The problems facing the U.S. economy are daunting especially when it comes to issues of Government spending and the current deficit. We recently wrote about the dependency on Government programs which are currently making up as much as 35% of personal incomes. Social Security, Medicaid and Medicare make up the largest portions of the current spending requirements of the Federal Budget. The current administration has promised that cuts will not be made to government “entitlement” programs but is that a promise that any administration can actually keep?
When it comes to Social Security the facts are rather alarming. By 2017 the Social Security Administration will pay out more in benefits than it takes in. This is not surprising given that in the 1950’s there were roughly 5 workers for every retiree. Today, it is roughly half of that. With 78 Million “baby boomers” moving into retirement the demands on social security are set to spiral higher in the coming years ahead. Is it really any wonder then that with demographics heading in the wrong direction, not to mention a much slower growth economy, that the Social Security Administration has moved up its estimate that the Social Security Fund will be exhausted entirely by 2033?
With these rather stark points in mind it was much to my dismay that Smart Money published an article by Alicia Munnell entitled “Social Security: The Cheapest Annuity In Town” which stated: “The Center for Retirement Research at Boston College has just released a new study that shows that the best way for people to turn their 401(k) balances into a stream of income is to ‘buy’ an annuity from Social Security. Many people don’t recognize that Social Security is in the annuity business, but it is and it has the cheapest product in town.”
The premise is that as individuals approach retirement they should use 401k and IRA asset’s first to live on and postpone drawing Social Security for as long as possible. She states: “A much better alternative is for the household to ‘buy’ an annuity from Social Security. They can make this ‘purchase’ by using their savings to pay current expenses and delaying claiming to get a higher monthly benefit at an older age. The savings used is the ‘price’ and the increase in monthly benefits is the annuity it ‘buys.'”
This sounds great on the surface. She uses the following example: “Consider a retiree who could claim $12,000 a year at age 65 and $12,860 at age 66 – $860 more. If he delays claiming for a year and uses $12,860 from savings to pay the bills that year, $12,860 is the price of the extra $860 annuity income. The annuity rate – the additional annuity income as a percent of the purchase price – would be 6.7 percent ($860/$12,860). Remember that Social Security benefits are indexed for inflation, so the retiree is buying a real annuity.”
The proverbial “fly in the ointment” was brought forth by Jim Horney at the Center on Budget Priorities where in an USA Today article he exposed the lie that is Social Security: “It’s not easy, but it can be done. Retirement programs are not legal obligations.” Read that last sentence again. While we have all been led to believe that there is some “lock box” in Washington that are safeguarding the semimonthly payments that are drafted from our paychecks — the reality is that this is simply not the case. This is why Mr. Horney stated that Social Security should not count as part of the deficit because, unlike businesses, the Government can change what it owes by lifting taxes and cutting benefits.
Therein lays the problem with Ms. Munnell’s article. The “cheapest annuity in town” may also be the worst possible investment. Why? Because the money you pay into Social Security is not yours. Politicians can confiscate those dollars at their discretion such as when the Clinton Administration used the dollars from Social Security to balance the budget. They can raise the retirement age thereby shortening the number of dollars that must be paid out. Moreover, as we have seen over the past decade, they can eviscerate their obligations by debasing the dollar. In other words, by spending your saved retirement dollars today, which could be invested in assets that will produce an income stream in the future, in the hopes of a better “annuity” stream in the future there could likely be very negative ramifications. This is especially the case when you consider that the average American is woefully under-saved for retirement and two nasty bear markets during this century alone has all but insured that many Americans will be working far longer than they originally planned.
Combine those issues with the reality that eventually the government will have to take steps to begin to deal with the problem that is Social Security. While there has been much discussion of the issue of cutting the deficits, reducing spending and raising revenue to return to a path of prosperity — the simple fact is that nothing can be accomplished without attacking the 800-lb guerrilla that is entitlement spending.
My friend Doug Short wrote an excellent commentary on this very issue which is worth reviewing in the context of this article. The simple fact is that while “By law, the federal government can’t tell the truth,” according to Sheila Weinberg of the Chicago-based Institute for Truth in Accounting, the “math” doesn’t lie. The entitlement programs alone consume more than the entire tax revenue for the year which is why the current Federal Debt levels have now surpassed 100% of GDP.
The trend is clearly unsustainable and something will have to ultimately give. While Ms. Munnell believes that Social Security annuities are a better deal than those in the private market the major difference is that the government has no “legal” responsibility to pay what is currently owed. In the coming years the currently under-saved and aging “boomer” population may be faced with the tough decisions of working longer and reducing their standard of living. For those that are currently working and paying into the system — the best advice still remains to save more, spend less and be self reliant for your retirement because the truth is that “social safety” net may just turn out to be a big fat lie.