Is Social Security a Good Investment?
THE HISTORY OF SOCIAL SECURITY (SS)
SS was created in 1935 by President Roosevelt in response to the financial devastation caused by the Great Depression. It was initially meant to be a retirement safety net to protect against the “hazards and vicissitudes of life.” The program has dramatically changed through the years including the addition of a disability program in 1954 and an automatic COLA (Cost of Living Adjustment) in 1975.
TODAY’S SOCIAL SECURITY
SS makes up 20% of total current federal spending and is funded primarily through the SS payroll tax. With a declining population and increasing average lifetimes, SS faces a trust fund depletion in 2035 at the current pace. If you would like to try your hand at fixing SS, you can use this interactive challenge to try your hand at a fix (I fixed it without raising the rate but had to increase the applicable wage limit).
EARNING SOCIAL SECURITY BENEFITS
The way to earn SS Benefits is to pay into the SS system via Payroll or Self-Employed taxes. The more you pay in the more you will get out. The actual calculation is based on the highest 35 years of annual earnings during your career. The SS Administration used to mail out annual estimate but has now replaced that with an online benefits tool.
THE SOCIAL SECURITY CAP
Since there is a cap to the wages (the first $160,200 in wages) subject to SS tax (12.4% in total), there is also a cap to the SS benefits that you can earn. To fully earn the maximum benefit, you would need to have paid SS tax at the annual maximum for at least 35 years of your career.
THE YOUNG DENTIST EXAMPLE
You are a young dentist (born in 1995) who just purchased a practice in 2023 and you have the ability to set your wage at a reasonable level. You plan on working until 65 so your practice wages account for your top 35 years. By paying yourself $10,000 less than the SS cap, you will cost yourself $36,900 in SS Benefits if you pass at the age of 90. But you will have saved yourself $43,400 in additional SS taxes.**
THE RETIRING EARLY DENTIST EXAMPLE
You are a 45 year old dentist who has been paying yourself over the SS wage limit to comply with reasonable wage standards and maximize your 401k profit sharing allocation. Even if you retire in just 10 years, you will likely not qualify for the SS maximum benefit due to your low earning years in your early 20s. But your SS benefit would be near the maximum** and working another 5 to 10 years to ensure the maximum SS benefit might not be worth it for you personally.
THE DENTIST’S SPOUSE EXAMPLE
You meet and marry a dentist (or more likely, a dental student). After a few years, you and your spouse purchase a practice and you quit your job as a teacher to raise the kids for the next 20 years. Now those kids are out of the house and you have stepped in as the practice manager. Due to the 20 year gap without paying into SS benefits, you will not be able to qualify for maximum SS benefits, but you would qualify for 50% of your spouse’s benefit amount. Therefore, it most likely does not make sense for you to maximize your wage for SS benefit planning alone.**
**All calculations are simplified in nature and based on the SSA Benefits Calculator.
DON’T COUNT ON SOCIAL SECURITY
With the annual debate on how to fix SS and the chances that the program could change before you retire, you should not be counting on SS to provide a significant portion of your retirement funding. While each case is different (and you should work with an advisor to sort out your retirement plan), paying yourself more just to get a maximum SS payment is generally a losing proposition.
The examples above are very general in nature and should not be used in your personal decision making, please work with a qualified advisor to help you plan your SS Benefit and Retirement Goals.