One of President Bush’s most significant initiatives for his remaining administration is to create private investment accounts for a portion of your Social Security contributions (withholdings). The immediate problem with this concept is that the money workers would divert to these private accounts is currently being used to pay current Social Security retirees. In order to continue full retirement benefits to current retirees, our government will have to borrow funds. This will likely increase the deficit by trillions of dollars. Opponents argue that the newly created deficit will cause our economy to go into a tailspin and burden our children with a tax bill they will not be able to afford to pay. Advocates of the private accounts points out that Social Security is headed for bankruptcy within the next 15 to 20 years based on its current path and that the additional deficits can be handled over the long term. What seems clear to everyone is that Social Security needs ‘fixin’. It’s the ‘how to’ that is at the center of the controversy.
Corporations faced similar problems years ago and approached a resolution using a similar remedy. Before these reforms, many large corporations had defined benefit plans that provided a retirement income for retiring employees based on a percentage of their pay. There were various formulas used but most included weightings based on years of service and average wages during the final 5 to 10 years of service. Money to fund these obligations was invested in stocks and bonds and each year an actuarial review determined if the plan was over-funded or under-funded. During the long bull market in stocks, many of these plans became over-funded and corporations used this as an opportunity to raid the retirement plans of cash that would be needed in the future when the stock market entered a bear market period. Ultimately many of these companies opted to terminate their defined benefit plans for favor of defined contribution plans such as the 401(k). This has shifted the responsibility for providing for retirement away from the companies back to the employees. There are obviously differences between the Social Security system and corporate defined benefit plans but the core issues are similar. The solution President Bush is proposing resembles the solution used by corporate
Would Social Security private accounts be a good financial strategy for workers? It depends on which worker is in the crosshairs of the debate. On one side of the issue, you give people more say in their financial destiny. Instead of being limited to treasury type returns, they could choose among several choices that would include allocations to stocks. Over longer periods of time stocks have typically outperformed bonds by a wide margin. It would also allow retirees to leave something for their children…their remaining account balance. The problem is that multitudes of workers have little understanding of how the stock and bond markets work and will often make poor decisions, which results in poor long-term performance. These people would be better off under the current ‘managed’ system. Remember, too, that today approximately two-thirds of retirees depend on Social Security as the foundation of their retirement income and an astonishingly 50% depend on Social Security as their sole source of income! This is a sad commentary on financial literacy in
Clearly there are pros and cons to both sides of the argument as well as agreement that something must be done. The current system simply is not viable over the long term. To continue it means that the government will have to continue to raise the wage base that is subject to Social Security taxes (currently $90,000) and/or increase the tax itself (currently 12.4%). I personally favor allowing private accounts and beginning to wean the government from the retirement funding business. An important element in the long-term success of the program will be better financial education for workers. The workers who will be contributing to these private accounts must clearly understand how they work and the best ways to use them.