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Why Social Security Won't Bail Out Many Detroit Workers

The bankruptcy of the city of Detroit has turned the spotlight on the fate of thousands of current and former city workers whose pensions and health benefits are now potentially at risk of disappearing. Yet many Americans don't understand the full importance of the loss of those pension benefits, as they erroneously believe that Social Security will step in to provide at least a baseline level of subsistence income for workers affected by Detroit's bankruptcy.

Unfortunately, many public sector employees don't have Social Security standing behind them. That stands in stark contrast to what many private workers receive, like the much-ballyhooed benefits that Detroit-area automakers Ford (NYSE: F  ) and General Motors (NYSE: GM  )  offer some of their employees, who could get both lucrative private pension payments and potential Social Security benefits down the road. Unlike them, many city and state employees only have their pensions as support -- pensions that could now be in jeopardy from Detroit's bankruptcy filing.


The city of Detroit. Source: Wikimedia Commons.

Looking at Social Security history
To understand why Social Security doesn't help all state and local employees, you have to go back to the origins of the Social Security program. At its inception, Social Security didn't cover any state and local government employees, as the idea was that Social Security was supposed to be a supplemental income program and that government employees who already had access to public retirement pension programs didn't need a further backstop.

Since then, laws have changed that allow states to voluntarily enter Social Security under what's known as Section 218 agreements. Moreover, federal law in 1991 began to protect public employees of state and local governments that weren't members of a public pension system.

Even with those opportunities, many state and local employees still aren't part of Social Security. The benefit of that is that unlike private employees, they don't have 6.2% of their wages withheld to cover Social Security taxes. But the downside is that they also aren't entitled to Social Security benefits based on their earnings record as a government employee, and they sometimes also have benefits that they've earned during past private employment reduced.

How Social Security takes benefits away
In particular, two provisions affect benefits of government workers who've previously had private-sector employment subject to Social Security. The Windfall Elimination Provision involves using a modified formula to determine your benefits, resulting in a benefit amount that is lower than you would receive under the normal formula. The idea is that because Social Security benefits are tiered to return a higher percentage of income to low-wage workers, those with substantial government service often end up resembling workers with low income levels, thereby getting a disproportionately large Social Security benefit in addition to pension payments. The formula the Social Security Administration uses essentially takes away the low-income advantage of Social Security, reducing benefits by as much as half even for those with more than 20 years of non-government service, subject only to maximum reduction restrictions.

The other provision creates a Government Pension Offset that affects spousal and survivor benefits. This offset is a lot simpler to understand: If you worked in a government job that wasn't covered by Social Security but are entitled to benefits under your spouse's work history, then the amount of your Social Security payment will be cut by two-thirds of whatever you receive from your government pension.

Both of these provisions have more detailed rules that create exceptions in certain cases. Still, they explain why so many of the workers involved in the Detroit bankruptcy might not have Social Security to fall back on if their pensions are cut.

The Detroit debacle
Of course, it remains to be seen whether Detroit workers will actually suffer pension reductions, and legal wrangling over benefits could continue for years. If they do, though, one other problem they face is that unlike private employers, government entities aren't eligible to have pensions insured by the Pension Benefit Guaranty Corporation. In the past, the PBGC has protected workers of US Airways (NYSE: LCC  ) , United Continental's (NYSE: UAL  ) United Airlines, and many other formerly bankrupt corporations whose workers had benefits cut.

What all of this makes clear is just how high the stakes are in the bankruptcy proceeding, both for Detroit and for public-sector workers around the country. If benefits are cut, it could set a dangerous precedent that other cities across the nation could follow. For those who lack a previous work history covered by Social Security, an adverse finding from the bankruptcy court could leave them completely on their own to salvage their retirement prospects.

If you're eligible for benefits, Social Security plays a key role in your financial security. In our brand-new free report "Make Social Security Work Harder for You," our retirement experts give their insight on making the key decisions that will help ensure a more comfortable retirement for you and your family. Click here to get your copy today.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.


Read/Post Comments (17) | Recommend This Article (13)

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 July 31, 2013, at 10:52 AM, KUBLOTNIK wrote:

    even for those of us who have paid into SS it may not be there. how many SHEEPLE know that SS has been part of the general fund since the days of LBJ.? ex congress PERSON pat schroeder of col. said on C-SPAN in 2001 that the congress used SS as a "slush fund" and that they always promised that they were going to put it back,BUT THEY DIDN'T. they used it up !!! to buy votes for 50 years.!!! good luck if all you have is SS for retirement.

  • Report this Comment On July 31, 2013, at 2:49 PM, whyaduck1128 wrote:

    She's right in this case, but I wouldn't cite her as a bellwether. If Pat Schroeder says the sun rises in the east and sets in the west, I'm going to check it out. She was and is hardly the most reliable person when it comes to "fact" reporting. Strictly a party-line, kneejerk has-been.

  • Report this Comment On July 31, 2013, at 3:45 PM, yooperintx wrote:

    She is wrong. SS has redeemed bonds in 11 different years due to tax receipts being less than benefit payments. Yes, Congress has spent the money, but when necessary they have replaced what was needed. SS earns billions annually in interest on the bonds it holds. Would you have them just keep the cash in a vault instead and not earn interest? If they did that, the fund would be depleted much sooner. That information is readily available on the SS web site.

  • Report this Comment On July 31, 2013, at 3:53 PM, yooperintx wrote:

    The statement that "...SS has been part of the general fund since the days of LBJ" is also not totally correct. Here is the explanation from the SS web site about the supposed promise that SS Trust Funds would only be used for SS and no other program:

    "The idea here is basically correct. However, this statement is usually joined to a second statement to the effect that this principle was violated by subsequent Administrations. However, there has never been any change in the way the Social Security program is financed or the way that Social Security payroll taxes are used by the federal government.

    The Social Security Trust Fund was created in 1939 as part of the Amendments enacted in that year. From its inception, the Trust Fund has always worked the same way. The Social Security Trust Fund has never been "put into the general fund of the government."

    Most likely this myth comes from a confusion between the financing of the Social Security program and the way the Social Security Trust Fund is treated in federal budget accounting. Starting in 1969 (due to action by the Johnson Administration in 1968) the transactions to the Trust Fund were included in what is known as the "unified budget." This means that every function of the federal government is included in a single budget. This is sometimes described by saying that the Social Security Trust Funds are "on-budget." This budget treatment of the Social Security Trust Fund continued until 1990 when the Trust Funds were again taken "off-budget." This means only that they are shown as a separate account in the federal budget. But whether the Trust Funds are "on-budget" or "off-budget" is primarily a question of accounting practices--it has no affect on the actual operations of the Trust Fund itself."

  • Report this Comment On July 31, 2013, at 5:13 PM, Snakepit456 wrote:

    It doesn't take a genius to see what happens when the entitlement state outgrows the economy upon which it rests. The time of Greece, Cyprus, Portugal, Spain, the rest of insolvent social-democratic Europe — and now Detroit — is the time for conservatives to step in and yell "Stop." You can kick the can down the road, but at some point it disappears over a cliff.

  • Report this Comment On July 31, 2013, at 6:13 PM, ScottPletcher wrote:

    Quote: "The benefit of that is that unlike private employees, they don't have 6.2% of their wages withheld to cover Social Security taxes." For private workes, it's actually **12.4%** since the employer also pays half -- which they can't then pay to the worker. SocSec is the biggest Ponzi fraud in history. 401Ks get a tiny % compared to SocSec and they've grown HUGE. If we were allowed to invest our own retirement money -- as any FREE society would allow -- we could retire rich, instead of worrying about which cat food tastes best.

  • Report this Comment On July 31, 2013, at 7:57 PM, yooperintx wrote:

    No one is stopping you from investing your own money. I retired just over two years ago from a lower level management position. I paid in to SS for almost 50 years and for my last job, 21 years, paid a small amount toward a small pension and 10% to a 401k type plan with a 5% match in addition to SS. Most developed countries have government sponsored pension plans that either the employee pays for directly out of their paycheck or through taxes. Having the option of 401k plans and IRAs is just extra. While you could retire rich on your investments, you could also retire quite poor if you retire just after a big market downturn like we had in 2008. At least SS provides a base for retirement, which is what it was designed to be, that is not affected by the stock market. If you are planning to retire solely on SS, you really are not planning.

  • Report this Comment On August 01, 2013, at 11:21 AM, pondee619 wrote:

    "government entities aren't eligible to have pensions insured by the Pension Benefit Guaranty Corporation"

    Why is this? Could it be because government pesions were deemed to be "safe" and, therefore, insurance was an unneccessary expense? Perhaps that mind set needs to be revisited.

  • Report this Comment On August 01, 2013, at 1:58 PM, ershler wrote:

    Snakepit456,

    The state didn't grow bigger, the economy collapsed. Detroit definetly isn't a good example unless you are trying to learn about govenment corruption but do you really any type of government could do well if 5/6th of its population disappeared?

  • Report this Comment On August 01, 2013, at 2:51 PM, Olderider wrote:

    "The benefit of that is that unlike private employees, they don't have 6.2% of their wages withheld to cover Social Security taxes." I recently retired as a government worker, and throughout the entire time I was not contributing to Social Security, I was required to pay 8.5% towards my pension, which was matched by my employer. The percentage varies from agency to agency, but government employees generally pay a higher percentage towards their retirements than do private employees to theirs.

  • Report this Comment On August 01, 2013, at 3:08 PM, Elbonian wrote:

    While bankruptcy law is determinative on procedural issues, the substantive issues (what are assets; what are liabilities; etc.) are all determined by state law. The Michigan Constitution says that public employee pensions may not be reduced. Of course, if the pensions were outrageously large, I'm sure the bankruptcy judge could be persuaded to adjust them under usual principles of equity in bankruptcy. But the Detroit pensions are small as compared with pensions for other cities of similar size and prestige. So I'm personally willing to bet that the bankruptcy judge will tell the Emergency Manager that he lacks the power to reduce pensions below the already reasonable levels currently provided and thus the Emergency Manager will need to find some revenue stream that can/will be used to fund the city's pension obligations.

    While the Emergency Manager has requested the bankruptcy court to declare Detroit's pension obligations to be unsecured debts, I'm betting that the Michigan Constitution creates a security interest in the city's revenues until those benefits are completely paid for.

    Whatever happens, it will be interesting to watch.

  • Report this Comment On August 01, 2013, at 3:24 PM, Elbonian wrote:

    Venom writes: "Smart retirement investing can make you a millionaire in your retirement, pensions and social security will not, and will give an eternal fixed income."

    That is SO NOT TRUE!! Wall Street stacks the deck against average investors, telling them to buy this great stuff while, if it is really any good, keeping it for themselves. How else can the average bonus at places like Goldman Sachs be far more than the average salary for common folks like me? Playing on Wall Street is little different than playing at an Atlantic City casino. The deck is stacked against you and the house always wins. One of the first books I read when I started investing decades ago was "A Random Walk Down Wall Street," which shows that buying random amounts of random stocks yields a better average return than the typical deliberate investment strategies followed by most investors.

    If you think you know a better way/investment/strategy, then you might get rich writing a newsletter to a million fools, but you still won't make money playing on Wall Street!

  • Report this Comment On August 01, 2013, at 8:59 PM, ershler wrote:

    Elbonian,

    So you read a book full of BS and we should change our investment philosophies. I was going to write a long reply listing investors track records and the odds they could be by chance but it has been done before.

  • Report this Comment On August 01, 2013, at 10:32 PM, BMFPitt wrote:

    They'll get as much from Social Security as anyone under 35 will. At least they haven't had to pay into it their whole lives.

  • Report this Comment On August 02, 2013, at 1:30 PM, ynotc wrote:

    So much for the idea that investments and promises made by the government are better and more reliable than the private sector.

    Probably makes them wish they could have invested thier retirement in the market instead of placing it with the "safe" government source.

    Don't worry there will be a bailout because no one should ever suffer any consequences.

  • Report this Comment On August 04, 2013, at 1:36 AM, ChrisBern wrote:

    "The benefit of that is that unlike private employees, they don't have 6.2% of their wages withheld to cover Social Security taxes."

    That is one massively extraordinary benefit!! How many of us private employees would sign up for this arrangement in a heartbeat, where we could keep that 6.2% of our wages and invest it ourselves? I would without a moment's hesitation. Just putting that 6.2% in SPY or TIPS for 40 years would get me way more than I'll ever get from SS--if I ever get anything from SS.

  • Report this Comment On August 06, 2013, at 3:46 AM, Rowants wrote:

    My cats like Purina.

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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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