A Better Way for Young Families to Build a Future: Social Security Taxes vs. Down Payments
Saturday, March 9, 2013
Would you rather save for retirement by building equity in a house or by putting money in an underfunded government program?
Thanks to Social Security, what will be done with 12.4 percent of your salary has been decided for you by government nannies. (The 12.4 percent is 6.2 percent directly taken from your compensation plus 6.2 percent indirectly taken from your compensation as an employer payment on your behalf.) This money is going to be sent to a government retirement program, which admits to having liabilities much greater than its assets, rather than use it for something you might prefer — such as making a down payment on a house. Would it be better to save for your retirement by building equity in a house, or by having your money put into a government program which entails no property rights at all?
A constant theme of American politics is the individual and social advantages of home ownership. But a constant complaint is how difficult it is for young people to accumulate sufficient funds for a meaningful down payment, which would allow them to become property owners on a financially sound basis. One big reason that saving is hard for them is that Social Security taxes take so much of their youthful incomes, sight unseen, and, as everyone knows, these receipts are forthwith spent by the government, not saved. Having made saving harder, the government then sets up other programs to push risky, low-down-payment loans.
Suppose you are 24 years old, finished with schooling, employed, and launched into grown-up life. By 30, you would like to be married with children, or at least planning on them soon, and, by 32, you would like to buy a house for your family. Suppose you are making a moderate $40,000 a year, and will have modest annual raises of 3 percent (2 percent inflation plus 1 percent real).
Having made saving harder, the government then sets up other programs to push risky, low-down-payment loans.
In the eight years between the ages of 24 and 32, you will have paid more than $44,000 in Social Security taxes from your income. Suppose that instead this money had been put in a special restricted savings account for accumulating a down payment on a house. Even with Bernanke-level interest rates of less than 1 percent on savings, you would have about $45,000.
That would provide a sound, 20 percent down payment on a house costing $225,000. The median house price of an existing home in the United States is now about $180,000. You get an 80 percent traditional mortgage that amortizes in 30 years. If you pay it off on schedule, you will own the house free and clear at the age of 62. If over those 30 years you get the long-term U.S. average house annual price increase of 3 percent (2 percent inflation plus 1 percent real), the house you own, debt-free, at age 62 will be worth about $546,000. If the annual house price increases cover only the 2 percent inflation, your home will still be worth $408,000. Nothing wrong with that as a retirement savings program, as our grandparents and great-grandparents thought was obvious.
Of course, if you pay fewer taxes into Social Security, you should have correspondingly lower benefits in later years (considering whatever benefits Social Security will by then be able to afford). But in exchange you will really own the house! Moreover, you will have been able to afford a proper down payment at the right time of life, when you have a young family.
Which is a better deal? And who should get to decide?
I propose that until the age of 35, an individual should be able to choose to have 12.4 percent of his salary paid not to Social Security taxes but instead into a restricted savings account covered by deposit insurance, from which savings can be used only to make a down payment on a house. The down payment (using this and possible other savings) must be a minimum of 20 percent, the house must be bought to live in, and the related loan must be a sound credit which is a “qualified mortgage,” as now defined by regulation. The point will be to create retirement savings in the form of equity in property, as a partial alternative to earning benefits from a troubled government pension program.
If you pay it off on schedule, you will own the house free and clear at the age of 62.
If this down payment alternative were chosen by the individual, and the property purchased, Social Security benefits would be fairly adjusted downward to reflect the lower amount paid in. If our hypothetical individual bought the house at age 32 (after eight years of reallocating Social Security taxes to the down payment) and worked until age 67, Social Security taxes would have been paid for 35 years. Out of 43 working years, this is 81 percent of the time, and the fair downward adjustment would be modest. If by age 35, the restricted savings were not used, I suggest the accumulated funds should be paid to the government as Social Security taxes and the individual’s Social Security status should go back to what it would have been in the first place.
So: as our 24-year-old, would you rather put your money into Social Security or a down payment on a house? Would you like to have the choice? If you did have it, which would you choose?
The biggest obstacle is whether we can get the government nannies to admit that you should have such a choice; that this would be better than their promoting home ownership by pushing low down payments and risky loans; and that we could in this fashion beneficially combine retirement finance and young families’ down payments.
Alex J. Pollock is a resident fellow at the American Enterprise Institute.
FURTHER READING: Pollock also writes “The Housing Bubble and the Limits of Human Knowledge,” “Harmonization Lifts Systemic Risk” and “Would You Settle Your Claims on Social Security for 80 Cents on the Dollar? (I Would).” Aspen Gorry and Sita Nataraj Slavov say “To Protect Future Generations, Fix Social Security.” Andrew G. Biggs advises “Don’t Raise Social Security Taxes: But if It’s Necessary, Here’s How.”
Image by Dianna Ingram / Bergman Group