Is Social Security a Giant Ponzi Scheme?

Jim Cramer has called Social Security the largest Ponzi scheme in history. To an extent, he's making a valid comparison. Like a Ponzi scheme, Social Security pays its benefits out of new contributions, rather than out of investment returns.

Also like a Ponzi scheme, Social Security is in the process of collapsing under its own weight. According to its most recent annual report, the Social Security trust fund is expected to be exhausted by 2037. With similarities like that, it's no wonder Cramer felt he could make the comparison.

Surely that's not right?
But Social Security isn't exactly a Ponzi scheme, no matter how similar it may seem on the surface. For one thing, Social Security is a mandatory program. With few exceptions, if you're a working American, you're paying into the system. That helps shore up its foundation far more firmly than a typical Ponzi scheme.

For another, Congress has the authority to increase the taxes you pay into Social Security -- and it has, on numerous occasions. When the program started, taxes for retirement benefits were set at 2% of the first $3,000 of your earnings. That figure now sits at 10.6% of your first $106,800 of income (half paid by you, half by your employer on your behalf). That's quite an adjustment, and it's a big part of the reason Social Security hasn't collapsed yet.

And of course, while Ponzi schemes attract clients by promising impossibly high returns, Social Security promises no such nonsense. On the contrary, on average, Social Security's promised payout is about the same as a minimum-wage job. Not promising the moon and the stars also helps keep Social Security from quickly falling apart, like a Ponzi scheme would.

It's still not enough
Perhaps the biggest difference between the two is that Social Security admits its shortcomings in a way no Ponzi scheme ever would. Regarding what you can expect from the program, here's what the Social Security Administration itself says:

"For an average worker, Social Security replaces about 40% of annual preretirement earnings. Since Social Security will only replace part of your lost earnings, your savings and investments play an important role in ensuring adequate income for you and your family."

And even that 40% level won't be reached after the trust fund is exhausted in 2037. Once again, Social Security has this to say on the matter: "Even if modifications to the program are not made, there would still be enough funds in 2037 from taxes paid by workers to pay about $760 for every $1,000 in benefits scheduled."

In other words, you shouldn't depend on getting more than about 30% of your preretirement earnings from Social Security, starting around 2037.

What can you do?
The traditional thinking was that your retirement would be funded by a "three-legged stool" comprising Social Security, employer pensions, and your own personal savings. Unfortunately, all three legs are under assault. Not only is Social Security on the rocks, but employer pensions are a vanishing breed as well. And of course, with the market meltdown we've just lived through, you may be wondering whether it's still worth your while to invest.

With the deck seemingly stacked that far against you, is it even worth it to try to retire?

Of course!
Traditional pensions may largely be lost forever, but even under the worst-case scenario, Social Security is still expected to pay some benefits -- about three-quarters of the scheduled amount. And while the market may be down, it's not out. Many publicly traded companies are still profitable and still pay dividends. Over the long haul, earnings and dividends drive stock prices and investors' total returns. So as long as the ability to earn a profit and pay dividends is not forever lost, long-term investors should be able to earn capital gains and investment income.

In fact, even in the short run and amid this economic malaise, there are still strong, profitable businesses that continue to pay dividends to their shareholders. Here are just a few:

Data from Yahoo! Finance.

These companies are making -- and handing out to their shareholders -- this kind of money amid what has been called the worst economy since the Great Depression. That should give you hope for their futures, once a recovery finally takes hold.

At the very minimum, it should help you continue to invest through this mess. After all, your investments make up the one part of the three-legged retirement stool that you control. It'd be a pity to relinquish that control based on a single year's slipup -- no matter how disastrous that year may have been.

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This article was originally published on July 21, 2009. It has been updated.

At the time of publication, Fool contributor Chuck Saletta did not own shares of any company mentioned in this article. Coca-Cola is a selection of both Motley Fool Inside Value and Motley Fool Income Investor. The Fool has a disclosure policy.