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Is Social Security a Ponzi Scheme?

The short answer is ‘no’. First, one must understand the definition of a Ponzi scheme. When one invests their money in a business they expect a certain return on their money based on the profit-making ability of that business. A Ponzi scheme is a fraudulent investment program in which the manager of the program promises a certain investment return and then uses new cash flows from new investors to pay the previous investors. To keep the program going the manager (or fraudster) needs ever-increasing cash flows from a greater number of new investors. The key to understanding what a Ponzi scheme is the word ‘fraudulent.’  So, one must ask: is Social Security a fraudulent program? Will younger workers receive benefits in the future?

Social Security is designed to provide income to older Americans through a payroll tax system. It has always been designed this way. It is in effect a social compact whereby younger workers pay for a certain level of income for older beneficiaries. It is not a program where you pay in and get nothing out. (That would be fraudulent!) Let’s understand some basic facts about the solvency of Social Security.

For quite some time now, Social Security has taken in (from payroll taxes) more than it has paid out to current beneficiaries on an annual basis. This ’surplus’ has accumulated in the Social Security Trust Fund which now has approximately $2.6 trillion. (I will not go into the details of the Trust Fund in this post.) In 2010, outlays exceeded receipts by nearly $49 billion dollars. How was this shortfall covered? By funds from the Social Security Trust Fund. In fact, interest alone in the trust fund was greater than $117 billion last year, so in spite of the fact that outlays exceeded receipts in 2010, the Trust Fund actually got larger!

Over the next 25 years it is expected that outlays will continue to be larger than receipts from payroll taxes so it will be necessary to use assets from the Trust Fund to meet promised obligations. But one must understand: even if Congress does nothing, benefits will be paid as promised based on current projections.

So, what would happen in 2036 if no action is taken? While the Trust Fund would be depleted, the program would still be taking in receipts from then current worker payroll taxes. It is anticipated that those receipts would still cover 77% of promised benefits to those who are then retired. So, for those who claim that younger workers will never see benefits from Social Security or describe the program as a ‘Ponzi scheme’ they are just plain wrong.

Whether Congress takes action sooner and makes the necessary benefit cuts (or increases in taxes), or the benefit cuts happen in 2036 because our leaders never get around to reforming the system, those of us who have 25 or more years to collect benefits will still get to collect benefits. They just may not be as great as the program is currently designed to do.

Please use the comment section below to add your thoughts or ask questions. Thank you to Michael Kitces for providing some of the information stated in this post.

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