Relevance of the Social Security Pension - Roberto Isasi

When most Latin Americans think of the social security systems we experienced in our countries, we usually think of low pensions and poor customer service. The Social Security system of the United States is often categorized along the same lines and, therefore, some people do not take it into account as a fundamental pillar in their financial planning and consider mandatory contributions to be just another tax.

In the United States, the Social Security was established in 1935 as a public system and today covers 254 million people, of whom sixty-six million are already receiving some form of benefits: 78% receive old-age benefits, 13% disability benefits, and 9% survivors’ benefits.¹

Today we will focus on the old-age benefit, or pension, which seeks to replace a percentage of the income earned during the working years. It is worth noting that this percentage will be higher for those with lower incomes. In this sense, a person who has enjoyed a high income will receive a Social Security pension that will cover a smaller percentage of his or her previous income, but not irrelevant. Husbands or wives who have not worked will also receive an old-age benefit, subject to a maximum percentage of the working husband’s or wife’s benefit.

One of the most notable features of the Social Security pension is its lifetime nature and the possibility of receiving annual adjustments for inflation. These two characteristics make it highly valuable as a retirement product that serves to hedge the risks of longevity and inflation. The present value of this benefit can be considerable in the case of long-lived people.

The Social Security pension can be claimed starting at the age of sixty-two and can be delayed as long as necessary. However, the amount of the pension will not increase by postponing it beyond the age of seventy. For someone born after 1960, the difference between starting to receive the pension early (62 years) and late (70 years) can be a deviation of -30%² to +24%³ with respect to someone who claims it at the normal retirement age for this cohort (67 years). For this reason, a proper age-of-claim strategy can make a significant difference.

Finally, it is relevant to mention that the amount of the pension will depend on an average that considers the 35 years with the highest incomes, that is, if the person does not have 35 years of wage history, these missing years will contribute a value of zero to the calculation of the average⁴. Other things being equal, a person who has not contributed for 35 years will receive less than one who has done so.

Given its characteristics, the old-age pension provided by Social Security represents a fundamental pillar in financial planning. In future articles we will cover other aspects of Social Security and talk about its long-term viability.