Department of Economics
McAnulty College of Liberal Arts
Duquesne University
Pittsburgh, Pennsylvania
Evaluating the Effects of Race and Gender on
Lost Social Security Retirement Benefits
Andrew J. Litvin Jr.
Submitted to the Economics Faculty
in partial fulfillment of the requirements for the
degree of Bachelor of Science in the Honors College
December 2007
Faculty Advisor Signature Page
Matthew Marlin, Ph.D. Date
Professor and Chair, Department of Economics
Jennifer Bayley Date
Assistant Professor of Economics
Evaluating the Effects of Race and Gender on
Lost Social Security Retirement Benefits
Andrew J. Litvin Jr., B.S.
Duquesne University, 2007
Abstract
The method commonly used to estimate lost Social Security retirement benefits after death can either over- or underestimate the amount that the household would have received had the worker not died. The purpose of this analysis is to expand upon previous work through the inclusion of racial and gender differences to examine the amount of Social Security retirement benefits lost after death with regard to the worker alone. I observe the potential retirement ages of the worker to determine if there is an optimal retirement age to plan for based on current age.
The results are consistent with prior work, differing in only two cases. These differences produce results directly opposite to the previous beliefs, further supporting the assumption that the FICA tax method is not an accurate predictor of lost Social Security benefits. The results also indicate that it is best for a worker to plan to retire at the full retirement age, given he or she will live to his or her life expectancy.
Key Words: Social Security, benefits, death
Table of Contents
2. Literature Review………………………………………………………………. / 6
3. Methodology…………………………………………………………………….. / 10
4. Results and Economic Implications…………………………………………… / 15
5. Conclusion and Suggestions for Future Research……………………………. / 16
6. References……………………………………………………………………….. / 18
7. Appendices………………………………………………………………………. / 19
1. Introduction
Social Security is a social insurance program whereby all workers and employers pay annual premiums to the government and the workers receive benefits upon retirement. For 2007, workers and their employers each paid Federal Insurance Contributions Act (FICA) taxes on all earnings up to $97,500. FICA taxes are separated into three main parts: 5.3% for Old Age and Survivors Insurance (OASI) paid up to the maximum; 0.9% for Disability Insurance (DI) paid up to the maximum; and 1.45% for Medicare paid on all wages. The OASI tax is the focus of this study, as it funds the retirement benefits paid by Social Security. A worker’s retirement benefits are a function of past earnings that redistributes the premiums to lower income retirees.
A person can collect the benefits due as a result of his/her past earnings, or an amount equal to up to 50% of the person’s spouse’s benefits, whichever is greater.[1] Should a worker die, his or her surviving spouse is entitled to up to 100% of the benefits the worker would have received had the worker started collecting based on the salary at the time of his death, or the benefit due to the surviving spouse’s past earnings, whichever is greater. The amount the widow(er) collects is based on the age of collection, ranging from a fraction of the full benefit at the earliest retirement age of 62, and climbing to 100% at full retirement age (FRA), which varies based on year of birth.
This paper builds on Rodgers (1999) study, “Estimating the Losses of Social Security Benefits.”[2]. One method of estimating the loss of Social Security retirement benefits from a worker’s death or injury, the “FICA tax method,” estimates the worker’s loss as the present value of the total contribution the employer would have made from the worker’s death until the age at which the worker could have been expected to retire. This is not an accurate representation of the total loss, however, as it incorrectly assumes a one-to-one relationship between taxes paid and retirement benefits.
In this analysis, I propose a model in which a worker dies or is injured before retirement. I look at representative workers who die or are injured at various ages. In the case of death or injury, the lost benefits will be calculated in terms of the worker alone. Though injury may qualify a worker for DI, he may be unable to pay FICA taxes, preventing the worker from potentially increasing his retirement benefits. Thus, the lost benefits will be similar to those of a worker who dies. The losses are calculated as the difference between the present value of the net lost benefits and the present value of the FICA taxes the employer will not pay, and are observed as a percent of lost wages. The life expectancy and average earnings of the worker will be based on race and gender through data collected by the Census Bureau and the Department of Health and Human Services. In a death case, the loss would actually be in terms of the widow or widower, but these calculations are not observed in these scenarios.
2. Literature Review
In 2000, less than 95% of all workers earned less than the maximum taxable income of $76,200 (Armour, 2004). All workers are taxed on all earnings up to a set maximum, receiving benefits calculated through their past contributions.
When the worker dies or is injured, there are several ways to calculate what the worker would have received had he or she lived to collect. The loss of benefits is commonly calculated through the “FICA tax method,” in which the loss is estimated as the lost employer contribution. The current FICA tax is 7.65%, but 1.45% goes to Medicare, 0.9% goes to disability insurance, while 5.3% goes to the Old Age and Survivors Insurance (OASI). Table 1 illustrates the FICA taxes taken out for a worker earning $30,000 in a year.
Table 1.
Yearly Salary / Medicare (1.45%) / Disability (.9%) / Retirement (5.3%)$30,000 / $435 / $270 / $1,590
This method tends to be an incorrect representation of the actual benefits lost, and each scenario should be calculated individually by comparing estimated contributions to estimated benefits (Rodgers, 1999). According to Rodgers, an overestimation in the benefits lost will lead to an overpayment, an unearned financial gain for the worker or his or her family. Similarly, an underestimation of the benefits lost will lead to a financial loss. In Rodgers’ examples, the FICA method is closest for a 40-year-old worker making an average or lower salary, while it overestimates the loss for the higher than average earnings. For a 22-year-old worker, the FICA method consistently overestimates the loss, causing a financial gain at all salary levels. The lost benefits are underestimated at all levels for a 55-year-old worker, indicating a financial loss. The FICA tax method is unusable in the case of a worker who has just retired because there are no lost earnings, so the lost benefits must be calculated directly. Rodgers suggests that the Social Security benefits could be ignored completely while focusing solely on lost wages, or that the present value of the losses could be calculated directly, accounting for any taxes retained. It is assumed in all death cases that the worker earned more than the spouse. If the spouse earned more than the worker, than the worker’s benefits would not matter, as the surviving spouse would only collect his or her own benefits (Durham, 1993).
In this analysis, I will expand upon Rodgers’ findings by observing and calculating net lost benefit differences between direct calculation and the FICA tax method that result from gender and racial differences. The benefits lost vary among demographic and socioeconomic groups with differing life expectancies and average wages. Data suggests that average salary for males is higher than females, though females live longer. Data also suggests that the white population has a higher average salary and live longer than the black population. A causal relationship for the wage imbalance is unknown, as it cannot be seen whether females and blacks tend to be hired in lower-paying positions, or if payment declines in professions that begin to hire female or black workers (Catanzarite, 2003). The variations in life expectancy and wages indicate differences in the benefits lost, and are also examined to determine the optimal retirement age for a worker to aim for, a goal that may change as the worker ages. In a normal retirement situation, it is detrimental for a male to delay retiring due to a declining return and a shorter life expectancy, while females gain by staying in the workforce longer due to a longer life expectancy (Duggan, 2002). I explore whether these incentives change over time.
When calculating the lost Social Security benefits by use of the FICA tax method, the unpaid taxes are estimated through calculating the potential lost wages. Though both the worker and the employer pay the same amount of each dollar earned into the Social Security system, the assumption is made that the worker’s taxes taken out of these wages will be similar to the benefits returned. This is a debatable assumption as the benefit payout and the contribution do not necessarily have a one-to-one relationship (Fort and Rosenman, 1992). The FICA tax method is instead calculated as the total employer contribution foregone at up to the full 7.65% of taxes taken out. In looking at only the lost retirement benefits, only 5.3% of the lost wages will be used.
There are several potential issues faced in this analysis. First, the average life expectancy data includes disabled people, who have a higher mortality rate than the average worker (Duggan, 2002). Whether a race or gender has a higher rate of becoming disabled is beyond the scope of this study, so it is assumed that the disability rate is not applicable. Second, average salaries and life expectancies are not kept on a continuous basis, limiting me to data from several years ago. Average annual wage increases from the Bureau of Labor Statistics are used to find the wages for 2007. Third, the benefits are calculated on the basis of the highest earning years of the worker. If a worker earns the maximum taxable earning for 35 or more years before dying or being injured, the lost wages would have no effect on the Social Security benefits paid (Fractor et al, 1997). In this case, it is suggested that the unpaid taxes on the lost wages may negatively affect the settlement amount. Fourth, in the case of a worker who has just retired at the full retirement age, several assumptions must be made. Due to the change in the full retirement age from 65 to 67 based on year of birth, no scenario fits perfectly with a worker born in January retiring immediately upon reaching the FRA in January 2007. Since the calculation of benefits lost only takes the highest earning 35 years of work in this scenario, it is assumed that the worker is born in April 2007, as the partial year will have no impact on fulfilling the 35 years of work.
3. Methodology
In each case outlined in this paper, it is assumed that the worker dies or is injured in 2007 at age 22, 40, 55, or immediately after retiring at the full retirement age. To retire exactly upon reaching the FRA in January 2007, it is assumed that the worker is born in April 2007 and has the FRA of 65 years and 8 months. It is also assumed that the worker consistently earns the maximum taxable earnings, the national median annual earnings by race and gender, or an annual wage based on the national minimum wage during late 2007 of $5.85. The maximum taxable earning formula is set by law and can be found on the Social Security Administration website.
3.1 Data
To determine the differences in benefits lost between races and gender, it is necessary to determine the median wage for black and white males and females. Using the varying life expectancies by race and gender serves to accurately measure the number of years the Social Security benefits are collected. The data, sources, and year observed are detailed below.
Table 1. Life Expectancies and Median Wages by Race and Gender
Life ExpectanciesAge / 22 / 40 / 55 / 65.7 / Median Wage
White Male / 76.4 / 77.6 / 79.5 / 82 / $41,944.00
White Female / 81.2 / 81.8 / 83 / 84.8 / $29,979.00
Black Male / 70.9 / 72.9 / 76.1 / 80.1 / $30,050.00
Black Female / 77.3 / 78.4 / 80.7 / 83.6 / $25,875.00
Median Wage Source: U. S. Census Bureau (2004)
Life Expectancy Source: U. S. Department of Health and Human Services (2004)
I assume that the relative life expectancies are unchanged, and the values from 2004 are used. It is assumed that the wages for each race and gender have grown at the same rate annually based on data from the Bureau of Labor Statistics.
3.2 FICA Method
For the FICA tax method, the present value of 5.3% of the employer’s contribution to the Social Security system after a worker is unable to work is calculated. An example for a 40-year-old white male can be found in Table 2.
Table 2. Lost Salary and Taxes for a 40-Year-Old White Male Worker
40-Year-Old White Male / 3.9% Growth Rate / Discount Rate = 5.7%Year / Age / Lost Salary / PV(Lost Salary) / PV(SS Taxes)
2007 / 40 / $45,301 / $45,301 / $2,401
2008 / 41 / $47,068 / $44,530 / $2,360
2009 / 42 / $48,904 / $43,771 / $2,320
2010 / 43 / $50,811 / $43,026 / $2,280
2011 / 44 / $52,792 / $42,293 / $2,242
2012 / 45 / $54,851 / $41,573 / $2,203
2013 / 46 / $56,991 / $40,865 / $2,166
2014 / 47 / $59,213 / $40,169 / $2,129
2015 / 48 / $61,523 / $39,485 / $2,093
2016 / 49 / $63,922 / $38,813 / $2,057
2017 / 50 / $66,415 / $38,152 / $2,022
2018 / 51 / $69,005 / $37,502 / $1,988
2019 / 52 / $71,696 / $36,863 / $1,954
2020 / 53 / $74,492 / $36,236 / $1,920
2021 / 54 / $77,398 / $35,619 / $1,888
2022 / 55 / $80,416 / $35,012 / $1,856
2023 / 56 / $83,552 / $34,416 / $1,824
2024 / 57 / $86,811 / $33,830 / $1,793
2025 / 58 / $90,196 / $33,254 / $1,762
2026 / 59 / $93,714 / $32,687 / $1,732
2027 / 60 / $97,369 / $32,131 / $1,703
2028 / 61 / $101,166 / $31,584 / $1,674
2029 / 62 / $105,112 / $31,046 / $1,645
2030 / 63 / $109,211 / $30,517 / $1,617
2031 / 64 / $113,470 / $29,997 / $1,590
2032 / 65 / $117,896 / $29,487 / $1,563
2033 / 66 / $122,494 / $28,984 / $1,536
$987,143 / $52,319
In the example, the worker is unable to work beginning in 2007, and he consistently earned the average wage, which was $41,944.00 for 2004. The average wage is extended to 2007 by using the national average wage increase. It is assumed that the worker’s birthday is at the beginning of the year for ease of calculation. As he was born in 1967, he will reach the full retirement age of 67 in 2034. The 2007 OASDI Trustees Report gives the intermediate forecast of the expected average wage increases (AWI) for all years after 2015 as 3.9%, a rate also used in indexing the earnings. Likewise, intermediate forecast of the cost of living adjustments post-2015 gives a COLA rate of 2.8%, and the intermediate forecast of the nominal interest rate is 5.7%. Thus, the FICA Method estimates the loss of a 40-year-old white male at $52,319.