This article stems from a presentation I gave last year. Someone told me afterwards that it “made him think”. That is the highest compliment I can receive. I don’t expect everyone to agree with everything I say. But if it makes you think then I have done my job.
So here we go…
701 billion dollars were paid in Social Security payments in 2010. That’s $701,000,000,000. This number makes Social Security the largest government program in the entire world. Unfortunately, that’s not even the scary part. The scary part is that the program is going broke (or is already broke depending on how you look at it).
But before we can talk about why Social Security is going broke and what we can do about it, we need to understand how it’s currently working.
Right now, in 2011, you contribute 4.2% and your employer contributes 6.2% of your gross pay into the Social Security Trust Fund. That’s a total of 10.4% of your compensation. The money in the trust fund is immediately distributed to people who are currently on Social Security. Anything left over is invested in Government Bonds, or to put it another way, loaned to the Federal Government.
Historically, Social Security has taken in more money in taxes than it has paid out in benefits. Population growth allows for us to have more workers than there are beneficiaries. However, the worker to beneficiary ratio has been dropping for decades. In 1945 there were 42 workers for each beneficiary. In 1950 there were 16.5 workers per beneficiary. In 1980 there were 3.2 workers per beneficiary. By 2030 it is expected that there will only be 2 workers for each beneficiary. One reason for this change is that people are living longer and therefore receiving Social Security Benefits for longer periods of time. Another reason is, as the Social Security Administration puts it, “lower fertility rates” or less children. Fewer babies now means less workers later.
This graph put out by the CBO shows the historical and projected levels of the trust fund.
As you can see, we are about to start dipping into the trust fund. The problem is even worse than it looks on the graph because as soon as Social Security starts to use the trust fund the federal government is going to have to start paying back the bonds. The area under the dark blue line isn’t money, it’s IOUs from the Federal Government. There is great debate on how the Federal Government, with its current deficit, is going to be able to pay back what it owes.
So you can see how the system is broken. Something needs to be done to fix our Social Security problem before we have to start borrowing money to pay benefits. With the current structure there are really only 3 options.
- Lower benefits – Lower benefits can be obtained by raising the retirement age, cutting cost of living increases, or decreasing the promised benefit.
- Increase taxes – Increasing taxes is pretty straight forward. This means more money taken out of our paycheck in order to receive the same benefits we have already been promised. It could also mean raising the current income cap.
- Borrow – I wish this wasn’t even an option; it’s unsustainable to continue to borrow, borrow, and borrow to meet our needs.
However, there is another option that is a long term sustainable fix to Social Security. And that is privatizing it.
I think a lot of people are turned off by the word “privatize”. In this case it doesn’t mean to take it out of governmental control. It means to create individual accounts rather than have one general pool of money. It should be called “Personalizing” Social Security.
Privatizing Social Security would look something like this.
The benefits of privatizing Social Security are:
- Your money stays your money. You are putting money aside for your use. You don’t pay someone else’s benefits with the hope and promise that someone will come along later to pay your benefits.
- Unused funds can be inherited. Right now you could pay into Social Security your entire working life and die before you ever receive benefits. Or you die after only receiving a small benefit. If Social Security was privatized the money you set aside could be passed on.
- The government can’t reduce or withdraw your benefits. You would own your account. As it stands now you have no right to Social Security benefits. The government can change the rules at any time. If it were privatized you would not be at the mercy of the government to allow you to have your money.
Funding Private Accounts
The average wage in the US in 2009 was about $41,000. A person earning this amount would contribute just under $98 per week to Social Security. (Half as payroll deductions, half as employer match).
Now not all of Social Security payments are paid out as retirement payments. Disabled workers and survivors of deceased workers also receive benefits. Disability and life insurance would cover these needs and can be purchased fairly cheaply for most people. But for simplicity we will leave these benefits in the current system. About 66% of benefit payments pay retirement benefits and 34% pay everything else. We will use that same break down the example.
Using these same percentages Joe Average earning $41,000 would sock away $53 per week into his own personal Social Security retirement account. (The other $27 would fund the current disability and survivor benefits of Social Security. Or, if the whole thing were privatized that $27 per week could be used to purchase life and disability insurance.)
Now the tricky part. How much would that leave Joe Average in retirement? That’s tough to say since he isn’t likely to graduate from school, get a job earning $41,000, and make that amount for his entire life until he retires. He will most likely get a job earning less than that, then get raises and promotions along the way. But since we don’t know the specifics we will do the less than perfect thing and say that he made $41,000 for his whole life. We will say he started working at 22 and will retire at 65. We will also say that Joe Average would like his retirement savings to last him until he is 95.
The 4.2% employee contribution is reduced for 2011 from 6.2%. If we use the “normal” 6.2% contribution and move the beginning working age to 25, we get almost the same results below. Just sayin’.
We will run two scenerios. One with “reasonable” numbers and then one very conservative numbers.
The “Reasonable” Scenerio
$53 per week invested at 8% interest for 43 years yields him $1,029,237. Once he is in retirement he decides to take less risk and moves his entire balance to safer investments. He earns 4% while retired.
Joe Average would be able to withdraw $4,913 a month for his entire 30 year retirement. That is $3,574 per month more than the estimated $1,339 Social Security payment he would receive. (To estimate benefits I used the birthday of May 1, 1980. Earnings of $41,000. Retirement in May 2045. And Today’s Dollars)
The “Conservative” Scenerio
The opponents of privatizing Social Security argue that the average person can’t get good returns from the stock market. They liken it to gambling. I disagree with this. Over the last 40 years the stock market has seen a gain of 11.2%. Will the stock market go up 11.2% over the next 40 years? Only time will tell. So let’s play into the opponents view that it’s not possible for Joe Average to get even reasonable gains of 8%.
So let’s say that Joe Conservative invested $53 per week and earned 6% for 43 years. He would have $557,178. At age 65 he takes all his money and puts it into a savings account earning 2% at a local bank.
With $557,178 earning 2% per year Joe Average could withdraw $2,059 a month and his money would last him 30 years. This is $720 more than the estimated $1,339 he would receive from Social Security.
What about taxes, you ask? In the conservative example, if Joe Average were paying his regular income tax rate (using 2011 tax brackets) he would owe a total of $3,281 a year if he had no deductions, or $273 per month. This is still above what he would be receiving from Social Security. In the reasonable example, Joe Average would owe $10,864 or $905 per month. Again, he would still be better off than under the current Social Security system. However since Social Security payments receive tax breaks I would like to think they still would under a privatized system. But who knows?
Can we make the change?
Making the change from the current system to a new system isn’t a smooth transition. We are on a pay as you go system. It’s hard enough to pay the current benefits with income coming in. What happens if we divert that income to private accounts? How do we then fund the current obligations? I say screw the old people! Just kidding. Clearly we have to keep paying to those who receiving benefits or are about to start receiving them. My whole complaint is that I’m going to pay into Social Security my whole life and get nothing out of it. I don’t suggest we do that to anyone else. There is an age at which it would be more beneficial to not be in the current Social Security system. Let those people out! Anyone older than that can stay in the current system. At some point those people will die, and the pay as you go system will die along with them.
Now, paying current benefits with less income is going to cost money. Figuring out just how much money is quite the battle. Proponents of privatizing it say it will cost $2 trillion. Opponents say more. How much more? One site said $9 trillion. I have no idea where they got that number, but even so. Let’s say it will cost somewhere between $2 and 9 trillion.
But even considering the enormous costs I have to ask myself “How much will it cost NOT to privatize the system?” Consider this; in 2010 Social Security paid $41 billion more in payments than it took in from taxes. Right now, that deficit is mitigated by investment interest. But it shows the hole we are facing. Once the trust fund is depleted there will be no more interest earned. Think how quickly we can spend $2-9 trillion when we are running a $41 billion deficit. And what do we have at the end? Nothing but more deficits. At least if we spend that money to privatize the system we will have an end in sight.
Ok, I know not everyone agrees. I’m not a politician, clearly. I didn’t even try to address the millions of details that go into privatizing Social Security. But either way, I’m curious to know your thoughts.