Should Americans Be Able to Put Some of Their Social Security Contributions in Private Accounts?
Overview/BackgroundDue to the aging of the baby boom generation along with increased average life spans of American citizens, the current system of social security is headed for bankruptcy, meaning it will no longer generate the funds necessary to meet its obligations to retirees. Democrats and Republicans debate the actual timing of this insolvency, but no one disputes the fact that changes must be made eventually to keep the system going. Because the system is severely underfunded, one of two courses must be made at some point: 1) raise taxes to increase revenue generated, or 2) cut back on benefits paid out. Former President Bush first popularized a new idea -- private accounts.
Currently, employees pay 6.2 percent in social security tax, which is matched by another 6.2 percent paid by the employer. Under several Republican plans (or rather their adaptation of an idea that's been used in Britain, Argentina, Australia, and Chile and proposed in the past by President Clinton and Senate Minority leader Harry Reid), employees would be able to take a certain percent (e.g. 4 percent) and put it into a special private account they own, and for which the government can never touch (with the other 8.4 percent staying in the general trust fund). This private account could be invested in a number of mutual funds which could include stocks and bonds (in addition to no-risk investments such as treasury instruments). This private account would be transferable to next of kin upon death. Since investment in stocks and bonds are historically much higher than the return currently earned by the government system, advocates are convinced that the additional earnings of private investment will more than make up for the cutback in benefits.
- It gives poor people a better chance to retire wealthy. Americans living at the poverty level must usually spend every cent of their disposal income just to survive. Few in the lower-middle class have the funds available to put into a wealth-generating retirement account. Thus, they must rely on social security income to pay the bills when they reach retirement age. Unfortunately, the current social security payouts are at or below the poverty level. The money you earn in benefits based on what you pay in is less than what you'd earn in a passbook savings account. Talk to any person of wealth in this country. Do they have their money stuffed under a mattress? Is it in a taxable savings account earning 1 percent? Of course not. The majority of their money is going to be invested in stocks, bonds, real estate, and other wealth-building assets. The private accounts would provide a method of forced savings that would allow poorer people to participate in the advantages of stocks and bonds, allowing many to retire wealthy. For example, an individual or family that earns an average of $30,000 during their working lifetime (age 18-65) will accumulate $213,743 in their private account based on a very conservative return of 5 percent. If they earn an average return of 10 percent (which is close to the historical rate of return on the U.S. stock market), they will have accumulated $1,046,370 when they retire. That's right -- a family making only $30,000 per year would retire as millionaires just based on the private accounts alone! Remember that the private account is only part of the benefits paid out by social security. The other 8.4 percent of taxes would go to the general trust fund which would be used to pay additional monthly benefits outside of the private account. In addition, Americans still have options outside of social security to invest for retirement -- 401(k)'s, IRA's, pensions, and so on. Obviously there are no guarantees, but private accounts give every American a better opportunity to retire wealthy.
- It makes up for inevitable benefit cuts that must eventually be made to the system. As many Americans are starting to become aware, the social security "trust fund" is not a diversified portfolio of assets waiting to be distributed to future retirees. It is a bucket of worthless government IOU's. Social security is based on a pay-as-you-go system. Social security taxes collected from current workers are used to pay benefits of current retirees. As the baby boom generation reaches retirement and life spans increase, the number of workers paying in will shrink while the number of retirees collecting benefits will increase. The system is currently not sustainable on its present course. This means taxes will have to rise or benefits will have to be cut. Tax increases are opposed by the Republican-controlled House since it could stifle a fragile economic recovery. Thus, benefits will have to be cut; i.e. the start age of benefits will have to be extended or the monthly check reduced. Private accounts would allow a larger accumulation of wealth that will make up for the inevitable benefit cuts. In other words, new retirees can at least do well as they currently are.
- The stock market should get an initial bump in value. Over 60 percent of Americans currently own stock in some form, most notably in 401(k)'s, IRA's, and pension funds. The implementation of private accounts would mean more money would be injected into the stock market. Thus, by the laws of supply & demand, the market should go up in value.
- People are given a personal stake in the U.S. economy, providing extra incentive to help their companies and the nation as a whole to do well. Many Americans feel disjointed from the success of their companies or the U.S. economy. In other words, if the stock market goes up or their company turns out record profits, they don't see an additional dime. They don't have a personal stake in the outcome. Thus, they are less likely to be motivated to do their best. After all, if they have no personal stake, it seems like they're just working to make rich people richer. The use of private retirement accounts would ensure that almost every American owned stock in some form. Thus, everyone would have a personal stake in the health of the U.S. economy. However small, this would lead to a greater motivation to give their best effort. More and more people would realize that the success of their company and the U.S. economy is good for everyone.
- Personal responsibility and ownership are injected into citizens' plans for retirement. It is unfortunate that the revolution of government programs instituted by FDR to help the less fortunate have led to a cradle-to-grave entitlement mentality. Too many Americans now believe that the government owes them a living. They are less motivated to work and save because the government is always there to bail them out. The whole idea of former President Bush's "ownership society" was the philosophy that if people reap the rewards or suffer the consequences of their own actions, the maximum benefit for society is achieved. Think about it from the perspective of yourself only. If you didn't have social security (or other entitlement programs such as unemployment compensation), would you be more motivated to save and invest? Would you be more willing to work hard to ensure employment security and success? Would you be more willing to take a less-than-perfect job if you were laid off? Private accounts force people to take a good hard look at their retirement planning. In other words, it returns personal responsibility to a system that badly needs it. If you want to see the negative effects of an entitlement mentality, take a good look at the double-digit unemployment rates in social welfare-rich countries like France and Germany.
- Stocks & bonds are historically safe in long-term diversified portfolios (as evidence by their existence in every major government/union/corporate pension & retirement fund). Any investment advisor will tell you that a diversified mix of stocks and bonds is very safe over the long term. Americans wouldn't have the option of withdrawing funds from their private social security accounts; thus, they'd be forced to invest long-term. In fact, almost every major
- Poor portfolio management could leave some retirees severely short of funds. Although stocks and bonds have historically done well over the long term, as any investment advisor will tell you, past success isn't a guarantee of future success. At the turn of the millenium the Nasdaq lost over 60 percent of its value as a result of the "tech bubble burst". The Dow index, which includes 30 of the most stable and well-known companies in the country, lost 30 percent of its value. Ironically, a mutual fund made up of stocks from either index would be considered a "well-diversified portfolio". Indeed, the funds of younger workers would most likely be put into smaller growth stocks that make up most of Nasdaq. Thus, imagine a scenario where you spent 30 years accumulating $200,000 in a private account; then, in one bad year, the value of the account dropped to $80,000. This is precisely what would have happened five years ago if private social security accounts had been in place. Hopefully, investment managers have learned from the tech market burst. However, do we want to be risking our retirement livelihood? Another terrorist attack could occur, sending the market into a tailspin. Someone at or near retirement age doesn't have a lot of options if his/her funds are suddenly lost. The subprime mortgage crisis in 2009 caused the same type of catastrophic drop in the entire stock market.
- Wide stock market price fluctuations could leave large groups of retirees in dire straits if their retirement occurs during a downturn. Most stock market experts will point out that the long-term return on stocks has always been positive, despite temporary setbacks now and then. In other words, the market may go up 150 percent one decade, then down 50 percent the next, then up 60 percent the next, then down 25 percent the next. Overall, the return may be positive, but what happens to the retirees that hit age 65 during one of the downturns? Hopefully they were wise enough to gradually put most of their money in safer investments, but there's no guarantee they did the right thing. Consequently, the unlucky retirees may be forced to live with a much smaller nest egg than they planned. The Nasdaq index lost over 60 percent of its value five years ago. It may take 10 or 20 years for it to return to its high value. Unfortunately, the trading technology of today (online transactions, program trading, up-to-the-second information dissemination, etc.) have made the market extremely volatile, which is the very definition of risk.
- There are several less complicated fixes to social security available. The money, time, and bureaucratic complexity of private accounts aren't worth the effort and risk when there are much less complicated fixes available. Among these are the following: 1) Remove or raise the cap on taxes subject to social security tax (which currently hovers around $90,000); the social security tax is currently the only tax on income that's regressive. In other words, once your income exceeds $90,000, the more money you make, the less you pay in tax as a percent of income. For example, someone who makes $50,000 pays $6200, or 12.4 percent (including the business share). Someone who makes $100,000 pays about $11,000, or 11 percent. Someone who makes $200,000 also pays about $11,000, or 5.5 percent. 2) Extend the age that benefits begin to be paid out. When social security was first put in place, the average life span was about 67 years. Now, it's in the high 70s and continues to grow. For practical purposes, the age needs to be extended. 3) Use a hybrid of methods such as cutting benefits for upper income individuals, raising the amount of benefits subject to income tax, extending the cap on taxes subject to social security taxes, and so on. A bipartisan effort working with a set of economic experts should be able to craft some kind of effective, less risky plan.
- This isn't the best time to address the problem (i.e. there are far more urgent issues). We have several decades to address the social security problem. In the middle of the War on Terror, with tension in Iraq, North Korea, Iran, Libya, Afghanistan, and Syria....in a time of trillion dollar deficits, this is not the best time to tackle the problem.
- Even more money will be taken out of an already underfunded system. We all know that the social security system is severely underfunded; it's headed for bankruptcy sometime in the 2040s. Implementing private accounts will take 4 percent of the 12.4 percent taxes from every worker out of the trust fund. Thus, almost a 3rd of the revenue generated by social security taxes will be removed. Drastic benefit cuts or increased taxes will have to occur even sooner, which is a recipe for disaster.
- Current IRA's and 401k's offer essentially the same benefits as social security private accounts. All of financial benefits of private accounts--market investment, estate transferability, etc.--are already available in existing retirement investment vehicles. The main reason these options were set up in the first place was to supplement the social security system. Setting up private social security accounts will essentially provide a certain amount of redundancy, which isn't worth the cost and risk.
- The transition costs of setting up private accounts would be prohibitively high and severely add to an exploding deficit. As previously discussed, almost a 3rd of revenue generated from social security taxes would be removed immediately. In addition, the tax and bureaucratic headache of setting up such a system would be a nightmare. The transition costs of setting up private accounts could add over a trillion dollars to a deficit that is already at a $1.5 tillion-per-year level. This is way too much of a burden to leave future generations.
Related LinksUnderstanding Social Security
How Today's Social Security Works
Social Security Choice
The Social Security Network
Written by: Joe Messerli
Page Last Updated: 05/08/2011