The Social Security program is a federal program that provides income for retired and disabled workers. This is done through the collection of Social Security taxes that every worker in the United States pays during their working years and these workers are entitled to receive payments when they reach retirement age.
Lately, you’ve probably heard a lot of chatter about the program and the fact that it is in trouble because there aren’t enough workers to provide benefits for an aging population. You may find that the problem is talked about most by the people who will be least affected by it. Many young people today are too far from receiving Social Security benefits to think about how the money they pay into the system from every paycheck might not necessarily come back to them in the future thanks to how underfunded the system is.
A lot of that has to do with how the system is set up. Money paid from into Social Security doesn’t get earmarked for each person for retirement, instead it gets put in a common pool of money which is supposed to be used to allocate for everyone. People in their 20s and 30s today may not see the money they’ve put into the system in the future. Millions of baby boomers are now collecting or will soon be applying for benefits from a system that needs to be reformed in order to stay afloat.
The program was originally set up during the Great Depression with the purpose of providing an income during retirement years. The payroll tax to fund it was originally only 2% with the passing of the Federal Insurance Contribution Act (FICA), but it has increased over time to the 12.4% it sits at today. Many lawmakers are coming to the realization that raising taxes might not be the solution and that doing so further could anger workers nationwide and potentially damage the economy.
So what needs to happen?
That’s a question we’ll be exploring in this post, as the federal government realizes it needs to provide retirees with some kind of income in the future, so keep reading to learn more.
Some Options on the Table
Some of the ways in which this country’s Social Security problem could potentially be addressed include:
- Payroll Tax Increase – This is an idea that’s been tried time and again but has never really worked because it only postpones the issue. The root of the problem isn’t a lack of tax dollars, and shifts in demographics have to be predicted to make sense of the Social Security program’s shortcomings. A temporary solution today will just delay an issue for our children and grandchildren to deal with instead. Besides, workers don’t want to hear their taxes are going up.
- Increase the Retirement Age – You can begin collecting a reduced benefit at age 62, but there are requirements you need to meet in order to do so. In order to take benefits without additional penalties, you have to reach the Full Retirement Age, FMR, which is 67 for those born after 1960. The age of 67 is higher than the FMR used to be, as lawmakers see raising the age as a solution to underfunding, when really all it does is reduce benefits.
Think about what would happen if the age was raised to 68 for anyone born after 1970, for instance. That might add 25 years of liquidity to the Social Security system, but would cost anyone receiving $1600 per month $38,400 over the time they missed. I think it would be better to see FICA taxes go up slightly as raising the age just seems like an admission of failure, plus those who have paid in will have to work longer to receive what is theirs. - Reduce Other Federal Spending – This seems like one of the more sensible solutions. Things could be rearranged as such that providing retirement income takes up more of the federal budget. We could spend nominally smaller amounts on things like the military and apply it to Social Security. Or maybe reduce spending on education? Or the Environmental Protection Agency?
But do you see the problem now?
The budget is already stretched thin. If other social programs are cut, then the problem for workers remains just as expensive. Lawmakers already disagree on where money should be spent, so shifting spending is no solution at all. But even when this wouldn’t work as a full solution, it could be of some help. - Set Aside an Amount for Individual Participants – You’ve probably heard someone at some point mention “Privatizing Social Security”, and this is what it means. If you ask me, it’s really the only one that makes sense.
I admit it could be problematic, but let’s look at why it could work. Under this idea, a portion of your FICA taxes would be put into a private account set aside just for you. You then determine if you want that money invested conservatively, moderately, or aggressively. This could outpace the rate at which the current system, where money is invested in ultra-safe treasury securities, grows. It also increases the risk potential.
Between 1926 and 2006, the annual rate of return for the S&P 500 was 10.44%. If FICA taxes grew at that rate, the Social Security issue likely wouldn’t be as bad as it is. Even so, there is the concern that the stock market might not always perform at the same rate. Social Security was established to provide a stable investment, but it could end up being worth less than what you put in.
This issue has generated a ton of discussion, but it gives way to the question of whether workers will take responsibility for some of their own Social Security income. Likewise, there’s the question of whether inexperienced investors should be making decisions about how their Social Security payments should be allocated. Are they competent enough to make those decisions?
In this scenario, the government still plays a role. It would still create the program, set up the options for investing, and provide investors with some sort of education.
There’s no way of knowing how well it would work, we just know the current system doesn’t work and that the S&P 500 over the past few decades has returned more than Treasury securities.
It’s impossible to tell what would happen over the next several decades, but many with solid backgrounds in economics can guess as to the types of problems that would occur with the privatization of Social Security.
Take Bill Gross, manager of one of the largest mutual funds of all time, for instance. He believes that the shortcomings in the program are because of demographics, not funding. He thinks that refocusing on the causes could influence our solutions.
Ralph Nader thinks the problem is “overstated” and that “pessimistic assumptions” taint the reality of the problem. He has been advocating against privatization, reasoning that it would be dangerous because of stock market fraud.
George W. Bush was in favor of the practice and pushed for it during his second term, but the country was not ready for such a drastic change in policy.
There are many, many resources out there to learn more about Social Security, such as the Social Security Administration website. There are a lot of blogs that speak on the matter, but you want to stick with sites that can act as authorities. Once such site, Social Security Choice, advocates for reform and privatization. Its parent organization, Club for Growth, believes that economic freedom leads to prosperity and opportunity.
There is also Secure Our Future, which was created by students who want to raise awareness about how young people are affect by Social Security changes.
You may also want to visit the AARP, which speaks against the idea of privatization on the grounds that the dramatic reworking of the system isn’t needed and investing in riskier securities would negatively impact everyone who relies on Social Security payments.
It’s impossible to say who is right, but we do know that the looming problem needs to be addressed somehow, because avoiding it could harm everyone’s retirement benefits.
If you want to know more about retirement planning and Social Security payments, get in touch with me today and let me know what I can do to help you.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Investing involves risk including loss of principal. Bill Gross is not affiliated with LPL Financial.