Things Shouldn't be This Difficult in Retirement

Social Security is engineered to cheat a lot of people. Why?

Social Security was one of the great and enduring accomplishments of the New Deal. It followed European models of progressive policy, insuring old age income for what was at the time a very low cost- a 2% tax on wages. It is fundamentally a semi-progressive program, with payouts indexed to what you earned (and paid in as taxes) while working, but using a formula of sharply diminishing returns at higher income levels. As we live longer and have fewer children, the finances of Social Security have had to be shored up a few times, with higher taxes, longer waits till retirement, and other revisions. One of the most devious of these has been the offer to get early benefits for a lower payout.

Basic Social Security rules: The monthly benefit payment is constructed out of a set of tiered rates, by income level, to define the "primary insurance amount", or PIA. The income level is based on the highest ten years of earnings. The lowest level of income (here up to $774 monthly) is paid back at 90%, for example.

A recent opinion column (with followup) noted that while 90% of people would be better off waiting to take their benefits, only 10% do, missing out on a large amount of lifetime income. The deal is that full retirement age is (now) pegged at 67 years of age. If you take benefits at the earliest time, age 62, you will get 70% of the full payout, forever. On the other hand, if you wait till age 70, you will get 124% of the full payout, (plus some extra based on inflation and other factors), which works out to almost double the lowest payout, each month. The life-time payout is of course highly dependent on when one dies, and the break-even point ends up at about age 77, after which everyone would do better waiting than taking the early payout. For example, if you make it to age 85, you would be 30% ahead in lifetime benefits having waited to take payments till age 70.

This is, as the columnist notes, a fraught policy. Psychologically, it resembles some of the most classic marshmallow experiments, testing self control in children. Just as most children don't have the self-control to wait for the two marshmallows, most retirees apparently do not have the foresight to maximize their ultimate income. And this is quite understandable. Principally, the future holds a great deal of uncertainty. Who knows (or wants to know) when one will die? Even if the average life expectancy, upon reaching age 62 is ~83, well past the breakpoint noted above, it is easy to rationalize taking the money while one can. Poorer people tend to have worse jobs, that they really want or need to retire from as soon as possible. The poorer one is, the less savings one is likely to have to tide one through from 62 to 70. And the poorer one is, the poorer health one is likely to be in, with a shorter prospect of collection. All in all, it can be an attractive, even compelling, deal.

But statistically, this ends up being a regressive policy, cancelling much of the otherwise progressively engineered system. Poorer retirees are in this way snookered out of possible income, on top of getting lower payouts to begin with (due to their lower incomes and contributions), and typically having shorter lives. It seems akin to the ever-loosening restrictions on gambling, sports betting, sub-prime lending, and the like, one more way to separate the poor from their money, via financial chicanery, aka engineering. It was a policy gradually developed over several Social Security reforms, from 1961 onward, and may have seemed a fair way to offer the option of earlier benefits to workers, to meet what can be rather urgent needs. But the psychology of it is very problematic and has produced what is described above- bad decisions by most people.

Some alternative models, accentuating their progressivity. Current Social Security is shown in red. A simple pay-in/payout plan is show in dashed lines, with no progressive aspect at all. And the solid line shows a flat payout scheme, where everyone is paid the same benefit. This was done by the Social Security administration in 2009, and notes that "... the program's progressivity has declined in recent decades."

How could all this be improved? There are innumerable ways to cut this cake, but the one I see as most promising is to go back to basics. Make the retirement age 65, and make the payout the same for everyone, across the board, at whatever level retains system viability. Then perhaps a special request board could be set up to offer earlier retirement, in cases of hardship or disability, related to the SSDI system already in place. This would be a way to reduce the complexity of the existing system, reduce the bad incentives, and make it more progressive at the same time. It would also strongly increase the incentive, at the lower end of the income distribution, to attain the needed work credits to participate in the system, which amounts to ten years of work that pays Social Security taxes. Death makes us all equal in the end anyhow, so a retirement system that brings that fundamental equality forward by a few years seems not just reasonable, but even a little poetic.

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• Jesus is Black.