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:


Earnings per Share

Dividends per Share

International Business Machines (NYSE: IBM  )



Coca-Cola (NYSE: KO  )



Abbott Laboratories (NYSE: ABT  )



Monsanto (NYSE: MON  )



Emerson Electric (NYSE: EMR  )



Marathon Oil (NYSE: MRO  )



General Mills (NYSE: GIS  )



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.

Use the tools you have
At Motley Fool Rule Your Retirement, we know how frustrating it is to plan your future when the cornerstones upon which it was supposed to be set seem to be crumbling before your very eyes. That's why we'll give you a free 30-day trial to check out our service and see for yourself the tools and strategies we've amassed to help you make the most of the reality we live in today. Simply click here to get started.

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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.

Read/Post Comments (8) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 12, 2009, at 8:57 AM, weiwentg wrote:

    One brief comment about the structure of the Social Sec trust fund. President Bush (43) said that the IOUs from the Feds to the trust fund are essentially worthless. That's incorrect.

    My interpretation of how the trust fund is structured is that the Feds collect money through the tax system. The Feds guarantee the trust funds their money back plus a 5.9% annual return. With the long-range CPI forecast at (iirc) 2.8%, that translates to a 3.1% real return.

    The payroll taxes go into general revenues and the Feds are free to use them any way they feel is wise. However, at the end of the day, they need to return the trust fund's money.

    In cost-benefit analysis for social programs, we've typically used 3 or 4% real returns as the discount rate, meaning that governments can be expected to generate a 3-4% return on money spent on public programs (education, healthcare, etc). In other words, the government's promised rate of return for the trust funds is within a reasonable range.

    In any case, there's a good argument for having the government invest some of the trust funds in a broad portfolio of index funds to generate a higher return. Individuals would not be bearing market risk. The government, with its presumably unlimited time horizon, would be able to bear market risk far better than individuals.

    Note, though, that investing 40% of the trust fund in an equities (assuming a real return of about 6%) would only meet 25% of the currently projected 75-year shortfall in the trust fund. In other words, the government will need to, and should, cut benefits and raise taxes. For the former, the retirement age should probably be raised to around 70 (although protections need to be in place for those not physically able to do that). For the latter, there are a number of ways to do it. However, I'd endorse increasing the amount of income subject to FICA taxes and extending some portion of the FICA taxes to investment income (capital gains and dividends).

  • Report this Comment On September 12, 2009, at 10:57 PM, phildevoyd wrote:

    So let's make a new plan. Kill social security as such. Rollover the benefits to to new IRA's. With similar restrictions, of course. The banks will love it.

  • Report this Comment On September 13, 2009, at 5:41 PM, craigh42421 wrote:

    Two comments:

    1. The social security component of FICA is 12.4 percent, not 10.6 percent. 6.2 percent is paid by the employer and 6.2 percent is paid by the employee.

    2. The trust fund as currently structured is as meaningless as putting IOUs in your piggy bank. The money to repay the IOUs and fund benefits will have to be raised through debt sales to the public, printing money, or higher taxes just as it would of had to have been raised if the IOUs didn't exist. There is not one cent worth of difference in the cash flows. The political power of the elderly will have far more to do with funding social security benefits than pieces of paper in a vault somewhere. I expect that benefits will continue to be funded out of the general fund even if the "trust fund" is exhausted, current law notwithstanding.

  • Report this Comment On September 13, 2009, at 8:22 PM, TMFBigFrog wrote:

    Hi Craigh42421,

    The Social Security component of FICA may be 12.4%, but only 10.6% goes to retirement benefits. The rest takes care of things like Social Security Disability. Since this article only considered the retirement aspect of Social Security, I wanted to make the comparison as apples-to-apples as possible.

    Best regards,


  • Report this Comment On September 14, 2009, at 10:24 AM, pmcw007 wrote:

    This "story" tells you very little about how social security really works. I think the real story is something all Americans should know. To read the truth behind social security, including links to government reports to support the data, please see:

  • Report this Comment On September 14, 2009, at 10:45 AM, Mr5StarFool wrote:

    Social Security was an idea that could not have recognized the onslaught Planned Parenthood would have on its projected participants contributions. If we were unclear as to the deleterious effects such bizarre practices might have on a society long term, let us mention one of them: We are missing around 30 million working, tax paying citizens.

    Now that we have opened our borders to illegal immigrants in an attempt to help to help fill the bill, let us hope that these hungry population control enterprises do not excessively target our new S.S. participants with their educational messages of "choice"and "convenience."

  • Report this Comment On September 14, 2009, at 1:51 PM, StopTaxingMe30 wrote:

    5Star, your observations are rather optimistic. The people Planned Parenthood helps are generally from the inner cities, low income families and scared high school kids whom are unlikely to be successful parents. In fact, I'd say the high graduation rate of these "30 million" would likely be well under 50%, as are many poor areas. They are people much more likely to require social support in life than they are likely to be a net positive on our social programs.

    As for illegals, that statement is even further puzzling. They are again a net drain on our social systems. Please take 5 minutes and look at California. They have to jack up taxes sky high, sending business running(see Toyotas recent move out) in order to support the lower wrung of our social system.

    Anyone counting on Social Security for more than 25% of retirement needs did a poor job planning. This is the problem with any social program. People just figure they'll have it as a crutch and no longer have to worry about personal responsibility.

  • Report this Comment On September 16, 2009, at 11:19 AM, WillBur73 wrote:


    You are correct that Social Security is missing many of the dimensions of a Madoff type Ponzi scheme, but it will not do to let the discussion pass without pointing out the primary similarity that inspired that name to be placed upon it.

    And that is gross overpayment to the first several generations of recipients to the financial ruin of those coming after. An average worker in 1950 (based on the index wages from 1937 to 1949) received 18 times the annuity value based on US long bond, of his and employers payments) Many lower income workers who came into the system with as little as 6 quarters of payments (1 1/2 year and less than 50 dollars) received hundreds of times that annuity value. In 1960 it was 8 times and 1970 5 times, 1980 3x and so on. In order to pay for this wrongful transfer of wealth (fraud voted increases by Congess to get votes) younger people endured huge increases in taxes, both percentages and income limits so far beyond what FDR envisioned. If you read the original papers, his vision was a fair annuity type system with primary socializations being that workers who died early paid for those wlived longer (ie no vesting) and that the first dollar paid in was worth more on an annuity basis than the last (ie higher paid workers did lees well on an annuity basis than lower) He never envisioned this type of generational inequity. Now the next generation will have to pay much more just to give me the current promised benefit which is less than 30 cents ont the dollar of my earned annuity. And don't tell me it is all due to longer lifespans. The life expectancy at 65 is only about 6 years longer now than in 1940. People often ignorantly use life expectancy at birt which is irrelevant.

    If I could have kept and invested my payments in a mediocre retirement fund since entering workforce I would have a million dollar retirement, now it is just min wage as was mentioned.

    One more thing, my cohort of mid-fifties baby boomers is the largest generational group around and we will not surrender one penny of the meager benefits that we are promised because we have paid for them many times over unlike our predecessors.

    Social security, if not a true Ponzi, is an intergenerational fraud marked by self dealing of first generations and therefore null and voidable.

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