What if I offered you an investment where you paid me 13% of your salary for the next 45 years. At the end of that 45 year period I promised to pay you about 15% of your final salary per year for the rest of your life. If you made $100,000, you would get about $15,000 per year. If you made $50,000, you would get about $7,500 per year. If you were not married and died at age 64 1/2, you would get $500, period. If you were not married and died at 65 and one month, you would only get one month’s payment and $500, period. If you were married, I would let your spouse collect your payment for the rest of his/her life, but if he/she were in my investment plan as well, he/she would need to give up the money I was paying him or her in exchange. If you both made the same amount of money over your working careers, you would lose half of your family income from my plan when one of you died. I would keep the rest.
Now what if I didn’t really guarantee what you would get? What if I just said in the past I’ve paid about this amount and I expect to continue to do the same in the future, but I could change my mind. What if I also was a little careless with the money, spending the money you invested with me on all sorts of things, giving myself an IOU, promising to pay myself back? What if the person I put in charge to monitor the investment account said he thought the plan would run out of money and need to cut the amount it would be able to pay within 15 years? What if that was only an estimate and it could be only 10 years, or 5 years, if the economy turned South or I started to spend a lot more of the money?
Would you invest with me? Probably not.
You would look at traditional pension plans and see that they typically pay 60-70% of your final pay, or more, and typically only require maybe 5-8% of your paycheck be invested. This means you would get $70,000 per year if you made $100,000 instead of only $15,000. You would also see that traditional pension plans had funding requirements. That the trustees couldn’t just go and spend the money on other things. That they needed to actually invest the money so that it would grow instead of just fill the plan with a lot of IOUs, because having that cash invested would ensure they could actually pay the benefits they promised.
You might also look at 401K plans, plug some numbers into a financial calculator, and see that you can retire with $5M or more if you make around $60,000 per year and put 15% of your paycheck away into a 401k. You would realize that you could probably withdrawal between 5-6% of that money each year and still have it last a good 20-25 years after you retire. That would be $250,000 – $300,000 per year for just a little larger investment than you were making in my retirement plan. If you died at 64 1/2, the $5M would not vaporize. Your spouse or children could get the money and use it. Or you could give it to a charity or whoever else you wanted to have receive it.
The existing Social Security plan is like the retirement plan I describe. You pay 13% of your salary and get very little in return when you retire. If you die early and single, you might get a $500 death benefit, but the rest is gone. Even if you have a spouse, if you die early your spouse can begin to receive your benefits if desired, but his/hers are just gone. It is true that there is also a disability benefit, but disability insurance in the private market costs 1% of your paycheck, not 13%.
The trustee (Congress) has not done a good job of saving and investing either. They have loaned the excess money to the Treasury, who in turn has spent the money and left an IOU in its place. While it is true that government bonds (the IOUs) are a safe investment for individuals, if the government has trouble paying Social Security payments, they’ll also not be able to pay back the bonds. It’s all pockets in the same pair of pants. With $17 T in debt, those pants are looking a little overdrawn. And to make things worse, so many people have transitioned from unemployment to long-term disability that the portion of the Social Security Trust Fund that pays disability is projected to run out of money by 2016. There are already proposals to use the money that goes towards retirement benefits to pay disability claims after that point.
If accounts were privatized, where each individual had his/her own private account, that money would truly be set aside and invested. No one could come along and take it away, promising that you would be paid back. You could see the balance grow. Just like a 401k account, it would be invested in real companies that build real things and make real profits. The value of these companies would grow, both due to inflation and because the companies would make more money over time. Could all of the companies go out of business at the same time? Yes, if there were some event like a nuclear war, but in that case, where would the government get the tax dollars needed to pay Social Security benefits anyway?
The system should have been set up with private accounts from the beginning (there was a proposal to do this, but they went with the public system instead). Without private accounts, individuals are forced to take whatever the government is able to scrape up for them when the time comes since benefits are paid entirely from current revenues. Because there are a lot of people retiring, resulting in a lot more people drawing benefits for each person who is working and paying into the system, the system is expected to run out of money in about 15 years and need to start decreasing benefits, either directly or by raising the age at which you can receive them. Even if it keeps paying benefits at the existing level, the return on your “investment” is terrible because the money is not really invested. Why would you want to continue with a system that pays terrible returns and if you die early, no return at all?
That is why we should have mandatory private retirement accounts instead of Social Security.
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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.