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Is Social Security a Ponzi Scheme?

As Gov. Rick Perry runs for president, he has referred to Social Security as a Ponzi scheme. This has scared some and made others question the system's long-term viability.

One of my first clients caused me to question these same things in the early '90s.

Bill is a humble man, and I always enjoy visiting with him. By the time I met him, he was 72 and had been retired for seven years. Every Friday, he would invite me over to his house for a beer. We would discuss the financial markets, politics, family and anything else that came to mind.

One day, I asked Bill why he invited me over every week for a beer.

Without hesitation, he grinned and said "Well Dave, I've been retired for seven years - and in that time I have pulled more out of Social Security than I ever put in. I'm in great health and plan on pulling even more out. Since I am not paying for it, but obviously someone is, I figure I might as well buy them a beer."

With just common sense and a high school education, Bill knew he would get far more out of Social Security than he put in. He also knew that younger people who are still working provide the cash flow for those who are currently receiving Social Security benefits.

As our nation grappled with the the Great Depression, our Social Security system was born. At the time, there were far too many people looking for work and not enough jobs.

A system had to be set up to allow older workers to retire and give opportunities to younger workers.

At the time, the system required you to reach age 65 to achieve full benefits. Interestingly though, the average life span at the time was only 62. As such, those who structured Social Security felt that there would be plenty of benefits to go around.

Furthermore, in the 1940s there were more than 16 workers contributing into the system for each beneficiary of Social Security. As such, there was tremendous excess cash flow to satisfy obligations.

Understanding this, two main things happened that tipped the system over. First, improvements in modern medicine increased the average life span from 62 to about 78 - a 25 percent increase.

Secondly, the system was set up prior to World War II and never anticipated the effects of 78 million Baby Boomers. While the Baby Boomers were contributing a percentage of their paychecks into the system, people like Bill benefited nicely and had very few cares in the world.

Now that the Baby Boomers are entering retirement, there are not enough people in today's workforce contributing into the system to provide the same benefits to the Baby Boomers. In fact, there are now less than three workers contributing into the system for every person receiving benefits - and this is before the full weight of the Baby Boomer obligation is felt.

So is Social Security a Ponzi scheme? No. We all know the rules of what must be paid in and what benefits have been promised to retirees.

What can be done to fix the system? It is pretty obvious that the retirement age needs to be increased. My generation (I am 44) needs to plan on working full time until at least 70.

Furthermore, there is probably room for Americans as a whole to contribute more into the system. My guess is that people would mostly support this - if they thought our elected leaders would actually preserve the money to satisfy future benefits.

Fixing Social Security is not that difficult. It requires some estimate of expected life spans, how much money is going to be paid out and how much money is going to be paid in. This is the type of question that any first year MBA student learns to solve. Therein may lie the real problem - the vast majority of our elected leaders have a woefully inadequate understanding of math, finance and fiscal discipline.

While the politicians make this harder than it has to be, I think I'll head to Bill's for a cold one.

Dave Sather is a Victoria certified financial planner and owner of Sather Financial Group. His column, Money Matters, publishes every other week.

Originally published Tuesday , October 19, 2011

Victoria Advocate