Social Security and Race

Studies | Social | Social Security

No. 236
Monday, October 02, 2000
by Liquin Liu and Andrew J. Rettenmaier

Social Security as an Investment

Social Security is an income transfer program in which the taxes paid by today's workers fund the benefits of today's retirees. Since these taxes are not used to buy stocks, bonds or other assets, Social Security is not an investment. Nonetheless, it can be thought of as an investment from the point of view of the individual worker. One way to evaluate an individual's investment in Social Security is to calculate its rate of return. That rate of return can then be compared to the yield on alternative investments.

Another way to evaluate an individual's investment in Social Security is to calculate the value today of expected future benefits minus expected costs, using an interest rate that represents the rate of return that could be earned on the best alternative investment. The resulting figure is called the net present value. If the figure is positive the investor gains; if it is negative the investor loses.

In evaluating the program's investment value, other studies typically treat 40 years of tax payments as the costs and 15 to 20 years of a retirement pension as the benefits. But if a worker dies and leaves dependent children, a few years of tax payments may spawn several years of survivors benefits payments. Or an individual may live well beyond ordinary life expectancy. To deal with this problem, we have considered all possible life spans. The expected outcome of participating in Social Security is the sum of all these potential outcomes, each weighted by its probability of occurring. We have made calculations for individuals at different ages based on their sex, race and marital status. In making these calculations, we estimate lifetime earnings patterns and life expectancies and identify tax rates for people born in different years. We estimate benefits based on Social Security's benefit formulas.

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