Will Privatization of Social Security Work? Here’s a Chance to Find Out.

Ask SmallIvy:  Please send investing questions to vtsioriginal@yahoo.com or leave in a comment.

You may have heard various candidates talk about privatizing some or all of your Social Security savings.  They say that instead of sending all of the money into the government to distribute, a portion or the whole sum should be put into private accounts that workers control.  Proponents (myself included) claim that this would result in significant increases in the amount people receive when they retire.  The mere mention of privatization, however, immediately results in dire warnings of the risk of putting worker’s retirement funds in the stock market.  The campaign letters then go out to seniors warning that their Social Security is in peril, ads are broadcast of reformers pushing old ladies in wheel chairs over cliffs, and the issue goes away in favor of the status quo.

Because such scare tactics are so effective, and therefore there has never been enough political stomach to actually privatize any of the funds contributed to Social Security, the idea that doing so would bring better results remains untested.  Ironically, however, the current payroll tax holiday, offers a chance to do just such a test.  How would this work?

Well, you may have noticed that your take-home pay has been a little bigger lately.  This is because the payroll tax on the worker side has been decreased from 6.2% to 4.2%.  This means that if you make $50,000 per year, you’ll be taking home an extra $1,000 per year.  While this may be too little to result in any economic stimulus, as was envisioned, it is plenty to perform a little experiment.  Since this is “found money,” instead of just blowing it on something, why not pretend your takehome pay is the same and use the money that would have been going to Social Security to see what privatization would be like.  After all, if you lose it all you would be in the same position as if you had sent the whole amount into the government in Social Security taxes.  Here is the experiment:

Take the extra take-home pay and start saving it in a savings account or in a drawer in your home.  Once you have $1000 saved (which will take about a year if you have a gross income of $50,000), call Vanguard (who recently lowered their minimums to $1000) and put the money into one of their equity mutual funds.  Good choices would be the S&P 500 fund, the Mid Cap fund, or the Small Cap fund.  Then, as long as this payroll tax holiday lasts, keep putting the extra into the fund.  You can even set up automatic withdraw to Vanguard so you don’t forget.

Once this is done, continue the monthly investments or, if you are worried about the market, just stop the deposits but leave the initial investment.  Then, forget you have the account for 10 or 20 years.

If I’m right, when you check back in 10 years, you’ll probably have something like $2300 in the account if you just made the $1000 minimum and nothing else.  In 20 years, you’ll have about $8,000.  In 50 years, you’ll have about $128,000.  In 56 years, you’ll have about $256,000.  With that money, you could take a withdrawal of about $30,000 for the rest of your life if you lived until you were 90 years old before exhausting the money.

So, if I’m wrong, you’ll be out $1000.  If I’m right, you’ll have $256,000 in 56 years.  If I’m a little wrong, you’ll have $100,000 in 56 years.  Anyone willing to give it a try?

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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