know those Social Security statements that you get in the mail every
year? The ones that arrive a couple months before your birthday?
Read it and weep, because unless you're 55 or older today, chances
are your benefits will not look quite as good as what's promised
on that statement.
They are calculated under the traditional Social Security
That system is getting ripped apart by rhetoric
emanating from the White House and Capitol Hill. In fact, you can
hear it all across the country now. Earlier this month President
Bush kicked off a road show, dubbed "60 stops in 60 days,"
to garner widespread support for his plan to "strengthen Social
Security for future generations." Through May 1, top administration
officials will follow the president's lead by spreading the message
to young and old alike at town hall meetings across America.
Their message: There is a problem with Social Security.
How do we fix it?
It's true that the system is old and needs some fixin'.
Social Security is a pay-as-you-go system where current workers
are providing for the incomes of current retirees. This system has
worked for decades because the ratio of workers to retirees has
been high. But now, as the baby-booming masses face retirement,
the numbers will get dicey. In 1950, when many of us were still
glints in our parents' eyes, there were 16 workers for every retiree.
Today, we're down to 3.3 workers. By 2040, the ratio will be two
to one, according to projections.
And much sooner than that -- by
2018 -- the system will become insolvent as revenues (meaning, the
Social Security tax that is deducted from your paycheck) will be
insufficient to cover expenses (meaning retirees' checks). Logical
ways to fix it are to increase taxes, delay the retirement age or
decrease the benefits. These strategies have already been implemented
in the 1980s.
President Bush deserves credit for putting the problems
of Social Security in the spotlight and making it a priority for
his second term. But his plan to allow Americans to divert a portion
of their Social Security tax into personal accounts subjects this
money to the vicissitudes of the financial markets, and Americans
already face enough risk in their retirement accounts.
Here's how his plan works (subject to revision, of
- Workers could divert 4 percent of their payroll
earnings into private accounts, subject to a limit of $1,000 in
the first year. This cap would gradually increase in annual increments
- The money could be invested in a handful of funds,
including those focusing on large-cap stocks, small-cap stocks,
international stocks, corporate bonds and Treasury bonds. Life-cycle
funds, which offer a mix of stocks and bonds targeted to investors
of particular ages, would also be available.
- Participants could not access money for any reason
prior to retirement. Once they reach retirement age, they would
get annuities through the federal government that assures them
of lifetime income streams.
- Any excess money earned above a particular level
could be reinvested, bequeathed to heirs or withdrawn in lump
sums to be spent on as-yet-undefined "pressing financial
needs." However, retirees wouldn't be able to withdraw lump
sums from their private accounts if doing so would place them
below the poverty level.
- The program would begin in 2009 for those born
between 1950 and 1965; it would phase in the younger populations
over the next two years. Those born before 1950 would continue
to receive benefits under the traditional system.
- The program would be voluntary. You could elect
to receive benefits under the traditional system. If you do choose
a personal account, your benefits under the old system would be
reduced by an amount "equal in present value to the money
placed in the private accounts up front," in the words of
a senior administration official.
- Those who opt out of the personal accounts would
not likely get the benefits described in the statement you receive
in the mail each year. Unless there's a large tax increase, you
can expect to get less, according to the official.
- This new personal-account program would do nothing
to alleviate the insolvency issue facing the current Social Security
system, and transition costs to make it happen would be $754 billion
through 2015, according to government estimates.
So let's do a calculation to see how a private account
might grow for the median-age baby boomer (born in 1955) who opts
to open a private account.
The calculation involves a lot of guesswork. For example,
you have to guess the type of return you could expect from the various
asset classes that you could invest in. Actuaries -- who are paid
big bucks to read the tea leaves of probabilities -- predict annual
returns of 6.5 percent for stocks; 3.5 percent for corporate bonds
and 3 percent for government bonds. All three are post-inflation
returns, with inflation estimated at 3 percent annually. Critics
say these projected returns are unrealistically high.
Nevertheless, we'll go with those returns as a basis
for our hypothetical portfolio, which would be composed of 60 percent
stocks, 24 percent corporate bonds and 16 percent government bonds.
Using the above returns, the portfolio's overall return would be
4.92 percent (after subtracting a 0.30 percent management fee to
run the funds).
Guess how much the baby boomer who was born in 1955
ends up with by the time he or she reaches age 67? A grand total
of (drum roll, please) $28,349.
That's not a heck of a lot, though it would be supplemented
by a traditional Social Security benefit, reduced by the amount
of money diverted plus the amount it would have earned up to 3 percent
above inflation. Confused? Me, too.
It involves taking a lot of risk for low expected
returns, especially for boomers. Generation X and Y would fare better
if market forces cooperated, thanks to the power of compounding.
But the administrative officials are right when they
say there is a problem with Social Security. And since they're asking
how to fix it, let's offer some solutions.
For years now, Social Security taxes have generated
huge surpluses. Last year's amounted to $152 billion. This year's
will be $10 billion higher than that. Unfortunately, instead of
saving and investing this surplus, our government is using it to
reduce the ever-widening budget deficit. In fact, this has been
going on since the 1980s, an unintended consequence of fixin' the
system back then.
We as Americans are expected to exercise restraint
and put aside some money for our retirement. If we spend everything
we make today, we'll have nothing left for our golden years. Why
can't our government officials also be so disciplined? If they set
aside the surplus instead of spending it, Social Security would
not be in crisis mode, and bankruptcy would not be an issue.
Solution No. 1: Don't spend our future retirement
money on the superfluous needs of special interest groups.
Currently, 6.2 percent of your wages goes to pay for
Social Security; your employer matches that amount, so the government
gets 12.4 percent. But that money is collected on salaries of up
to $90,000. Individuals who make more than that pay no more toward
Solution No. 2: Raise the $90,000 ceiling for Social
Security taxation to $200,000 or even higher.
There are plenty of other solutions, too, such as
reinstating the federal estate tax, which is scheduled to sunset
in 2010, or undoing the income-tax rate cuts for those at the top
end of the income scale. Such moves might not affect Social Security
directly, but it would do much to reduce the deficit. Then the government
could stop using Social Security surplus funds to try to stop the
budget from hemorrhaging.
Roughly two-thirds of retired Americans rely on Social
Security for half or more of their household incomes. For one-fifth,
that check represents their only source of income. It's the one
part of the retirement equation that Americans must be able to count
If you're not happy with the idea of personal
accounts, let your senators
in Congress know. They need to know how their constituents feel
about the matter. We are already taking enough risk as we manage
our retirement accounts. Tell your lawmakers to fix Social Security
so that we can get the benefits that we've been promised year after
Longtime financial journalist
Barbara Mlotek Whelehan earned a certificate of specialization in
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