By Kathryn Anne Edwards, Anna Turner, Alexander Hertel-Fernandez
Economic Policy Institute / National Academy of Social Insurance
INTRODUCTION: You’re insured
When asked, “What is Social Security?” most people answer with some variation of, “It’s money that old people get from the government.” But that is like saying that the Pentagon is the world’s largest office building—it’s not that it’s incorrect, it’s that it tells you nothing informative. Why is the Pentagon so large? Who works there? What do they do? The answer that Social Security is money for old people doesn’t tell us much either. How much money? Why old people? Why does it have its own tax? Why do some children receive it, and the disabled? Will I get it?
The answer is simple. Social Security is insurance. Workers pay premiums (the payroll tax) to secure coverage for themselves and their families. And like any insurance, their coverage protects them on the occurrence of a specific event. With Social Security, that event is being no longer able to work. This happens in three instances—old age, disability, and death. As early as age 62, you can claim reduced old-age benefits for yourself, your spouse, and your young children. If you become disabled, you can claim benefits for yourself, your spouse, and young children. And if you die, your spouse and children can claim benefits based on your earnings record.
Insurance exists to protect individuals from risk.
What are the risks associated with not being able to work? Poverty. It is the risk that you can end up with nothing, nothing because you made low wages and could never save, nothing because you never had pension or 401(k) benefits through your job, nothing because you were laid off during a recession and had to burn though your savings to make it to the next job, nothing because you became ill and had to stop working, nothing because your child became ill and you had to stop working, or nothing because the company you work for, such as Enron, went belly up or the stock market crashed and wiped out half of your 401(k).
When you buy a car, you also buy car insurance. When you buy a house, you also buy homeowner’s insurance. Social Security is insurance for the risks we all face—the loss of earnings due to retirement, disability, or death. So when you become a worker, you buy into Social Security.
Social Security then is a misnomer of sorts. It’s more than social security, it’s also individual security. It’s the insurance you have against the external factors that can derail the best-laid plans. Social Security is insurance for yourself—you earn it, you pay for it, and you benefit from it. And as far as insurance goes, it is the most comprehensive and most efficient plan you have. One in six Americans receives Social Security benefits, almost every worker contributes to it, and yet the program costs less than one cent of every dollar to administer. It’s impossible to say how this compares to similar private plans, because not all components of Social Security exist in the private market. In 2008, it was estimated that the disability and survivors insurance components were worth about $805,000 in net present value for a young worker with a family. The retirement insurance value is hard to measure because almost no one on the private market offers an inflation-protected lifetime annuity. But rough estimates suggest that to buy an annuity at age 65 that would match the average Social Security retirement benefit ($1,230 a month), plus keep up with inflation and continue to pay your widowed spouse, you would need to pay about $430,000 up front in a lump sum.
This begs the question: do you need the protection? Social Security is a pillar of the American economy. It is the most effective anti-poverty program in the United States. For more than half of the over-65 population it is more than half of their income. But does this apply to you?
If you are 22 years old and starting your first job in the fall of 2012, you have 45 years before you can claim full Social Security benefits. On the day you begin your first job, someone who began work 45 years earlier, in 1967, will retire. In his or her 45 years, this worker witnessed seven recessions—in 1969, 1973, 1980, 1981, 1990, 2001, and 2007; he or she lived through inflation, stagflation, oil shocks, oil rationing, the stock market crash of 1987, the savings and loan collapse, the bursting of the dotcom bubble, the bursting of the housing bubble, the stock market crash of 2008, and the bailout of AIG, the financial industry, and the auto industry; he saw unemployment climb above 10% twice; and all this over a time period with slowing wage growth for the bottom 50% and the decline of traditional pensions.
This worker faced risks beyond his control and so will you. And the answer to risk is not to work harder at accurately predicting the future, but to insure against it. Even the best drivers get in car accidents. The safest homes can be destroyed by fires. The healthiest people get sick. It’s not a matter of intelligence, it’s that certain things are beyond your control. Some of us will need Social Security before reaching retirement age —either due to disability or death. Some of us will not need Social Security until retirement. We cannot know which category we will fall into until we get there. But like all insurance, it’s better to have it and not need it than need it and not have it.
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