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
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
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.
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
into Social Security, thereby reducing their eventual return even
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.
to get your copy today.
Social Security: Why You'll Never Get the Big
Payoff Your Parents Got
originally appeared on Fool.com.
has no position in any stocks mentioned. The Motley Fool has no
position in any of the stocks mentioned. Try any of our Foolish
free for 30 days
. We Fools may not all hold the same opinions, but we all believe
considering a diverse range of insights
makes us better investors. The Motley Fool has a
Copyright © 1995 - 2014 The Motley Fool, LLC. All rights
reserved. The Motley Fool has a