What is the ROI of incremental Self-Employment taxes?
By taking GCC truly global and incorporating overseas, we can completely eliminate Self Employment taxes.
Although this is only one of many factors to consider, these pesky payroll taxes take 15.3% of every dollar of profit we make on this little blog. All else being equal, I would rather pay $0 than $5,000+.
But of course, all else is not equal. Fewer dollars paid in Self Employment taxes will result in smaller Social Security checks down the road. (Checks? I’m definitely dating myself.)
Even though I know Social Security is generally poor value for early retirees… since I won’t even change brands of toothpaste without a little research, I guess I better do the math.
What is the actual return for continuing to pay (now optional) Self Employment taxes?
SS Benefits Determination
The Social Security Administration does their part to help you determine future SS income by providing a great number of acronyms, formulas, and calculators. If you are interested in jumping down that deep dark well, Justin at Root of Good provides a great explanation of how Social Security benefits are determined.
Here are the Cliff Notes:
Social Security benefits are based on average indexed monthly earnings over 35 years, so an additional $420 of income increases the average by $1.
For every $420 in lifetime income:
– You pay $32.13 in payroll taxes (7.65%, 6.2% for Social Security, 1.45% for Medicare)
– Your employer pays $32.13 in payroll taxes
– Your future real monthly Social Security check increases by $0.15, $0.32, or $0.90
The actual monthly increase is a function of total lifetime income:
– First ~360k of lifetime earnings, $0.90 per $420 (SS ~$770/month)
– Second ~1.8 million of lifetime earnings, $0.32 per $420 (SS ~$2,146/month)
– Final ~2 million of lifetime earnings, $0.15 per $420 (SS ~$2,854/month)
– Additional earnings or income greater than $118,500 (2016) in any one year don’t have an impact on SS income.
This is the base income calculation for Full Retirement Age (for me, Age 67). Choosing to take SS “early” or “late” will decrease/increase monthly income.
Maximum Return
While the Social Security Administration formulas and acronyms tell us how much $ we may receive, for value, more important is when.. when we paid the taxes, and when we receive the benefits.
Naturally it is more rewarding to receive income now versus 30 years from now.
If we wanted to maximize return on our Social Security investment (taxes), we could (in theory):
– never work (in the US) until 10 years before SS eligibility
– work for no more than 10 years (minimum qualifying credits)
– earn no more than $360k (top of the 90% “bend point”)
– start receiving SS benefits immediately upon qualification (after 10 years of work)
In this scenario, we would pay ~$2,750 in annual payroll taxes for 10 years and then receive ~$9,000 in annual income for life.
Knowing the exact value of the resulting income requires knowing when we will die… For better or worse I don’t have that information. But thanks to our friend mathematics, we can forecast potential ROI by calculating the Internal Rate of Return (IRR) for a cash flow series (taxes paid and income received.)
For an immigrant or late bloomer, the ROI is impressively high… After just 2 years of SS income, we’ve already received more in income than was paid in taxes (“employee” contribution only.) By age 80, the IRR is an impressive 14.4%, above and beyond inflation. Contrast that with the US stock market which has returned ~7% over the past 40 years.
The return is even better when we factor in that 20% of the payroll taxes are to buy a ticket for the Medicare bus.
Early Retiree Social Security Return
A typical early retiree works less than 35 years and has a large gap in time between work and Social Security income, so Social Security ROI is much less impressive.
Using the exact same earnings as the late bloomer above (10 years, $360k), but with income earned decades earlier, the ROI plunges to single digits.
Extra Income in Early Retirement
In my 24 years of “work” (16 in my career and 8 during high school/college) I’ve earned more than the first Social Security bend point (~$360k) and less than the 2nd. At best, every $420 of additional income will earn $0.32 in monthly Social Security income… someday. Most Early Retirees will be in a similar boat.
If extra income does make an appearance, it is likely to be due to “Self Employment.” This means we must pay both the employee and employer payroll taxes, 15.3% in total.
How does this materialize in terms of ROI?
The ROI on the SE taxes I’m paying in my 40s reaches break even at around Age 83. Unfortunately, the Social Security people think on average I’ll be dead by Age 80. That’s nice.
However, if I beat the odds I may eke out a small real positive return of 1% by age 90 and 1.8% by age 100. That is better than my savings account. (Technically, the SS actuaries give me a 80% chance of living to age 67, a 50% chance of living to 80, a 20% chance to 90, and a 0.9% chance to 100.)
By contrast, making a one time contribution to a diversified portfolio of stocks (7% real return mas o menos), it would potentially grow by over 5x by Age 67 (and 13x! by age 80.) Or instead of increasing monthly income by $0.32 from SS, it could instead be $1.16 (4% Rule) starting at age 67.
And whereas the Social Security benefits cease with our final breath, our stock portfolio does not. (And then there are taxes…)
What about “Normal People”?
Not everyone is an aspiring early retiree (I know, right?!) How does SS ROI look for them?
I plotted the IRR for lifetime income equal to each bend point over 35 years.
SS is a progressive system, so the higher your income the worse the return… although it isn’t great for anybody except below poverty level (~$10k/year income for 35 years.)
Returns decrease for anybody working longer than 35 years, as only the taxes paid in the highest earning 35 years count.
Final Thoughts
As suspected, the potential for increased Social Security income based on additional post-retirement earnings is not good. In truth, SS IRR is poor for everybody except very low income people, late bloomers, and Lazarus Long.
Poor return on investment is not my favorite thing in the world, but it is nice to know that if I live long enough, I’m effectively just giving the US government a low interest rate loan. And they are taking all of the inflation risk. Hopefully my low stress early retirement lifestyle helps us beat the odds.
Some Caveats:
– Notably, in all cases the ROI for death prior to initial SS income is -100% (bigly)
– ROI can be increased by delaying SS income, assuming you live long enough (see Kitces.)
– ROI is reduced by taking SS early
– I haven’t estimated survivor benefits… if W outlives me by a large margin, ROI increases (slightly.)
– Social Security ROI could be changed at anytime by governmental edict. Most likely downward. (I like JL Collins’ thoughts on this.)
– Returns are “real” (adjusted for inflation)
Does Social Security seem like a good deal?
Even a small inflation adjusted predictable pension, such as your late bloomer, is nice to have – the essentials like food, utilities and property taxes are guaranteed. Regarding toothpaste; sodium hydrogen carbonate works just as well as the branded toothpastes.
Once upon a time while making a flight connection in Amsterdam, I was stopped by security for inspection. The officer dug through my carryon and pulled out a big ziplock bag full of white powder. I thought for sure I was going to be taken into the back room for questioning, but he just put the powder back in my suitcase and waved me on. That was the last time I traveled with sodium hydrogen carbonate for toothpaste.
Thanks for the mention of my deep dark well of social security benefits calculations :)
Past that first bend point I don’t see much point to paying self employed payroll taxes if you can avoid it. I mean I still do it but would skip it if it were possible. :)
Thanks for shining the light where it don’t shine often :)
And for answering my email Qs.
I hear the current Republican administration is interested in eliminating Medicare and some of SS, so maybe you’ll get the option to opt out.
At this point I’d probably choose to stay in, keep on mailing in my few thousand $ each year and then get many hundreds of thousands in another few decades. (or maybe take a lump sum cashout if that was an option :) )
Well now that you put it that way, it seems like an awful deal. And by the way, I didn’t even catch the “check” remark until you pointed it out – effectivey dating myself, as well.
It’s good to know my dad lived to be the ripe old age of 90 (he had me at 60 so I’m not crazy old) and had a below average salary, so SS was probably a good deal for him. I’d like to think I have those longevity genes hanging out inside me, so that I’ll be able to cash in on SS. The trouble for me, after reading this extremely detailed and informative post, is my above average salary.
Hmm, as soon as I get really close to leaving my W2, I will be scouring your website for insight. …not that I don’t do that now. But at that point, I’ll be taking notes and drafting spreadsheets!
Love this post, but to @Mad Money Monster’s point, I’d like to voice a thought.
Ignoring the employer contribution to Social Security is a sensible choice for the post. But that IS a factor in this thing. One might argue that if employers didn’t have to pay for SS they’d pay higher wages. That might be a naive or disingenuous notion, depending upon who’s making it.
But economic theory says it’s all one pot of money. “We” pay for stuff, one way or the other.
Agreed on all points.
Speaking of Lazarus Long, you might want to check out what we are doing at Methuselah Foundation ?
If you need any guinea pigs, let me know :)
will do LOL
I cracked up at the use of bigly. I do worry about the changes the government will make to keep these programs around. Now to turn all us PF bloggers into early retirees with a great asset producing income.
Here’s a grim but profitable thought: When I was putting together my life insurance to make sure we were properly covered, it appears that your wife and kid both get survivor benefits if you kick off early. Unless I’m reading something very backwards, both her and my 9 month old would get extra benefits until he turns 18.
I was extra nice to my wife before I showed her the math!
I read it the same way. Don’t tell Winnie
You are correct. There are potential widow/widower benefits depending upon the surviving spouse’s age.
There is a dependent child benefit that the child receives, regardless of whether the surviving spouse is age-eligible, depending upon the child’s age and whether she stays in school.
Very interesting analysis Jeremy! Do you include the value derived from medicare in your ROI? Since you discuss SE tax I’m assuming you have the 1.45% in the cost side of the equation.
If you think about it, including medicare would tilt the ROI EVEN more in favor of folks in the first bend point. Unlike SS, medicare is a “fixed” benefit not affected by how much one contributed to it. The insurance is the same for all except those who receive more income in retirement pay more in annual premiums. Medicare tax also doesn’t have the income cap like SS at $118.5K. In fact there’s an ADDITIONAL medicare tax of 0.9% for income above $200K.
So the higher one’s earnings the lower the ROI of Medicare.
I’m strongly in favor of Single Payer so I’m not trying to dis Medicare or SS for that matter. Putting the ROI in perspective however sheds some light on why some politicians want to “reform” the system.
I lumped all payroll taxes together, so it is included in the cost side. The ROI on additional Medicare taxes (after eligibility) is always -100%.
For the late bloomer example, the ROI would definitely be higher as 20% of the employee payroll taxes buys the ticket for the Medicare bus.
Thanks Jeremy. I was depressed before I read this. I’m retired now (age 55) and won’t be collecting SS until I’m 70 (that’s the game plan, anyway). My ROI will no doubt fall between the extreme early retiree’s and the late bloomer’s. Using this excellent analysis as a guide, I’ll run the numbers and see what my true ROI will be. But here’s a rhetorical question. With the ROI for so many SS beneficiaries being so poor, why is the SS program in financial trouble? Meh.
SS is still pretty robust, some minor tweaks would “save” it. The main issue is people live too long / the actuarial tables need to be updated.
Your ROI may be interesting, but I argue that at this point it’s not relevant to your decision.
I’m 61 and started receiving a widow’s pension when I turned 60. I, like you, need to decide at which of three ages I should start taking my own SS benefit which will be larger.
The way to calculate this is to decide when you’ll die — absurd notion, I know, but there are tools and actuarial tables and dartboards and Ouija boards to help you — then calculate how much each start date will pay you over your lifetime. It’s a fairly simple calculation once you figure out your date of death! ?
Maybe this is a pessimistic approach but I don’t factor SS into my retirement plans whatsoever. SS income already doesn’t cover the expenses of current retirees; I’m interested to see how much it will cover once I’m eligible in 40+ years. ;) But so many things can go wrong, especially when you rely on government programs, so it’s best to plan retirement income from your own private means. Hopefully it’ll still be around by then and I can get a small paycheck each month!
I don’t plan for it either. It’s a retirement bonus.
Same here. Although it is difficult at times to look at the Personal Capital “Retirement Planner” and see Social Security knowing that I’ve disregarded it entirely, because according to PC retirement will be a cake walk for me in like 5 years. (sans student loan payments, anyway) I know that my calculations show nothing of the sort, but I find myself wishing I could be as optimistic as PC :)
Fantastic analysis! Social security is a construction heavy on the overhead which explains the ‘low’ returns for most. It’s a system that mostly benefits the system itself. About 90% of the people would be better off if there was just a law saying you need to put X% of your wages in a IRA type account and then leave it up to the individual on how to invest it (because otherwie a lot off people would not save for old age). Welfare for low income people who go in retirement could help out the remaining 10%. But off course, the government choosing a simpler and more efficient system that leaves it with less power? Not going to happen!
That would closely resemble the Australian Superannuation system (mandatory 9.5% of wages) and Age Pension (means tested welfare) systems. Currently ~50% of retirees receive a full Age Pension, 30% a part Age Pension and 20% no Age Pension. To bring to 10% the portion receiving a full Age Pension would require mandatory contributions of ~20% over the life of the youngest in the current cohort. Saving for retirement is a larger task than buying a home – which some never achieve.
1. Was the stock market return of 7% indexed for inflation ?
2. How do you value stock market risk and volatility ?
3. The S&P periodically dumps its worse performers, does it not ?
1) yes, I linked to the calc I used
2) probably differently than most
3) indeed it does. That is one of the advantages.
I’m not following then. How does the dumping of worst performers benefit investors ?
It’s a cleaning process. The index reflects the overall economy, and funds get shifted from shrinking / dying industries into growing / thriving ones. Some of the biggest most profitable companies in the world didn’t exist 10 or 20 years ago.
Sorry, I forgot to add..
4. SS also includes disability benefits
5. Medicare is separate, so figure 12.4% of earnings as part of the retirement plan.
This is a beautiful analysis of SS but I came to the opposite conclusion: it has always been waaay to generous; and while I do not label it a “ponzi scheme” like some detractors, it is easy to see why it runs out of money when US population and GDP growth level off.
4) I estimated the value of disability benefits in an earlier post (also linked in the article)
5) The Medicare portion of payroll (or SE) taxes still has to be paid, and the ROI is -100% after eligibility. You could do the math either way.
Population growth is key for a program like this, which means efforts to curb immigration will have a negative effect on SS.
I looked at your disability link but have to admit I find it hard to follow. Is the disability insurance only for accident or also health ?
Injuries and illness, both.
I looked at this before and I’m right around the 2nd bend point. Even if I make good income ($100k+/year), my benefit won’t increase that much. I already got the best ROI from the years I’ve worked. I can work part time and make just a little money and my benefit will still be okay.
Hopefully, future changes (cuts) to the program will affect the future generations and not us. :)
Technically you can work not at all and your benefit will still be ok. Beyond the 2nd bend point the ROI is definitely negative.
I recently started ‘voluntarily’ contributing to my Social Security account —
I live in a country with a Totalization Agreement with the United States, so I am not required to pay self-employment taxes in the US (because I pay them here), and I hadn’t given much thought to Social Security since I left the United States at age 21. However, I recently learnt I was 9 credits short of qualifying for benefits, including Medicare, and since I can potentially earn 3 credits a year (I have an EXTREMELY low income, which is also an argument for this potentially being a good ROI), I paid the taxes last year and received my three credits. Will do that for two more years.
I wish I was better at math so I knew REALLY whether this made sense or not. I find it hard to figure out the tax code, and social security requirements for expats. I consider this a speculative investment. I think I am doing it more to honour that teenage self who worked hard in minimum wage jobs from the age of 14 and managed to build up those 31 credits. And, most expats want to leave the door back to their homeland a little bit open … Healthcare (Medicare) access would definitely be a prerequisite to ever living in the USA again.
Justin’s article a Root of Good was the catalyst for me attempting to do this, but, as I said, I am not great at math, and I also understand that laws can change at any time, so this may just be a charitable donation to the U S of A :)
I would do the same thing if I were in your shoes.
Could you comment on whether someone should contribute to an HSA through payroll or, instead, as an above-the-line deduction, in terms of future SS benefits? This “someone” is mid-career, likely to stay between the two bend points, interested in early retirement but still years away from it, and lives in one of the 47 states with HSA deductability. :)
I can’t think of any reason to not contribute through payroll.
Uggh … I wish I could edit my comments so that my stuttering thoughts were not so obvious
6. The stock market does not have a spousal benefit
It does, we just call it inheritance
With regards to SS:
That is true after one spouse dies, sort of.
It is definitely not true while both are living
My wife and I are both alive and our stock is still there.
Life insurance can provide a financial boost upon death, and is a much cheaper solution.
Are you trying to be obtuse ? SS provides a large benefit to couples of disparate lifetime earnings that you did not include in your analysis
It’s in there.
Using my wife as an example, her ROI should she receive spousal benefits is infinite. She never worked in the US and never paid any payroll taxes. But her “benefit” would be half of the income I would receive, and therefore the ROI shown in the charts above would be lower. So I agree with you, with the exception of the word “large.”
I want to summarize my criticism of this article, specifically the graphs that purport to show ROI:
1. They do not include the disability benefit, which is **accident or health**
2. They do not include the spousal benefit
3. They do not include the survivor benefit
4. They do not include the Medicare benefit
It’s all in there, with the exception of #1, which acts as a form of insurance. The ROI on insurance (if/when you use it) can always be large.
Feel free to do your own analysis, and get as precise as you like.
For completeness: I didn’t include the one-time death benefit of $255.
I’d be curious to know your thoughts on taking the benefits early vs. normal age vs. late. If you don’t need the money, you could take it at any point in time and just invest it. Choosing to take benefits late will increase your odds that your never collect anything (death) and all that money just went down the shitter.
Look at the Kitces article I linked to in the caveats. It is a great analysis of delaying.
Great analysis! I’m already way past the first bend point. In fact, one reason for early retirement is that I don’t see any reason to contribute to SocSec beyond the second bend point.
One interesting issue is that of spousal benefits. As far as I understand, a spouse claim the higher of two options:
1: their own benefits, naturally
2: 50% of their spouse’s
To be eligible for the spousal benefits he/she must have at least 10 years worth of contributions, but the minimum contribution is only very small (there is a points system, 1 point = ~$1,300, 40 points minimum over a minimum of 10 years, no more than 4 points per year, so a little over $5,000 in wages for 10 years).
So, for a couple where one spouse has some decent benefits from prior work history and the other has no SocSec points there is a way to hack the system and contribute only the minimum for the other spouse right before retirement and claim a substantial benefit and high IRR. Just a thought!
It isn’t necessary for a spouse to have worked to get spousal benefits.
Wow, you’re right! I confirmed that at ssa.gov. Same is true for Medicare. Not sure why I got that one wrong. Well, it’s good you corrected my mistake because that means my wife with a short earnings history doesn’t have stress out over the 40 credits any more. :)
So some of the implied returns above could be higher for couples where the lower earning spouse already knows he or she will claim the 0.5 times the higher earner’s benefits (including us). Given that the returns are in real, inflation-adjusted percent, they don’t look so awful any more. Though, having to tax 85% of the benefits at a marginal rate of 15-30% takes away some of the advantage again.
I’ve reached the same conclusion (“Given that the returns are in real, inflation-adjusted percent, they don’t look so awful any more.”)
When I goose the income in the IRR calcs by 1.5x, the IRR increases by about 1%.
I had the same thought as Eric above. I’d throw in one other benefit, in addition to Medicare, that comes with continued SS tax payments: Social Security Disability benefits. SSD requires that you’ve not only worked enough, but worked *recently* enough. That requirement is 20 “credits” ($1,260 of income per credit, max 4 credits per year) earned in the last 10 years.
The expected value of the disability insurance probably isn’t huge, and early retirees should be fine without it, but it’s at least worth factoring into the mental calculations. You could maintain SSD coverage with just $2,520 of annual taxable income.
And great post, by the way! I always enjoy these types of analyses.
Thanks Matt.
The value of Social Security’s version of disability insurance can be enormous (income for life), and I’m not aware of anything in the private market that is equivalent. Good point.
It’s a good deal because it is just a by-product of you getting Medicare;) (almost a “free lunch”) and it looks like it would be a good deal for Benjamin Button too…
I’ve never thought of SS in ROI terms, always looked at what the paycheck would be (time-insensitive), so this is definitely very interesting to see. I erroneously thought that I could lower my SS check if I added years of low pay income post-retirement, somehow lowering my average yearly income, so I guess this is also good news for me (except that I now have less excuse for not working).
And the big thing that makes it all apples-to-oranges is that if you die early, return is 0 as you clearly wrote.
Thank you!
My understanding of Social Security isn’t as sophisticated as most writers in this comment area. My one question is centered around the very idea of trying to figure out ROI like SSI is an investment. Isn’t it social society INSURANCE? What sort of benefits does one get in the event for disability and other benefits and how do you calculate the monetary value of that insurance?
Social Security can be a form of insurance, and you can estimate the value by comparing to products you can buy to create a sort of private version, e.g. an annuity, disability insurance, etc…
I did some of this analysis in an earlier post, see here.
I’m not sure the main purpose of Social Security is to achieve a healthy ROI. By your logic, one (or one’s family) would achieve a far better ROI if they worked a few years and died early with young children. Children would receive a death benefit until 18, widow/widower would received death benefit while children were 16 or younger. These combined have the potential to be an order of magnitude higher than contributions. Not sure that would be my preference…
Also, your analysis is missing key components such as inflation, salary growth through a career, SS contributions being discounted the older they are, and changes in SS benefits. As with most things financial, when you look at the full logical picture, the response is typically “meh”. No-one gets overly penalized and no-one reaps too much reward.
My apologies, apparently my writing skills are meh
I immigrated to this country just before I turned 30. I don’t yet have all the credits I need to be able to be eligible for a SS payout. I will by mid 2018. The plan is that I retire in Jan 2021. Yay, I think, for my (unintentional) optimization of ROI.
A general question. I know you travel most of the year outside the US. Junior is young now, but he’s school aged, what are your plans? Where do you plan his schooling? Won’t you need to subside the travels at that point?
I meant “when” he’s school aged
We’ll probably home school. TBD.
First let me say,thanks for the analysis. I’m not a fan of judging SSI in terms of ROI or as I like to call it “all about me”. I was happily surprised to see your “normal people” living to 80 has a positive IRR.
Great program, I hope it’s minor long term funding issues get fixed without cutting benifits.
It’s more like “all about math”
If the goal is “all about everybody but me” then the math says you could contribute more to others if you did it outside the SS system.
Fantastic article and really interesting look at something that most people don’t truly understand and are dependent on because they assume social safety nets will take care of them. It’s nice being around like minded people who realize that this program runs the risk of getting cuts and the more we put in, the less we really are getting out of it. I really find it interesting in the drop off between 1.8 and 2.0 million in the return. Seems like an early penalty to have that large a drop off and just because someone has earned two million it doesn’t mean they knew how to save it, but got used to their luxury life.
If I’m understanding your comment correctly, the dropoff in earnings isn’t between 1.8 and 2.0 million. The first $360k of lifetime income yields 90% credit, the next $1.8 million earns 32%, and the next $2 million earns 15%. Total lifetime income would be over $4 million before reaching the cap.
Single digit ROI? Yikes! I figured it might be slightly higher than that, but I guess not.
I confess to believing that I probably won’t receive SS payments at all, or just greatly reduced payments due to poor fiscal management.
As always, thanks for the analysis GCC!
So, am I understanding your takeaway as, if you’re an early retiree looking to make extra money, you should incorporate overseas, or otherwise you’re stuck paying 15.3% in Self-Employment taxes and receiving a negative or flat return, unless you’re blessed with extreme longevity? :)
Really great post! Thanks for all this great info!
That about sums it up.
I have been in asia so long, I won’t probably get OAS and a few hundred per month from CPP…from Canada… so I am depending on my China investments alone… perhaps I should start a blog or do a little tutoring to supplement things … God Bless, China ☺
If one is displeased with the “return” on SS, there are a few other options. One can become a teacher in a state that has a specific pension program for them, or a public employee in certain states or localties, or be Amish or Mennonite, to name the most obvious ones.
Doesn’t it make more sense to choose the highest paying profession possible, pay the SS, save and invest other money so you can do what you want with your life and not worry about about the “return” on SS? Wait, that sounds like what Jeremy and quite a few others have done.
I guess I’m not too sure what the point of this article is.
I was thinking the same thing about this comment
First off, great analysis. I believe social security will still be around in my golden years, although likely further reduced from what it is now. I’m not incorporating it into my long-term retirement planning. I more look at it as a donation to the government.
I’m almost 30 years older than my wife. She probably has a small chance of earning enough money to receive a benefit greater than my own. My understanding is that as my surviving widow, when she reaches full retirement age (assuming I’m dead) she has the choice of receiving either her benefit or mine. Since mine will be greater, the ROI of her payments is zero. Am I analyzing this correctly….anything she pays into social security is simply lost money? By the way, thanks…been looking for a concise analysis of this topic for years.
Yeah, I’m afraid so. She qualifies on your work history, so her own contributions are effectively a donation.
Hmm…so furthermore, the small business that she has in her name and social security number would be better off in my name and social security number. That would result in a higher benefit for me, and then later for her. To be fair, I can write her a “reimbursement” check for the social security dollars she contributes in my name and she can pop it into her IRA.
I don’t think you would enjoy an IRS audit in this case. She does the work so she pays the taxes and she gets the benefits (or lack thereof.) Trying to change that is basically tax fraud.
:-)……suspected that might be a problem….
What is the actual return for continuing to pay (now optional) Self Employment taxes? This may sound a bit basic, but is the “now optional” remark due to the fact that you can incorporate overseas or is it indeed an optional payment? If the latter, how?
It is due to being able to incorporate overseas. If you are in the US, SE taxes are compulsory.
So my question is what second country should my early retired self move to, legally work part-time, and then collect its version of Social security?
If you find a good one, please share with the rest of us :)
(I’m not familiar with the SS system in any other country.)
Working until the first bend point seems like a decent plan. As with you, I decided getting to the second bend point really didn’t make much of a difference. One should not continue work they do not enjoy just to get to that second bend point.
Now compare to having the SS withholding deposited in to a Vanguard 401k account.
Even the “normal” people could retire early in that case
Indeed, that is part of the argument for the privatization of Social Security
Hmmm, the returns are not good in comparison to historical stock market returns. BUT, at least there’s something! I think most people under 40 have written off SS to $0. I know I have, with the secret hope it at least pays out 70% of benefits when I’m eligible for withdrawal.
Sam
Please correct me if I’m wrong: I once regarded SS as a tax disguised as a Ponzi scheme, but I’ve recently come to regard it as an “outlive your savings” insurance policy. No matter how long I live or how poorly my investments perform, I can count on a monthly stipend to pay for catfood in my dotage.
Sounds about right to me.
It is interesting to look at what the additional taxes buy once you’ve already secured the lifetime subscription for catfood.
I like the analysis, but leaving out the value of the “ticket for the Medicare bus” grossly understates what most of us expect to get out of the system.
The 2009 Medicare spending per enrollee was over $10,000, and health care inflation in this country has consistently been 200-400% of CPI. Even for high income people, the nominal value of Medicare can be the majority of SS+Medicare package.
Those of you permanently living abroad may have a (justifiably) low opinion on the high cost of US health care, and you may have no plans to ever returning to the US to use Medicare. But the truth is that every insurance is worth something, and the option given by Medicare is extremely valuable.
Whether you work for 10 years or 100 years, you get the same ticket.
Working for more than 10 years just means you pay more for it, so the value of those additional years is zero / -100%.
I get that. But the bulk of your analysis looks at ROI on all payroll taxes paid, rather than the incremental payroll tax. Tye 14.4% in the first chart, for example, is likely > 30% when you account for Medicare.
Yup, completely agree
Your analysis here confirms the suspicions I’ve always had about the Social Security System. While I’m not entirely sure if the math works long-term for paying out those who are in their early 20s and 30s today, I know I could do much better investing the 7.45% (or 15.3% if self-employed) on my own. It’s so bad that I’d actually be better off losing out on the money I’ve contributed so far so long as I didn’t have to contribute anymore going forward. As your ROI calculations show, most Americans would have way more money if they were to invest in some growth stock mutual funds. Of course, the main problem is getting people to take control of their own future rather than depending on the government.
I could also see an argument for opening up the TSP to all citizens, with all payroll taxes (employee/employer, both) as automatic contributions.
I have to ask why you chose the overseas route? Another way to reduce your self employment income is to do a solo 401k and every dime you put of employer match is FICA tax free on both sides. Of course, the “individual contribution” of a 401k isn’t FICA tax free. However, solo 401k’s let you put tons of match into them. Why not go this route instead? Perhaps your blog makes more than I can comprehend.
Employer contributions to a solo 401k don’t reduce payroll taxes.
As a sole proprietor, that is correct. However, you can easily organize as an S Corp and your employer deductions would be deductible, employee deductions would not be (just like an employee)
I could do an S-corp, and if I lived in the US that would be something to consider.
As an expat, it could be a poor choice. Anything above the “reasonable salary” that I paid myself would be converting earned income (excludable with the FEIE) to ordinary income. This could be reduced with employer contributions to a retirement account, but no tax is better than deferred tax.
Am I following this S Corp idea correctly? : My wife works for herself, her own housekeeping business, and makes about $30,000 per year after her minuscule expenses. She pays, let’s call if 15%, on that for her social security and medicare – $4500. We put $9300. into her solo 401k (the amount above our standard deduction and personal exemptions on our joint return) to avoid paying any income taxes – so we just pay a total of $4500. ALTERNATIVELY with an S Corp are you saying that we could pay her, let’s say minimum wage, on the hours she actually works, maybe $16,000 per year – pay 15% SE tax on that, which would be only $2400. instead of the $4500. Contribute the same $9300. to the solo 401K for a total tax bill of just the $2400? Saving ourselves $2100. ?
It is a bit more convoluted.
S-Corp employer contributions to retirement plans are limited to 25% of the paid wage. If $16k is the W2 income then employer contributions are limited to $4k. You would save SE tax on this amount, or about $600. If you hired a CPA to do an S-corp tax return, you would probably pay more than $600.
If your wife hired another person to do her job, would the pay be higher than minimum wage? Assuming yes, that is the reasonable wage. If the reasonable wage is $30k, then you gain nothing. I’ve seen general comments from CPAs stating an S-corp is only worth considering once income is well above $40k/year.
Sounds like current contributions are only saving 10% federal income tax. Unless you have a plan to withdraw them at less than that in the future, you might consider making Roth contributions instead.
True dat
So assuming neither the wife nor I hit 360k individually in lifetime SS earnings, it’s better to pay SE taxes (as expats, excluding what we can from federal income taxes with FEIE) until we get past 360k in lifetime earnings? (Also relevant: I’m < 40 credits, so definitely need to hit that, she is over it, due to her working in HS/College.) Seems like we should do that first, before looking at an overseas corp to avoid the SE taxes. The SE taxes are significant though… maybe we can do some work for a foreign corp, and some not, to pay some towards SS, and exclude some? Probably best to talk to an expert at that point, but if you could confirm the first point (i.e. assuming the SE taxes weren't significant, it's better to work towards 360k bend point than avoid those taxes), I'd appreciate it. :D
I take back the credits thing at the end. I only have 7, she has 25 (as teachers in NV, we didn’t pay into SS). What I was recalling is that she has enough credits for Medicare at age 65, but I do not.
Qualifying for Medicare is important if you plan to be in the US, and I’m not sure if you (teachers) have different rules. But if you don’t plan on being in the US…
For SS benefits, the ROI is pretty good up to that 360k first bend point, especially if that tax is paid later in life. Basically, your situation. If one of you gets 40 credits, then you both get benefits (one of you gets the spousal benefit.) I would probably choose to pay the taxes up to the $360k bend point if I was going to work anyway, but probably wouldn’t work just for the increased payout. ymmv
Thanks.
Definitely have no plans to work just to hit SS credits, but the paying on what we happen to earn until we hit 360k, before doing a Belize company, is what I was thinking as well.
We’ll see if we ever hit 360k just from natural hobby earning, looks like a long way off (since we didn’t pay in as teachers, I’m about 350k off, she’s about 275k away).
Qualifying for Medicare would be good as well, I suppose. Guess we’ll cross that bridge in the future, if we need to. :)
I didn’t go into great detail but I should point out two things.
1. 6.2% of your FICA taxes do not fund your retirement benefit. Currently 1.45% goes to fund disability insurance – so the return should be based on about 5% contribution.
2.$420 increases your AIME by 1 dollar – but that is a wage inflation indexed $420. Given the Aver wage index for the late 60s or early 70s was greater than 7, you get that extra 1$ of AIME (and the subsequent 0.15, 0.32, or 0.90 of added income) for an investment of $60. Or, to view it another way, those paltry returns of just over 1% are real, over wage inflation (which is greater than CPI inflation) returns.
If I died today, there would still be considerable ROI for my contributions, as my surviving spouse and child would be paid based on my earnings.
SS has survivor benefits, but define considerable.