Update: Apologies for not greeting all you Carnival of the Capitalists readers earlier, but we try to take advantage of the long holiday weekends here at Political Calculations^TM!

Since launching the newest version of the Social Security vs. Personal Retirement Accounts comparison calculator that takes the President's proposal into account, a lot of people across the blogosphere are asking a lot of the same good questions regarding many of the details going into the assumptions behind the calculator. It quickly became clear to me that instead of responding in each forum independently, the best approach would be to write up the answers to the most frequently asked questions as a stand-alone post, and to refer back to it as necessary. So, without further adieu, here are the answers that many of you are craving:

There are aspects to Social Security regarding disability benefits and widow and orphan benefits that need to be incorporated into any reform. Did you take these into account in your research and development of your tool?

Currently, the taxes that your employer and/or you (it's "or" if you're self-employed) pay into Social Security are divided between two programs after administrative expenses are taken out. Of the 12.4% of your income that taxed toward Social Security, an amount roughly equal to 10.6% of your income goes to the Old Age and Survivor Insurance (OASI) program, which is the part that covers pension and survivor benefits, and the remaining 1.8% (approximately) goes into the Disability Insurance (DI) program. Since the President's plan would only affect the OASI program, those receiving disability benefits from the DI program will be unaffected by the proposed reforms. As a result, the calculator only considers the OASI contributions.

The question of how those receiving survivor benefits (widows, orphans) is not one I can really answer. There are a great many variables to take into account, such as how much the survivors would receive from the survivor's insurance program when they would outright inherit the amount in their lost breadwinner's PRA. Because survivor benefits are paid directly from the "pay-as-you-go" portion of the OASI trust fund, I would suspect that those receiving these benefits would be relatively unaffected since the President's program caps individual contributions to PRAs at 4% of their income (meaning that an amount equal to 6.6% of their income would be passed through the traditional Social Security OASI program). In the program's early years, even more funding would be passed through to the traditional OASI program, given that there will be a lower introductory cap on individual contributions that gradually becomes phased out over a long period of time.

For more information about how Social Security taxes are divided between the OASI and DI trust funds, the government's Railroad Retirement Board has a neat 266 KB PDF document that shows the history of these tax rates dating back to the inception of the Social Security program.

Why is SSI is not accounted for in the rate-of-return estimates?

The Supplemental Security Income (SSI) program, which provides monthly benefits to people who are age 65 or older, or are blind or disabled, and have limited income and financial resources, is not accounted for in the calculator's rate of return estimates since no Social Security taxes go toward paying these benefits. SSI benefits are instead financed directly from the U.S. Treasury's general fund, which is where all the other tax revenue collected by the federal government is pooled. As a result, SSI benefits have no bearing on the amount of money you would receive in retirement from the Social Security program, and SSI is therefore not accounted for by the comparison calculator.

There is some common confusion about these details since the Social Security Administration (SSA) is responsible for managing the SSI program. However, as noted before, no Social Security taxes other than those for the agency's administrative expenses are applied toward these benefits. For more information, see the Social Security booklet Understanding SSI.

Are cost of living adjustments taken into account?

No. The reason is that this kind of adjustment is not necessary for the purpose of comparing the equivalent investment returns. Since cost of living adjustments are based on the rate of inflation, the associated percentage increases you would see in your equivalent investment returns from Social Security would also be reflected in increased rates of return from your PRA investment. What this does mean, and I have revised the calculator to indicate this fact, is that the rate of return you enter is the inflation-adjusted rate of return you would anticipate from your investment.

How does the calculator's rate of return for Social Security compare to the official projections?

Relatively well, but with certain things you should take into account in assessing how useful the calculator is to you. The calculator's Social Security rate of return is based on numbers published in 2000 (the details behind how I developed the formula used are available for your review). I think we can be pretty sure that the official projections are backed by much more data, including more recent data.

Compared to the offical projections from the SSA, the formula I developed overstates the rates of return in the years leading up to the mid-2020s, and understates the rates of return in the years following the mid-2020s. What this means is that up until the mid-2020s, the calculator will return investment values for SS Only that are higher that what the official projections estimate. After the mid-2020s, the calculator will return values that are lower that what the official projections predict. I am presently working on a new version of the tool that will allow you to choose between the various projections that have been made regarding the future rates of return from Social Security, so you'll be able to go with the numbers you find most plausible.

Does the calculator use realistic growth estimates?

That depends on you. It's inherent in the value you enter for your PRA's rate of return.

What investment options will be available?

The President's plan references the kind of investment options that are available through the government's Thrift Savings Program (TSP) for federal employees. Historical performance data for these investment options are available from the TSP.

More Questions, More Answers

In the comments section!

Besides just wanting to see which would be better, my goal in developing the Social Security vs Personal Retirement Account comparison calculator has been to provide its users with an unprecedented amount of transparency in being able to see the assumptions behind how the calculator determines its results. I welcome all constructive feedback.

- posted by Ironman at 6:52 PM | Permalink | Home |