Saving Social Security

14 Friday Oct 2016

Posted by Nuetzel in Privatization, Social Security

Tags

Disablity, FICA Tax, Redistribution, Self-Directed Investments, Social Insurance, Social Security, Social Security Privatization, Social Security Returns, Social Security Trust Fund, Survivors' Benefits

Social Security benefit levels are anything but sure for current workers, given the likelihood of benefit cuts to preserve the long-term solvency of the system. In fact, even without those cuts, Social Security provides very poor yields for retirees on their lifetime contributions. Instead of a tradeoff between risk and return, the system offers bad outcomes along both dimensions: lousy benefit levels that are not at all “safe”.

To get a clear sense of just how bad the returns on Social Security contributions (i.e., FICA tax deductions) truly are, take a look at this Sacred Cow Chips post from late 2015: “Stock Crash At Retirement? Still Better Than Social Security“. According to the Social Security Administration’s own calculations, without any future changes in the program, a retiree can expect to get back 1 to 4 times their lifetime contributions (obviously, this is not discounted). If you think that’s acceptable, consider a real alternative:

“Suppose you are given an option to invest your FICA taxes (and your employer’s [FICA] contributions) over your working life in a stock market index fund. After 40 years or so, based on historical returns, you’ll have stashed away about 12 – 18 times your total contributions (that range is conservative — 40 years through 2014 would have yielded 19x contributions). A horrible preretirement crash might leave you with half that much.“

Allowing workers to self-direct their contributions over a lengthy working life, whether they invest in equities, government bonds, or other assets, holds much more promise as a way to provide for their retirement needs.

As for risk, projected benefit levels are worse when possible program changes are considered. It’s widely accepted that changes must be made to the way contributions by current workers are handled and how future benefits are determined, or else the system’s value to them will be a greatly diminished. The Social Security Trust Fund, which once funded government deficits via FICA surpluses over benefit disbursements (while the demographics of the labor force allowed), has dwindled, and it has never been invested to earn the returns necessary for long-term solvency. Shall today’s workers face later eligibility? Reduced benefit levels? Or both? Or can we face up to the reality that workers will do better by choosing the way their funds are invested?

The contributions of today’s workers are paid out directly to current retirees. This practice must be modified, but the nation still faces a large and immediate liability to current retirees. How will it be paid if the system is overhauled to allow self-directed investment alternatives? Current workers must pay for some portion of that liability, but that portion could be phased out over several decades. The transition, however, would initially require additional taxes, borrowing, or voluntary conversion by some retirees to a discounted cash-balance equivalent, much as most private sector defined-benefit pensions have been converted to cash-balance equivalents.

Ultimately, workers should benefit from their own individual contributions. One objection is that self-directied investments and “privatization” of one’s own contributions would cause the system to lose its function as social insurance. Recall, however, that eligibility for benefits requires contributions, so it is not a general program of assistance. Nevertheless, there are several ways in which Social Security fulfills an insurance function. In a strong sense, it provides insurance against the risk of failure to save for retirement. More fundamentally, disabled workers can qualify for benefits, and the dependents of a deceased contributor are also eligible (survivors’ benefits). In addition, the current system provides greater returns to individuals with relatively low contributions. Under self-direction, these features could be retained via minor redistributional elements applied to investment returns, particularly given the superior returns available to equities over periods of sufficient length.

When U.S. politicians discuss the future of Social Security, they usually say they’ll fight against the dark intent of those who wish to take away hard-earned benefits from seniors. This despite the fact that few (if any) observers have suggested cutting benefits for current retirees, or even for those now approaching eligibility. The self-righteous proclamations about protecting retirees are a dodge that avoids the need to take a position on dealing with the system’s insolvency. But an easy answer is available: reform the system by allowing workers to self-direct their contributions into more promising investment vehicles.

Stock Crash At Retirement? Still Better Than Social Security

30 Wednesday Dec 2015

Posted by Nuetzel in Social Security

≈ 4 Comments

Tags

Economic Policy Journal, Jeremy Siegel, Medicare Returns, payroll taxes, Restricted Application filing, Revocation of Benefits, Social Security, Social Security Administration, Social Security Privatization, Social Security Returns, Social Security Trust Fund

That’s right! Suppose you are given an option to invest your FICA taxes (and your employer’s contributions) over your working life in a stock market index fund. After 40 years or so, based on historical returns, you’ll have stashed away about 12 – 18 times your total contributions (that range is conservative — 40 years through 2014 would have yielded 19x contributions). A horrible preretirement crash might leave you with half that much. At the low-end, you might have as little as 4.5 times contributions if the crash is as bad as the market decline of 1929-32. That would be very bad.

But you don’t have that option under current law. Instead, the return you can expect from Social Security will leave you with only 1 to 4 times your contributions — without further changes in the program — based on your current age, lifetime earnings, marital status and retirement age. The latter range is based on the Social Security Administration’s (SSA’s) own calculations, as quoted in “Social Security: Saving or Tax? Proceeds or Aid” on Sacred Cow Chips.

Social Security, billed as the most reliable source of retirement income because it is not dependent on market risk — would almost certainly buy you less than a private investment even when a horrible market outcome is factored in immediately prior to retirement. Keep in mind that this is an unfair baseline for equity investments, because historical returns already factor-in historical market crashes, and we are imposing an extra, instantaneaous crash at the end-point! Note also that the calculations above do not account for ongoing, post-retirement returns in private investments. In view of this comparison, Social Security’s status as an “untouchable” third-rail of U.S. politics is a testament to the economic ignorance of the American voter.

Wharton’s Jeremy Siegel offers perspective at wsj.com based on his own experience in “My Sorry Social Security Return” (gated — Google “wsj Siegel Social Security”). Siegel’s Social Security benefits represent about a third of what he could have earned in private investments; the value of his benefits is also much less than what Siegel would have earned for retirement had those funds been invested exclusively in government bonds, as the Social Security “Trust Fund” does when there are surplus contributions over and above benefits paid. The return Siegel can expect over his retirement years on Medicare taxes paid is similarly bad. Siegel is just the kind of high earner whom many assume Social Security favors.

Even worse, Social Security benefits for future retirees are quite risky, given the long-term demographic changes underway in the U.S. The Social Security system is not solvent. Only recently, we have witnessed the revocation of “Restricted Application” filing for married filers born after 1953. This change can mean a significant reduction in benefits to any married couple, but it may be a more meaningful blow to married filers in the age cohort now approaching retirement or full-filing eligibility. This will not be the last revocation of future benefits, because the system is now “cash-flow negative” (benefit payments exceed payroll-tax contributions) and it will be for the foreseeable future. There will be hikes in payroll-taxes and reductions in benefits down the road.

This post is a follow-up to earlier discussions on Sacred Cow Chips of Social Security’s horrid returns to retirees: “Reform Not: Play Social Security Slots” in October and the link given in the second paragraph (above) from August. The Social Security “Trust Fund” is not an asset with any net value to the economy. Earlier surpluses have been used to fund the government’s general budget, so the SS Trust Fund is not “saving” your contributions in any real sense. Government debt held by the Trust Fund as an “asset” must be repaid to the SS system via future taxes. Some asset for the public!

Privatization of Social Security accounts would offer tremendous advantages over the current, unsustainable program. From the August post:

“There are several advantages to privatization of Social Security accounts beyond the likelihood of higher returns mentioned above: it would avoid some of the labor market distortions that payroll taxes entail, and it would increase the pool of national savings. Perhaps most importantly, over time, it would release the assets (and future benefits) accumulated by workers from the clutches of the state and self-interested politicians.“

It’s true that a shorter market horizon makes private investment returns more variable. Transitioning to a system of private accounts would involve a risk tradeoff for private accounts that is less attractive than over a lifetime. That makes it important to offer current workers within, say, 20 years of retirement an option of remaining on a defined benefit plan or converting to a private account, or perhaps some combination of the two.

The safety of Social Security benefits is greatly overrated. As a social mechanism for shielding retirees from market risk, it provides even less in exchange for one’s contributions than would a terrible down-market in equities at the end of a working career.