Ponzi

Charles Ponzi, namesake of the scheme that has since taken many forms.

When Social Security's trustees issued their recent report on the financial health of the program, they said the trust funds that support Social Security were on track to run out of money by 2033.

Absent a change in the law, when those trust funds empty, benefits will be cut by about 23%. That fact, combined with the reality that Social Security operates largely on a model whereby today's workers pay the costs of today's retirees, leads many people to call it a Ponzi scheme.

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Source: Social Security administration.

Such an accusation is tempting to make: Yes, Social Security is pay-as-you-go, and yes, it's not currently in a perpetually sustainable state. But, rest assured, Social Security is not a Ponzi scheme.

What sets Social Security apart?
First and foremost, Social Security's Trust Fund is invested in real-life assets: special-issue U.S. Treasury bonds. It's not the world's greatest investment, but those bonds carry with them real obligations of the U.S. Treasury to hand over cash for Social Security to pay its beneficiaries. Contrast that with a typical Ponzi scheme, where the scheme's assets are completely phantom, and you can see that those real investments make Social Security far superior to a Ponzi scheme.

Second, Social Security's accounting is about as honest as any accounting based on projections can be. Its trustees are actively telling you that it is running out of money. On top of that, Social Security's website explicitly tells you that the program likely won't be enough to cover your costs in retirement. Social Security tells you what's going on, warts and all, and it wants you to invest around its shortcomings. A Ponzi scheme, on the other hand, will lie through its teeth in its accounting and projections to try to encourage you to "invest" more in it.

Third, Social Security is a mandatory program for nearly all U.S.-based wage-earners. The money coming in to pay benefits will keep coming in unless there's a tremendous shift in the law. When Ponzi schemes collapse, they often collapse quickly after they're uncovered as scams, because people stop contributing new money.

Fourth and finally, Social Security has a multidecade history of being patched up by Congress. When it started, Social Security's tax rate was 2% (half paid by you, half paid by your employer), while today it's 12.4%. Similarly, Social Security taxes were originally levied on your first $3,000 of income, while today's taxes are taken out of your first $117,000. That's a substantially higher tax rate on twice the income base after adjusting for inflation. Additionally, since the mid-1980s, your Social Security benefits themselves can be taxed if your total income level is high enough, with a huge chunk of that tax money helping to shore up the system. 

Those Congressional patches have already been applied to bolster Social Security, and chances are good that Congress will come up with other sorts of patches to keep the program running in the future. Having Congress behind it gives Social Security a far better foundation than any Ponzi scheme in history.

It's not perfect, but it's no Ponzi
Even if Social Security doesn't get patched again, it will still pay out about 77% of its expected benefits once its trust funds empty. While that's less than any of us may have anticipated, that money will still make its way through Social Security to those anticipating that cash. Given that Ponzi schemes typically evaporate when funds dry up, Social Security is a far better system.

Chuck Saletta is a Motley Fool contributor. 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.