2005 Year in Review

Social Security plan - will it fix it?

The plan is rather complex. The President wants to create what he calls personal accounts. These accounts would be created by diverting up to 4% of the total 12.4% (almost 1/3) of the payroll taxes individuals pay which is now dedicated to Social Security.

The personal accounts would work much like your 401k or IRA accounts. You would invest them in mutual funds and allow them to grow until you reach retirement age. They could be invested in a mixture of bonds and/or stocks.

What would be the benefit of diverting this money? The biggest benefit is that over the years the stock market has outperformed bonds by several percentage points. Social Security invests payroll taxes in US Treasury Bonds. Although the bonds are very secure, they have had an average return several percentage points lower than the stock market.

Another advantage, advocates say, is that the plan takes the money out of the government and allows individuals to control it, much as you control your 401k of IRA now. This is the ideological argument.

Part of the plan decreases this control over your retirement, however. At retirement, individuals would be required to purchase annuities. Annuities are instruments that you purchase and they pay out a fixed (usually) amount as long as you live. They are not passed on to heirs. After the annuity requirement is met, individuals (mostly wealthier) could use the remainder of the fund for any purpose.

The big question is how does this save Social Security. Well, it doesn't.

Removing 1/3 of the payroll taxes that the Social Security fund depends upon would actually require the government to take out loans to pay current benefits. Even the President's staff and other supporters have admitted that the plan, by itself, doesn't do anything for the long-term health of Social Security.

It is very expensive. The White House estimates that "borrowing and debt service costs would total around $754 billion between 2009, when the program would start, and 2015, the end of the current 10-year budget window."

Does it make sense for the government to borrow money so that we can save money?

Who pays the debt service on the money the government borrows? Well, the bad news is that you do or your children or grandchildren will. The government will simply have to tax future generations to pay the interest on the debt.

So, a twenty year old, starting out in life will be able to build these personal accounts, while at the same time, he or she will be incurring a huge government debt.

In addition, the only way that the government can make this work and the most likely outcome of this process is to reduce Social Security payments. The White House has said that it will not affect those who are over 55, but what about those who are between the ages of 40 and 55, who have paid in 12.4% of their total wages for decades?

Well, under this plan you're the sucker. President Bush has ruled out increasing payroll taxes, so they're planning on reducing your Social Security payments. So, you, the good citizen, have paid the higher payroll taxes, since 1983, to shore up the fund, now they'll tell you that you're going to have your benefits reduced to pay for a potential shortfall which is almost 50 years down the road.

Since the average recipient receives about $950/month or $1,400/month for a couple and many people live almost entirely on this, a reduction in benefits would be cruel.

Can you live on $950/month?

In addition, personal control over your retirement funds may not be a good idea after all. How many people do you know who lost money in their IRA or 401k during the burst of the stock market in 2001? How would you like that to happen to you with Social Security funds a year or two before retirement?

The plan to create personal accounts and reduce the Social Security fund is the start of the dismantling of Social Security, a goal of some conservatives and replacing it with personal accounts.

Social Security has been the primary safety net for elderly Americans since its founding. It would be a mistake to allow the destruction of Social Security in the name of saving it.

Next column I'll look at some alternative plans.

by John Legler, Guest Columnist
February 10, 2005