Social Security: Why You'll Never Get the Big Payoff Your Parents Got

The days of getting a lot of bang for your Social Security tax buck are over. Find out why.

Aug 25, 2014 at 7:00AM

Ssa Save For Retirement
Source: Social Security Administration.

Social Security recently celebrated its 79th birthday, and over the decades, hundreds of millions of Americans have received payments under the program. Most people consider their benefits to have been well paid for by the payroll taxes they've paid throughout their careers. But no matter how valuable Social Security benefits will be to them, today's workers won't get anywhere near as big a payoff as their parents got in return for the money they paid in payroll taxes.

Where Social Security benefits come from
Many people believe their Social Security benefits are linked to the amount they paid in Social Security payroll taxes during their careers. In essence, they see Social Security the same way they'd look at a company pension or 401(k) retirement plan account, comparing what they put into the system with what they took out. If they end up with more money than they put in, then they figure that they got a reasonably good deal. The more excess they take out of Social Security, the better they feel they fared under the system.

But in reality, Social Security taxes play no direct role in the benefits that you receive. Social Security's benefit calculation formula takes average earnings into account, using your work history to produce a primary insurance amount that the Social Security Administration uses in turn to determine how much your monthly Social Security benefits will be. But the benefits that the formula produces are specifically designed not to be directly proportional to average earnings: There's a level of progressivity built into the formula that helps lower-income earners replace more of their past income through retirement benefits than higher-income workers.

The rising tax burden under Social Security
Beyond the progressive nature of Social Security, the other big variable that has changed over the years is the amount people pay in Social Security taxes. When the program first started, the payroll tax rate was a meager 1%, and it only applied to the first $3,000 of income someone earned. Over time, payroll taxes climbed, but it was only in the 1990s that they reached their current rate of 6.2% for the employee contribution toward Social Security.

Ss Tax Rate History
Source: Author. Based on Social Security Administration data.

What that means is that those who worked much of their careers during the 1950s, 1960s, and 1970s ended up getting the best of all possible worlds. Many of them earned retirement benefits calculated similarly to the way that benefits get paid today. Yet by paying tax rates of 1.5% to 5%, they put far less money into the system -- and so their return on the taxes they paid will be far greater than those who put the full 6.2% toward Social Security throughout their working lives.

Ssa Spousal Benefits

Source: Social Security Administration.

Demographics will never be the same
The big factor that made low tax contributions possible was that early in its history, Social Security had far more workers paying into the system than it had recipients collecting benefits. According to the Social Security Administration, the ratio of covered workers to beneficiaries in 1950 was 16.5, falling to 5.1 in 1960 and 3.7 in 1970. Today, it's below three, and the ongoing retirement of the baby boom generation is projected to keep that number shrinking well into the future.

As fewer workers support Social Security, it takes higher tax rates to maintain benefit levels. That means that if anything, the trend will be for current workers to pay more into Social Security, thereby reducing their eventual return even further.

Social Security is still a valuable program, and you can expect to rely on it for at least a portion of your income during retirement. But when it comes to comparing payroll taxes to your eventual benefits, you'll only be able to look back longingly at the big payoffs that your parents and other Americans of past generations got from Social Security.

How to get even more income during retirement
Social Security plays a key role in your financial security, but it's not the only way to boost your retirement income. In our brand-new free report, our retirement experts give their insight on a simple strategy to take advantage of a little-known IRS rule that can help ensure a more comfortable retirement for you and your family. Click here to get your copy today.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information