are off because the motion sensors don’t register you as a person due to your motionless toil at your computer. Major disrespect from the motion sensors.
However, once the novelty of building models wears off and you gain some wisdom, you realize that your models are only as good as your assumptions. GIGO. Garbage in, garbage out. You can make a discounted cash flow model say whatever you want it to mean. These models are typically projected forward for five or ten years. The Social Security Administration projects forward 75 years! Slight tweaks to a model that projects forward that far out in the future make enormous changes.
In the assumptions below, the Board of Trustees presents three scenarios: I, II, and III.
I is optimistic, III is pessimistic, and II is what the Board of Trustees expects to happen.
The demographic categories used to project forward the country’s long-term growth rate are:
The table below lays out these assumptions.
As you can see in the table above, the SSA’s fertility projections range from 1.8 to 2.2 children per women. More children per woman are better as far as they are concerned because that means, all else being equal, that more people will pay social security taxes.
Here’s how the historical fertility rates look on a chart:
The 2015 fertility rate is 1.84. Provisional 2016 data shows that the fertility rate is at an all-time low.
I took the liberty of looking at the OECD’s data and I compared the fertility rate in the USA vs those of India, South Africa, and Japan. While we’re not in as much of a demographic crisis as Japan, it’s small consolation.
Now, looking above, what would you say the trend is with fertility rates? It’s decreasing across the board. The “baby boom” era increased the fertility rate massively, and perhaps these declines are a reversion to a more sustainable mean. To its credit, the SSA report acknowledges several reasons for the decrease of births. These include:
However, the report then assumes that a 2.0 total fertility rate (“TFR”) is going to be the average going forward. Given that we’re already at 1.84 and the birthrate is declining over time, I think it’s hazardous and ignorant to use 2.0 TFR in the projections.
The reasons listed above are cultural and medical…do you believe they’ll shift radically over the next decade or two and pop us back up to long-term 2.0 TFR? Do you think that women will give up autonomy and control over their bodies, or that we’ll lose all our recent medical advances?
The report states that the lower birth rate we see now is a “deferral, rather than decrease, of birth rates.” I do believe that there is a significant deferral of births. Anecdotally, I’ve known plenty of women who put off having their first kid until their mid-thirties. However, I also noticed that many couples have a tough time conceiving in the latter part of their thirties. IVF and nature have their limits. To assume that these deferred births will equal the number of births there would have been without a deferral is nonsense.
Further, the report ties the recent decrease in birth rates to the Great Recession. That makes sense. However, it projects that the birth rate will jump back up as our economy improves and we enter a glorious new era of prosperity. Everything I see points toward another recession imminently. That topic is for an entirely different post, but let’s keep it simple and say I don’t agree with the SSA’s assumption for now.
The Tier III scenario of 1.80 TFR should be used as a maximum. It should be a Tier I assumption. To be conservative, maybe it’s best to assume our birth rate will approximate Japan’s over time and get closer to a 1.60 or 1.70 TFR.
I’m well aware of the massive issues that overestimating mortality rates has on things such as pensions. However, I wasn’t familiar with the SSA’s track record on correctly estimating people’s average life expectancy. Luckily, I found some data. How good is the SSA at predicting life expectancy?
Not so great. In 1992, the SSA underestimated how long people would live. It seems like the gap is widening over time. To be fair to the SSA, most actuarial estimates have been off regarding longevity.
The International Monetary Fund refers to this trend as “longevity risk.” It’s having a massive impact on both financial institutions and individuals. Retiring at 65 hardly makes sense anymore if there’s a good chance you’ll live past 90. Where are those plagues when you need them the most?** Here’s the IMF’s summary of its report on longevity risk:
The SSA made its first social security payment in January of 1937 after FDR signed the Social Security Act in 1935. The life expectancy for a male in 1937 was 58, and it was 62.4 for a female. However, back then, the ratio of women to men in the workforce was less so let’s assume the average is skewed toward males and is just under or around 60. When the Act was signed, the minimum age to collect full benefits was 65! It’s easy to promise money when most people won’t live long enough to receive it!
Thankfully, the SSA has revised its long-term life expectancy projections. Moreover, the increase in life expectancy appears to be slowing down. Yay?
Regarding mortality, it looks like the SSA is doing a better job than in the fertility rates. However, it must be noted that the previous erroneous assumptions have the momentum of decades behind them and that the SSA is playing catch-up now. A lot of the damage has already been done.
As I mentioned earlier, underfunded pensions are a massive issue right now. These pensions are underfunded because they used similar estimates to the SSA for their projections. However, they don’t have the benefit of a massive mandatory influx of cash every year that the vast majority of people working in the U.S. pay for.
For state and local pensions, the unfunded pension obligation has increased from $292 billion in 2007 to $1.9 trillion today.
The corporate pensions don’t look much better. Of the 200 most massive pension plans in the S&P 500 companies (based on assets), 186 are not fully funded. These companies face a $382 billion funding gap. The switch to 401(k)s in recent decades alleviates the problem somewhat, but it still exists.
Between local, state, and S&P 500 pensions, there is a cumulative shortfall of $2.3 trillion. This does not include the tens of thousands of companies not in the S&P 500 and that are private. The pension shortfall is logically MORE THAN $2.3 TRILLION, but I don’t know by how much.
I’m an immigrant, so I automatically know everything there is to know about this topic. No, I don’t. While I’ve kept a close eye on the previous two areas, I must admit I’ve been lax on monitoring immigration. My family has already been put through the wringer by the immigration process, so I pushed immigration to the back-burner of my mind.
The first table in this post shows that in 2016 and 2017, the SSA decreased its expectations for the number of “other-than-legal” immigration. Interesting. It also shows that there is a substantial spread between the most optimistic Tier I and pessimistic Tier III assumptions. That spread sits at 662 thousand people per year now.
Let’s see what the Trustees Report has to say about immigration.
Nobody has a great idea where net immigration will be in the next 75 years. Immigration is a big question mark.
Politics aside, this headline does not encourage me to be bullish about immigration levels shortly.
Given the number of unknowns here, I’m not going to go with my gut (immigration will decrease). Instead, let’s call this a big wildcard.
It is important to note here that immigration has kept the population growing in the United States. Without immigration, the community would decline (we need a 2.0 TFR net of immigrants to maintain), which further aggravates the issues caused by the Boomer generation. Moreover, immigrants tend to have more kids than the “native” population. A decrease in immigrants will likely decrease fertility rates overall in this country.
OASDI Assumptions: Rosy At Best
I have shown here what the OASDI assumptions are. The fertility rate assumptions are overly optimistic in my opinion, mortality assumptions have been off for decades, and immigration is a giant question mark. Let’s say that fertility is inaccurate, mortality is now accurate, and immigration is likely to be incorrect.
The SSA’s assumptions are too bullish in light of these issues! It is wildly irresponsible to use such friendly numbers in projecting the actuarial status of Social Security funds.
I’m working on a model of the OASDI Trusts’ balance sheets currently. If I find anything interesting there, I’ll post an update. However, it’s important to me that people are aware of the issues with social security, so I am publishing this post now.
Don’t be a dependapotamus. You are responsible for yourself, not the government.
If you’re a millennial or younger, ASSUME YOU WILL RECEIVE NO SOCIAL SECURITY BENEFITS when you project your path to financial independence. Do not rely on the government, friends, or family to bail you out. You are your own responsibility.
If you have been counting social security benefits, stop and see how much more you need to save. Save as aggressively as you can. Embrace the suck now, know your Money Multiple, and give yourself a better life in the future.
I’ve seen other financial bloggers dismiss concerns about Social Security as crazy talk. “Anyone who can do math/understands economics isn’t worried about it,” they say. I can do the math, I went to a top business school, I’m adept at modeling financials, and what I see scares me. I hope here that I’ve at least persuaded you to ramp up your savings rate if you need to.
I hate to be a downer, but I don’t want you to have issues later in life. That’s what this whole blog is about. If there was another Great Depression, who do you think would fare better: someone on the FIRE path who lives a restrained lifestyle or a creampuff who frequently overspends? It’s better to live leanly now when you don’t have to than to have austerity foisted on you by forces beyond your control.
Hopefully, I’m completely wrong about everything here, and Social Security will carry on uninterrupted and in full. There is a non-zero risk that this will not be the case, though. It’s better to err on the side of caution. If you do end up getting Social Security benefits, consider them icing on the cake and enjoy them. But NEVER rely on them if you can help it.
*I know not all of you are U.S. citizens (whatup Canada!). Still, pay attention. Most other “social security” programs in other nations are laboring under the same or similar assumptions as those used in the United States. Many corporate and government pensions are also facing massive shortfalls due to overly optimistic assumptions used decades ago. I listened to Larry Fink, the Chairman, and CEO of BlackRock, speak about this issue in 2012 or 2013 in person. This was his most pressing long-term concern.