Social Security is a federal program which provides retirement and disability income to workers through the collection of Social Security taxes. Every worker in the United States is responsible for paying these taxes during their working years and entitled to receiving benefit checks when they are eligible for retirement. That fact alone should make you at least a little bit curious about what all the recent chatter is about. The program is on its way to financial trouble because not enough workers exist to provide adequate benefits to the rapidly aging population. The most perplexing aspect of the Social Security problem is that the people who are most concerned about it really aren’t the same people who will likely be most affected by it. For example, I’m the youngest financial advisor at my firm and stand to lose the most from an underfunded Social Security system. At the same time, I not only talk about it less than my co-workers, but I don’t lose sleep over it either. That’s not to say I’m unaware that 12.4% of my paycheck goes towards these taxes, I’m just too far from receiving benefits to worry about it. Perhaps part of that irresponsible logic stems from how the system is organized. Rather than each taxpayer’s Social Security dollars getting earmarked for their own retirement, they get paid into a common pool of money allocated by the federal government. It’s a controversial system because workers currently in their 20’s and 30’s may not ever see the money they’ve paid in. It’s also impractical because of the baby boomer generation. Millions of people will soon be applying for benefits and the program needs some sort of reform if it wants to remain financially solvent. The irony of this problem is that Social Security was set up in part as a reaction to the Great Depression. Its inherent purpose was to provide a safe and stable income during retirement. When the Federal Insurance Contribution Act (FICA) was passed in 1937, the payroll tax needed to fund the system was only 2%, not a bad deal for a promise of secure income during retirement. Needless to say, that payroll tax has increased gradually up to its current 12.4% level. Some politicians may finally be realizing that raising taxes isn’t necessarily the solution. It’s more than questionable what the affects would be of raising FICA taxes another few percentage points. Some believe that would infuriate many hard working people, and potentially risk a shake-up in the economy. It seems to me that the system makes less sense each and every year it continues. So, what are we to do about all this? Keep in mind throughout this discussion that eliminating the Social Security system along with the taxes that fund it is not an option currently on the table. The government understands that they need to, at least in the short run, implement a uniform program which provides some form of income to older Americans.
There are a few solutions currently being entertained by politicians which would allow the system to remain in place and, at the very least, delay the lurking problems for another few decades. Here they are, along with a brief opinion about each of the ideas.
• Raise the Payroll Tax – We’ve been trying this for about 70 years. It just doesn’t seem to work. It postpones the problem and costs us money in the interim. More importantly, raising taxes can probably never be the permanent solution because a lack of tax dollars isn’t the root of the problem. A more accurate prediction of demographic shifts is really what we need to properly assess the Social Security shortfall. If our temporary solutions don’t address the right problems, they’ll probably fail and become an issue again for our children and grandchildren. Not to mention, the concept of raising taxes doesn’t exactly get workers excited.
• Raise the Retirement Age – Technically, you may begin receiving reduced Social Security benefits as early as 62 years of age. However, there are a bunch of annoying requirements you must satisfy to qualify for such a benefit. The age in which the system intends for us to take benefits, and doesn’t penalize us for doing so, is known as Full Retirement Age (FMR). FMR currently varies depending on when you are born but is around 66 years old. The official Social Security website estimates it’s likely to be 67 years old for those born after 1960.* FMR is the age politicians are referring to when they suggest raising the retirement age as a solution to an underfunded Social Security system. I don’t see much of a point to this solution since it’s really just a reduction in benefits. For example, let’s hypothesize that raising the retirement age to 68 years old for those born after 1970 would add 25 years of liquidity to the Social Security system. That would cost a person receiving $1,600 per month a total of $38,400 over those two years. So, all we really did was cut their benefit. Frankly, I’d rather see FICA taxes go up slightly than see a reduction in benefits. Raising the retirement age or reducing benefits doesn’t seem to be a solution, rather an admission of failure. Plus, it discriminates against those who paid their fair share and will have to work more years to receive their benefits. I throw out this solution along with raising taxes.
•Reducing Other Federal Spending Programs – When I first heard about this solution I thought it sounded reasonable. We rearrange our priorities such that providing retirement income requires a greater percentage of our federal budget. Perhaps we can spend 1% less on the military and apply it to Social Security? If not the military, we could try reducing federal spending on education? Or maybe eliminate the Environment Protection Agency? Do you see the problem here? Our federal budget is already stretched out like silly putty and interest accrues on the money we borrow. If we cut something like subsidized housing projects to provide more Social Security dollars, it ultimately just becomes an equally expensive problem for workers. We can talk about altering federal spending to increase Social Security funding but I can’t really see it happening. Politicians already disagree on nearly every piece of spending which crosses Congress. If the solution to the Social Security problem becomes a shift of the problem to a different sector of the economy, it may as well not be implemented in the first place. Thus, I throw away this as the full solution to the problem but believe shifts in federal spending are inevitable and could be helpful in the process.
•Earmark a portion of the money for individual participants – Have you ever heard the expression “Privatizing Social Security?” Well, this is what it means. In my opinion, it’s the only solution currently on the table which makes sense. Yes, there are reasons why this solution is problematic, but let’s entertain why it may work. The idea entails a portion (not the whole 12.4%, but a portion) of your FICA taxes to be deferred into a private account which is earmarked just for you. The individual worker then determines whether they want the money invested conservatively, moderately, or aggressively. This provides the potential for your money to grow at a rate much faster than the current system, where funds are invested in ultra-safe treasury securities. Consider the fact that from January, 1926 through September, 2006, the annualized total return for the S&P 500 index was 10.44%.** If our FICA taxes were growing at this rate, we probably wouldn’t have the Social Security issue on the table yet. The obvious concern would be that the stock market might not perform at the rate it has for the past 100 years. Social Security was set up to provide stability, not a fluctuating investment which could possibly be worth less than what you originally put in.
Just the amount of debate and interest this solution has created lends credibility to it. The heart of the issue is whether individual workers are capable of taking personal responsibility for a portion of their Social Security income. Further, is it safe to let inexperienced investors make decisions about how their Social Security funds should be allocated? Are Americans, overall, competent enough to make decisions about these sorts of things? Keep in mind that the private accounts aren’t intended to totally eliminate the government’s interaction. The government would still create the program, set up the investment options, and provide some form of investor education. Again, this whole concept is hotly debated and there is no way of knowing how the system would work in practice. What we do know is that the current system doesn’t work. We also know that an S&P 500 index fund would have, over the past 80 years, provided a much higher rate of return than Treasury securities.***
I’ve read up on professional opinions regarding the privatization of Social Security and they vary widely. This would make sense considering it’s nearly impossible to predict the events of the next fifty years. That being said, those with solid backgrounds in economics can hypothesize to some extent the sort of problems which are likely to occur. Bill Gross, one of the largest mutual fund managers of all time, feels that Social Security imbalances are curses of demographics and not financial funding.** He feels a refocus on to the causes of the Social Security problem could influence our choice of solutions. Ralph Nader, the former presidential candidate, believes that the Social Security problem is “overstated” and the use of “pessimistic assumptions” taints the reality of the problem.* Furthermore, he has advocated against privatization as he feels it would be dangerous because of stock market fluctuation and investment fraud. Our current president, George Bush, is a strong advocate of private accounts, pushing hard for it during his second term agenda. It is looking, however, like the American public is not ready to dramatically alter a system which is so fundamental to our lives.
The internet is loaded with resources for learning more about Social Security. For sheer accuracy and to avoid partisan politics, I would recommend a visit to the official website of the US Social Security Administration . After you get the cold, hard facts, the blogosphere will certainly help you form your own opinion about the matter. Because the topic has political undertones, and blogs originated in the political arena, there’s a surplus of sites having a similar discussion to the one we had above. I’m going to reference only authority sites which truly stick to the issues. Social Security Choice is a major proponent of reform and promotes the idea of privatization and establishment of individual accounts. They are part of a larger organization called the Club for Growth which believes that prosperity and opportunity come through economic freedom. Secure Our Future is a site created by students to spread the word to other students that the Social Security issue does affect them. As I mentioned in the first paragraph, younger workers will ultimately shoulder the burden of national debts, Social Security and otherwise, more than workers nearing retirement. You way wish to visit the AARP’s blog as well. They have taken a strong anti-privatization stance since the idea surfaced. They maintain that the system doesn’t need the sort of dramatic overhaul that would require private accounts. Further, they maintain that the process of privatizing accounts and allowing funds to be invested in riskier securities is dangerous to people who rely on Social Security payments. We don’t know at this point what the right answer is. What we do know is that a problem is brewing and avoiding it could jeopardize our retirement benefits.
Russell Bailyn
Wealth Management
Premier Financial Advisors
14 E. 60th St. #402
New York, NY 10022
212-752-4343 *31
*http://www.ssa.gov/retire2/agereduction.htm
**http://www2.standardandpoors.com. Investors cannot invest directly in an index. Past performance is no guarantee of future results
*** Investors cannot invest directly in an index. Past performance is no guarantee of future results.
**http://money.cnn.com/2005/02/04/markets/gross_social_security/index.htm
*http://www.ontheissues.org/2004/Ralph_Nader_Social_Security.htm
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