By Xin Lu
I received my Social Security statement this week and it was a useless piece of paper to me since I do not qualify for retirement benefits yet. I always hear critics of Social Security say that it is a government sanctioned Ponzi scheme, and today I did a little research into why this comparison is often made.
Ponzi scheme is named after Charles Ponzi, an Italian immigrant who promised investors 50% returns in 45 days on an investment of postal coupons. He raked in millions of dollars in investments in less than a year in 1920. In actuality he was paying the earlier investors with money he collected from later investors and did not invest the money at all. Eventually the scheme collapsed because Ponzi just could not find enough new suckers to pay for the ealier investors who wanted to cash out. Ponzi went to prison and after he was released he returned to Italy and became a top financial advisor to Mussolini.
The Social Security program does have a few similarities to a Ponzi scheme. The main point is that it is a system where the later contributors pay for the returns of earlier contributors and if the number of later contributors dwindle to a point where they cannot support the existing promised benefits then the system would collapse. Second, the money collected is not invested to produce more money so the system pretty much depends on new taxpayers. Finally, the earlier participants of Social Security do get a bigger return on their money. For example, the first Social Security beneficiary who received monthly checks was Ida May Fuller. She collected a total of $22,888.92 from the program and contributed only $24.75 from her paychecks. Of course, she was extremely lucky to live to 100, and her Social Security earnings amounted to an annualized return of 22% on her contributions over 36 years of retirement. I am sure when I get my checks I will not have such great returns.
So why is Social Security not a Ponzi scheme? Well, first of all it does not make wild claims about making money fast. It also does not claim to be investing your money so it is not actually fraudulent. It is also based on taxes so it is not a voluntary scheme like the original. Finally, when a person dies then the payout stops under Social Security so it is possible that some people who contribute never see a single penny returned. The Social Security Administration actually calls the program a "pay-as-you-go insurance system" and claims that it is sustainable as long as the population demographics of retirees and working people stay stable.
Regardless of the semantics, in the near future there will be many more retirees than working folks so the demographics shift will make Social Security pay out more than it takes in. According to the 2008 Social Security Administration report the program could cover 75 percent of scheduled benefits until 2082 after the current surplus exhausts in 2041. This means that young people like me probably cannot count on solely Social Security for our retirement. Just in case Social Security collapses, I think everyone should be putting at least the amount paid in Social Security taxes in an IRA or mutual fund for the sake of a better financed retirement.
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