How I Would Fix Social Security, by Scott Stolz, CFP, RICP (week 47)

 

 

Before considering potential solutions to shore up the Social Security system, it’s important to understand how we got to this point.  Up until 2010, more tax money went into the Social Security system than was paid out in benefits.  The extra money went into the Social Security Trust fund and was used to buy “special-issue” U.S. Treasury Securities.  These are U.S. government bonds that are issued solely for Social Securities reserves. This is the only investment Social Security is allowed to own.  In short, Social Security lent the money to the U.S. government which then used the proceeds to help pay for general expenditures.  This is why some people claim that the U.S. government spent all of the excess reserves.  On one hand, they did.  On the other hand, they replaced the money with IOUs that paid interest each year to Social Security.  Regardless of how you view this situation, the fact of the matter is that the bill is now coming due.

Until 2021, the new tax money coming into the system plus the interest Social Security was receiving from those IOUs covered all of the benefits.  Beginning in 2021, that was no longer possible.  At that point, Social Security began redeeming these “special-issue” bonds.  Each year, it must redeem more and more bonds.  It’s estimated by 2034; all of these bonds will be redeemed and the only money coming into the system will be new tax dollars.

The question therefore is why is so much more money coming in than going out?  First and foremost, there are more people receiving benefits than ever before.  There simply isn’t enough workers to pay enough money into the system at the current Social Security tax rates.  It also doesn’t help that all of these people receiving benefits are living longer than ever.  But there is one other seldom talked about reason.  The “special-issue” bonds held by the Trust fund currently pay little in interest.  These bonds pay interest at rates equivalent to outstanding U.S. Treasury bonds of at least 4 years of maturity.  In the early 1980’s when interest rates were much higher, the Social Security Trust Fund was earning about 10% per year on its reserves.  However, since 2010, that annual return has been closer to 3-4%.

When you sum it all up, there are only 3 levers to fix this problem:

1.      Decrease the amount of money coming out by reducing benefits for some or all recipients.  This could also be done by removing people from the system completely.

2.      Increase the money coming in by increasing taxes.

3.      Increase the rate of return on the remaining reserves.

How I Would Fix the System

1.      Increase the rate of return by allowing the Trust Fund to invest in other securities.

It’s illogical to me that the Trust Fund is limited to a single type of security that earns so little.  The Trust Fund isn’t even allowed to sell those securities.  No pension plan works this way, nor does an insurance company portfolio that must also provide lifetime income.  I understand the arguments against a government entity owning stocks and other equity investments, but that’s also how you generate wealth.  Becoming passive owners of companies through index funds can’t be worse than our current situation.  The problem is that now that the reserves are being depleted, it’s too late for this solution to have much of an impact.  Had this been adopted back in 1999 when proposed by the Clinton administration, we may not have a problem at all.

2.      Allow participants to take a lump sum based on their expected lifetime income

If a male age 65 is getting the average monthly social security benefit of $2,000, that is worth roughly $350,000 as a lump sum today.  I would therefore offer this person the option of taking a $300,000 lump sum.  Given today’s annuity rates, that same individual could take that $300,000 and buy an immediate annuity that will duplicate the $2,000 per month.  Social Security has just saved almost 15% of its expected payout.  The recipient is getting the same amount of money and no longer has to worry about a benefit cut down the road.  Given that possibility, most recipients would probably be happy with an even lower lump sum just to get peace of mind,

I would make a similar offer for those still working.  Give them a lump sum based on what they have paid in thus far.  Then require them and their employer to pay 75% of what they are currently paying in Social Security taxes into an account similar to a 401K.  For example, the current Social Security tax rate is 12% - 6.4% for both the worker and employer.  Under my plan, both would be required to deposit 4.5%.  These accounts would be fully owned by the working taxpayer.  In essence, rather than paying into a general fund such as Social Security with no investment flexibility or control, each taxpayer will now have their own retirement account.  And, since they are paying it at only 75% of the current tax rate, they will actually get a pay raise.

This solution would eventually lead to the end of Social Security by removing people from the system over time.  Corporations realized long ago that paying pensions to a growing number of retired workers simply doesn’t work.  It’s time for the Federal Government to reach the same conclusion.

One Last Requirement

One of the benefits of Social Security is that it’s a forced retirement plan.  You have to pay in and you have to take the money in the form of lifetime income. If this requirement doesn’t continue there will be people that choose not to pay into the system and people that liquidate their funds before they die.  Like Social Security, contributions must be required and must come out of each paycheck.  Benefits must be received as lifetime income.  In addition, individuals that elect to receive a lump sum in lieu of their current Social Security benefit must be required to use that lump sum to buy an annuity that provides a lifetime income equal to at least what they are receiving today.  I’m quite sure the insurance industry would be more than happy to help fill the lifetime income needs of all working Americans.  Personally, I would much rather have them manage it than the Federal Government.