What is Social Security Choice?

1. What is Social Security Choice?

The option of personal retirement accounts would let workers deposit their payroll taxes into personally owned and invested accounts similar to 401(k) plans or IRAs. Currently, workers pay a 12.4 Social Security payroll tax (FICA) on all wages up to $87,900, and Congress sets their retirement benefits. Under reform, workers would be able to deposit that 12.4 percent into their personally owned accounts. Workers and/or their employers would select a company to manage and invest that money. Over time, a worker's account would grow in value, culminating in a substantial nest egg. Once a worker had accumulated sufficient retirement funds, she could purchase a lifetime retirement annuity, which would pay a monthly retirement check.



2. Why does Social Security need reform?
Social Security is going bankrupt. The federal government's largest spending program, accounting for nearly 22 percent of all federal spending, faces irresistible demographic and fiscal pressures that threaten the future retirement security of today's young workers. According to the 2003 report of the Social Security system's Board of Trustees, in 2018, just 14 years from now, the Social Security system will begin to run a deficit. That is, it will begin to spend more on benefits than it brings in through taxes. Anyone who has ever run a business--or balanced a checkbook--understands that when you are spending more than you bring in, something has to give--you need to start either earning more money or spending less to keep things balanced. For Social Security, that means either higher taxes or lower benefits.

But even if Social Security's financial difficulties could be fixed by raising taxes or cutting benefits, the system would still need to be reformed because it is a bad deal for most Americans. Social Security simply costs too much and pays too little. Social Security's rate of return on payroll taxes is dismal (about 2 percent) and declining. Workers deserve a retirement system that will make the most of their money.

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3. What is the Social Security Trust Fund?
Ever since the last set of Social Security reforms in 1983, Social Security has run a surplus; that is, Social Security taxes have brought in more revenue than is necessary to pay current benefits. The surplus will continue until 2018, when the situation will reverse, and Social Security will begin to run a deficit. The present surplus is lent to the federal government in return for specially issued government bonds. The government then uses those borrowed surplus funds to finance its general operations, from roads and bridges to welfare and foreign aid.

About half of the trust fund consists of those bonds. The other half consists of an accounting entry that "attributes" interest to the bonds. But there is no actual money in the so-called trust fund. To pay benefits out of the trust fund, the government will have to redeem the bonds and pay the actual interest. But because no money has been set aside for that purpose, the government will have to find the money somewhere else, for example, by raising taxes.

Most of us are accustomed to thinking of a trust fund as an asset. That's what it would be if we had one. But in the case of Social Security, the trust fund is really a liability-the money the government owes to future retirees.

The trust fund is actually irrelevant to Social Security's future. Consider what would happen if the trust fund had never existed. In 2018, when Social Security begins to run a deficit, the government would have to raise taxes in order to pay all the promise benefits. And what happens with the trust fund? In 2018, the government will have to redeem its bonds in order to pay promised benefits. To redeem the bonds, it will have to raise taxes. Either way, today's young workers can expect a tax increase.

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4. What are the benefits of personal retirement accounts?
Higher Returns and Greater Benefits: Even the most conservative investors would accrue substantial assets during their lifetimes through privately invested accounts, yielding far more than Social Security promises in retirement income.
Private Property: Individuals would own their personal retirement accounts. Accumulated assets could be used at retirement and/or passed on to family members.
Creation of Wealth: Low-wage workers would become shareholders in the U.S. economy and, through private investment and participation in the market, accumulate wealth.
Individual Empowerment: Individuals would control their retirement security, and they would see their accounts grow as a result of hard work.
Improved Economy: Economists believe that the overall economy will benefit from an increase in savings and investment resulting from this system.
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5. I don't know how to invest. How would I manage under an individual account system?
You don't have to understand financial markets or be an experienced investor to benefit from individual accounts. The history of 401(k) plans, IRAs, and mutual funds has proven that experienced account managers can help workers manage their accounts. The relationship between a worker and an account manager is like that between Patient Jane and her doctor. Patient Jane doesn't have to understand the intricacies of the flu to choose a good doctor-understanding the flu is the doctor's job. A good doctor, like a good account manager, will help Jane pursue the best course of action. Finally, as with IRAs or 401(k) accounts, personal accounts can be structured to keep out scam artists and restrict investment strategies that are too risky.

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6. I have been paying Social Security taxes for years. Would I get anything back out of that?
Social Security is now such a bad deal for younger workers that up until about age 40 or 45 they will probably still be better off in the private sector even without the refund of any past taxes, as long as they no longer have to pay into Social Security in the future and can use all those funds for their own investment accounts instead. However, most personal account plans would compensate you for your past taxes. Ideally, this would involve calculating the proportion of lifetime taxes the worker and his employer already paid. The refund would then equal this same proportion of expected lifetime benefits, in present value terms. The worker could be given this refund in government bonds for his private retirement account. The bonds would accrue interest over the years, reaching at retirement the present value of the proportion of retirement benefits the worker should receive based on the past taxes paid. These bonds could then be partially cashed in each year to help finance the worker's retirement benefits.

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7. Social Security provides disability and survivors benefits. What would happen to them with an individual account system?
A small part of the funds in your private investment account would be used to purchase private life and disability insurance covering at least the same survivors (pre-retirement) and disability benefits as Social Security. Workers consequently would be covered for these contingencies through the private system as through Social Security. Since Social Security only pays pre-retirement survivors benefits to workers with children, workers without children would be free to forego the life insurance and devote the funds to their retirement benefits. Similarly, workers would not have to buy disability insurance providing any greater benefits than Social Security would. In order to avoid any problems with adverse selection, all investors in a particular retirement fund would be treated as a common pool for underwriting purposes, with the insurance purchased by the investment management company, purchasing a group policy, rather than by individual workers.

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8. What are the alternatives to individual accounts?
The three most commonly proposed alternatives to allowing for individual accounts are cutting benefits, raising taxes and government investing.

The Social Security Administration reports that taxes will need to be raised to 18 percent by 2032. Tax increases have been tried many times in the past. In fact, our politicians have raised the Social Security tax more than 30 times. (It started at 2 percent of the first $300 earned.)

That benefit cuts needed to make Social Security solvent will have to be substantial. The Social Security Administration estimates that benefits would have to be reduced by between 33 and 25 percent. Today, one in ten elderly people live in poverty. Such benefit cuts would be devastating to many seniors who simply cannot afford live on less.

Some politicians suggest allowing the government to invest the trust fund, instead of allowing individuals to invest and own their money. But allowing the government to invest could politicize the stock market and have negative effects on the economy (see question #11).

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9. Isn't the stock market too risky?
History has demonstrated that markets are volatile-they can rise and fall with little warning. But history has also demonstrated that markets go up over the long term, and the long term is what matters when it comes to saving for retirement. Since 1926, the average real rate of return on the stock market has been 7.56 percent. Even the worst 20-year-period from 1929 through 1948, which includes the stock market crash of '29 and the Great Depression, had a positive real rate of return of 3.36 percent. Compare that to Social Security's 1 to 2 percent return. Workers who are uncomfortable with stocks could choose to invest conservatively in government bonds, for example, which typically yield a 3 or 4 percent return.
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10. Could the government invest the money instead?
On the surface that approach may have some appeal; in reality it is fraught with peril. It could potentially make the federal government the largest shareholder in American corporations, raising the possibility of government control of American business. In addition, there are serious questions about what types of investment the government would make. Political considerations and "social investing" are likely to influence the government's investment decisions, allowing the government to manipulate economic markets. After all, should the federal government be investing in tobacco companies or companies with holdings overseas?

When Federal Reserve Chairman Alan Greenspan was asked about allowing the government to invest he stated his belief that this "has very far reaching potential dangers for a free American economy and a free American society."

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11. What would happen to me if the money in my account isn't enough to provide for my retirement?
Virtually all legislative proposals for individual accounts include a safety net to protect workers. If a worker has not accumulated adequate funds by retirement, the government could "top off" the worker's account. The guaranteed benefit could be set to ensure that every worker's retirement income is at least at or above the federal poverty line. The safety net could be financed out of general revenues.

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12. How would individual accounts affect women?
According to a study by researchers at Harvard University, virtually every woman-single, divorced, married, or widowed-would probably be better off financially under a system of personal retirement accounts, the earnings of which could be shared by spouses. The researchers studied 1,992 actual women who retired in 1981, and compared their Social Security benefits to what they would have received from a personal account that returned 6.2 percent. Every woman studied would have been as well off or better off with a personal account. Not one woman was worse off under a voluntary system. On average, personal accounts would have provided the single women with 58 percent more than Social Security and wives with 208 percent more. Those higher returns are critical to women's well-being in retirement. Today, Social Security leaves 13.6 percent of women in poverty: the good news is that the research shows that it doesn't have to be that way. In addition, voluntary account plans typically include a safety net that can ensure that every woman's retirement income is at least at or above the poverty line.

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13. I'm a full-time homemaker, what will happen to me at retirement? What would happen if I divorced?
Plans for personal retirement accounts should include a provision called "earnings sharing." Simply put, earnings sharing would allow spouses to divide their payroll contributions 50-50, with 50 percent deposited into each person's account. This would ensure that a homemaker, for example, benefits from her spouse's earnings. In the event of divorce, no retirement savings would be lost because each spouse would still own their personal account.

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14. How would voluntary retirement accounts affect the middle class?
Middle class Americans would enjoy the higher retirement benefit, improved economy and personal ownership that are all a part of a system of personal retirement accounts.

Take, for example, John who is a thirty-five-year-old union worker who makes $33,200, which is the average salary for a union worker. He can expect just $1,559 from Social Security. In a system of personal retirement accounts, John would amass an account of $411,052 if you assumed a real rate of return of just 3 percent. This nest egg could provide a monthly retirement payment of $2,671. Or he could also choose to preserve a portion of his account, which could be passed on to family members.

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15. I'm a low-wage worker. How would individual accounts affect me?
Low-wage workers have the most to gain from Social Security reform. Today's Social Security costs too much and pays too little to be a good deal for any worker, especially those who earn the minimum wage. After paying taxes, like the payroll tax, and providing for necessities, low-wage workers often have no money left to save or invest for retirement. Those individuals depend entirely on Social Security for retirement security, but Social Security's benefits are simply not enough to keep many out of poverty. In fact, more than one in ten seniors live in poverty, despite this massive federal program.

In a system of personal retirement accounts, low-wage workers would receive substantially higher benefits, which would have a real impact on their quality of life at retirement. Take for example a 28-year-old earning $13,500 a year. He would get just $815 from Social Security but would receive $2,292 if he invested in a mixed fund that earned a 5.75 percent return (which is below the historical rate of return).

Low-wage workers would also benefit from personal accounts because they would own their retirement savings. This is particularly important because poor workers tend not to live as long as individuals with higher incomes. In today's Social Security, if you die before reaching retirement, you receive nothing in return for a lifetime of contributions. Reform, however, would give workers the opportunity to pass their savings to surviving family members.

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16. I've heard that individual accounts would help minorities. Is that true?
Yes, minorities, and African-Americans in particular, would benefit from a system of personal retirement accounts. Under the current system, how much you get from Social Security depends on how long you live. Life expectancies for African Americans are shorter than for whites. Therefore, they often receive far fewer retirement checks. For example, a white man who reaches age 65 can expect to live 15.7 years, while a black man can expect to live for only 13.6 more years. That means that the white man can expect to receive 24 more checks than the African-American man.

An individual in a system of personal retirement accounts owns his retirement savings. If he dies before reaching retirement, then he can leave this money to family members. Moreover, the greater benefits generated in a funded system would be particularly important to the African-American community. Currently, 29.6 percent of all African Americans over age 65 have incomes below the poverty level. The greater monthly payments would have a substantial impact on the lives of these individuals.

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17. How would Social Security Reform affect the economy?
Social Security Reform would lead to an increase in national saving, with hundreds of billions of dollars invested through individual accounts every year. Those investments, in turn, would substantially increase national investment, productivity, wages, jobs, and overall economic growth. In addition, Social Security Reform would amount to an effective cut in payroll taxes, boosting productivity and employment. Martin Feldstein, of Harvard University, estimates that modernizing Social Security has a value of $10-$20 trillion to the U.S. economy and would permanently increase our GDP by 5 percent. That would translate into at least one million new jobs and an increase in annual income of $5,000 for a family of four.