What if You Invested Instead of Paying Social Security Taxes

One day, Wanda Worker comes into my office to discuss retirement planning.  She was born in 1959 and wants to make a plan to retire. 


She dumps this on my desk and gripes about how much a rip-off Social Security is:

“This is bullcrap!  My Full Retirement Age is 67 and I’m only going to get $1,915 a month after all the taxes I will have paid into the system!  If they just would have let me invested on my own I would have been far better off!”

I hear this a lot, my friends.  And I mean A LOT. I will hear examples like this…


If I Only Could Have Invested My Social Security Taxes


“If I would have invested only $5,000 a year over the course of my working life (40 years) and received 8% a year returns, I’d have $1.28 MILLION by the time I was 65.  That would have bought a joint life annuity of $5,125 a month income. More than DOUBLE what Social Security pays! And that’s without my employer contributions too! 


This just proves Social Security is a SCAM!”


So, let’s just run some numbers, using REAL numbers, shall we? 


What you see above is Wanda Workers taxable earnings.  These are the ACTUAL dollars she earned in which she paid her Social Security taxes.   


And here are the taxes she actually paid over her working career:

You Didn’t Pay Much Tax Into Social Security


Now, let’s just skip the employer contribution for now and focus solely on Wanda here. She paid all of $68,327 into Social Security over her working career from 1975-2017, that’s 42 years.


And here are the actual tax rates for Social Security (middle column) and Medicare(right).


History of Social Security Tax Rates 


Anything jump out at you here?


Well, let’s look at her earnings in, say, 1999.  She made $32,040. The tax rate for Social Security at that time was 6.2%.  Thus she paid $1,986 into the system. Even if you throw in her employer contribution only $3,927 was paid into the Social Security system on behalf of Wanda. 


Invest Your ENTIRE Income?


Yet, she was griping that if she “only” contributed $5,000 annually over the course of her working career she’d have more than doubled what Social Security is providing.  Well, that means she would have had to invest MORE than what her ENTIRE income for the first 6 years of her working career. For the next 10 years she’d have to have contributed a minimum of 33% of her income on average to her investment accounts.  


In reality, she NEVER contributed $5,000 in taxes into the Social Security system in any year.  The most she ever paid in was $3,100 and that was last year. So, for her to flippantly say if “only” she contributed $5,000 a year since she began working is a most silly argument because she never came close to contributing that amount to Social Security to begin with. 


So, stop that nonsense. 


What’s a Reasonable Rate of Return?


Secondly, she assumes she’d have invested in a “reasonable” rate of return of 8%.  Well, I ran the numbers of her ACTUAL taxes paid into Social Security year over year and gave her that 8% rate of return. (Be advised, I’m greatly over-estimating her actual taxes paid in because I’m using a 6.2% tax rate for her entire working career.  But that rate only started in 1990. If we used the actual tax rates from previous to 1990, it’d look even worse for Wanda!)


What do we find?  She would have paid in around $77,000 total. With an 8% return each year her account would be worth $340,446 today. Using the annuity estimator at schwab.com she’d receive all of $1,204 for a Joint Annuity with 100% survivor benefit. 


An annuity based on her life only would pay $1,499 a month.  Tell me again what her Social Security benefit would be? Oh, right… $1,915. 


Would You Have Actually Invested?


Now one can’t forget we’re making a HUGE assumption here;  That she’d actually have invested the money to begin with. I simply don’t feel that’s a reasonable assumption to make for the vast majority of Americans.  But, in this one case, because my point is still proven, we’ll assume Wanda is unique and actually does invest the equivalent of her Social Security taxes.  


Oh, I hear you yelling “But Josh, the Social Security estimate is based on her Full Retirement Age, not the benefit she’ll get NOW! So, this isn’t a true apples to apples comparison if you don’t include the additional growth.”


Ooooh, so glad you brought that to my attention. The $1,915 Wanda’s Social Security statement says she’ll get a Full Retirement Age is in TODAY’S dollars when Wanda is only 60 years old.   We need to factor inflation, i.e., Cost of Living Adjustments, to determine what her payment will be in years when she turns 67, which is her Full Retirement Age. 


If we use a 2.6% COLA assumptions, her $1,915 a month today will actually pay her $2,351 a month.


Annuity Payments vs. Social Security


Now, mind you, we will assume her portfolio, the one she invested in instead of paying into Social Security, would continue to grow at 8% a year until 67 too.  In this case, that portfolio would have grown nicely to $629,000 which provides a monthly income stream over her life of $3,300, nearly a thousand a month more than what Social Security pays.  


However, Social Security does have survivor and spousal benefits so we also need to compare a Joint Life annuity too, which pays $2,503 a month for BOTH lives.

Fixed Payments vs. Inflation-Adjusted


But that doesn’t tell the whole story.  The annuity income is FIXED. The Social Security income has inflation adjustments. 


With inflation adjustments you’ll have this:


Total Payout After 25 Years
Joint Life AnnuitySingle Life AnnuitySocial Security

Wanda would actually invest the money she didn’t pay into Social SecuritySocial Security pays more than $225,000 over the joint life annuity. Yet it pays only $14,000 less than the single life annuity.  And let me repeat the assumptions we’ve made in favor of the annuity strategy:

  1. We’re using a 6.2% tax rate from the beginning of her working career. The 6.2% tax rate for Social Security didn’t actually begin until 1990.   So, we’re overstating her contributions quite a bit.
  2. We’re assuming Wanda received an average of 8% a year, not only while she was working and contributing her Social Security taxes to an investment account but also for the next 7 years until she turns 67. 
    1. Now, I want to make a point here.  From 1974 through 2018 the S&P 500 Index averaged 12.2%.  So, I imagine there’ll be some Negative Nellies here saying “Josh, you could have got a MUCH better rate of return than 8%!”  Which is true. (See the P.S. at the bottom of this article).
      1. But be advised, the USAA Income Fund, which is the bond fund I use for my proxies, averaged 7.47% from 1974 until today.  I have a very sneaky suspicion that many people would be happy if I said “we don’t even need to put you in the stock market and you could have averaged 7.47% annually for the last 45 years. Would that have worked for you?” Many would say yes. And yet, if they did, they’d have significantly less income than Social Security will pay.  
  3. We’re assuming Wanda would take the entirety of that portfolio and annuitize it at her Full Retirement Age.  Very hard to imagine that happening. More likely she’d take a portion from the portfolio each year, say the 4% rule or something.  And in that case,Social Security looks even better as it’s guaranteed against loss with inflation adjustments. 

They Always Stack The Deck Against Social Security


All in all, my pet peeve on the naysayers about Social Security is that they stack the deck against the program for nefarious purposes.  For instance, they may want to convince you there’s a Retirement Crisis and thus you need to “Work Longer and Invest More”. Or we need to raise taxes even more because the way things are now, NO ONE can retire.  Or you should buy gold. Or the government failed. You can’t rely on the safety net. Blah, blah, blah


It’s DOOMSDAY Out There!


These things are false. Yet doomsday purveyors are legion. And they exist on both the left and right. It’s weird to me, actually.  Especially given the empirical evidence of so many retirees are content and doing just fine. 


Of all the government programs to chastise, which there are many, they’re going to go after Social Security??? The one that works pretty doggone well? Again, it’s just odd.  Don’t fall for it. 



For those who say “I would have invested in the S&P 500 and not bonds.” Well I ran those numbers too. Again, using Wanda Worker’s actual income and taxes she paid.


If instead of paying your taxes into the Social Security system you actually invested in the S&P 500 since 1974 you would have averaged 12.2%.  And your total investment dollars of $77,320 would be worth $762,937 today, when you’re 60 years old. But you’re not going to take your annuity until you are 67. So we will assume for the next 7 years you STILL get 12%. That amount would buy you and Joint Life Annuity of $80,412 a year or $87,324 a year for a Single Life. 


In this case, Social Security is indeed a rip off. Here are the results. 


Total Payout After 25 Years
Joint Life AnnuitySingle Life AnnuitySocial Security


But I like to deal in reality.  So, while a case can be made against Social Security if we receive extraordinary rates of returns, even in this BEST case scenario, which will never happen, you only doubled the money you would have received in Social Security.  Let’s stay in the real world, shall we? And recognize while Social Security isn’t perfect, it is one of the best government programs we have. 

P.P.S.  I forgot to add one last thing…TAXES. Social Security is taxed much more favorably than investment income, especially if that income comes from a retirement account.   If you have nothing but Social Security you will pay no tax.  But if you have nothing but distributions from IRAs et al you most likely will have tax.  Remember that.

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