Sickening Social Security Shortcomings

EXECUTIVE SUMMARY

Since 1939, the Social Security system has acted as a retirement vessel for older Americans, but this system no longer works and is unsustainable. Initially, seven workers would pay the retirement benefits of one retiree, but now due to increased life spans and fewer young people, that ratio is now 2.8 to one, meaning more money is flowing out of the system than flowing in. This means that by 2035, Social Security will no longer be able to be paid out to retirees and those who have paid into the system. Despite the administration denying these claims, the mere fact that they pay out more than they bring in shows that eventually, the system will break down. In addition, Social Security yields an average return of only 2%, compared to risk-free Treasury bonds which yield 3%, and a stock market that returns an average of 10%, making Social Security the worst possible retirement investment strategy. In order to fix this issue, the privatization of Social Security is key in order to allow individuals to select an investment strategy that best fits their needs and risk tolerance levels. This change will increase returns for workers, actually making the benefits that they receive with Social Security ones that they can live off of, in comparison to the supplemental income that Social Security currently acts as. In addition, this will aid in the underfunding aspect of Social Security, as there will be more money in the system, which can be used to pay out those who have already paid in. This must be achieved through an act of Congress authorizing a change to the long-standing system of Social Security.

INTRODUCTION

While retirement is a long way away for many Americans, it is something that most center their lives around, and financial planning for retirement is a complex decision that for the most part is left up to the individual, except for what is mandated by the current Social Security system. While forcing people to think about retirement is necessary for American society, forcing them to partake in a system that is financially inefficient is far from beneficial. Since its inception, Social Security has been broken, but as a society, its shortcomings are overlooked, as it is an unpopular policy point to advocate for a change. Social Security as a vehicle for retirement makes laughably low returns, inhibits financial flexibility, and is a system riddled with copious amounts of debt. It is unfair to future generations who will inevitably feel the full effect of these problems, as by the time people realize the full impact of the issue, the system will be beyond fixing, trillions in debt with millions of Americans unhappy. In order to aid in planning for retirement and to fix the debt problems that the current Social Security system possesses, it is critical to alter the system to create adjustable investment vehicles that are tailored to the needs of the individual which will make higher returns while still minimizing risk.

CURRENT BENEFITS OF THE SOCIAL SECURITY SYSTEM

Although a key to a happy life is being able to spend money in the present, for a long, sustainable life, it is vital that all people plan for their retirement, and this mandate has been the role of Social Security in America for almost 100 years. The modern consumer is one that often buys in-the-moment items that will deliver short-term gratification, but it is still critical to save for the future, even if people do not want to address this reality. Social Security in general can be defined as risk-free in the present, as the government would likely just print more money if it could not meet its obligations: “Once someone starts receiving Social Security, their benefits increase to keep pace with inflation, helping to ensure that people do not fall into poverty as they age. In contrast, most private pensions and annuities are not adjusted (or are only partly adjusted) for inflation.”[1] While Social Security is merely supplemental income and is dependent on how much a person paid into the system, it provides income to all people, acting as a social safety net for the elderly. This is important because as a society the elderly must be cared for as they have laid the groundwork for future generations and deserve to be cared for when they cannot provide for themselves.

In addition to the retirement income aspect of Social Security, it also acts as an insurance fund for those who are unable to care for themselves: “Social Security is not only a retirement program but also an insurance program. About one-third of payroll taxes go to fund Social Security disability insurance and survivors insurance.”[2] Altering or privatizing Social Security might be beneficial for the income aspect of the fund, but in the process, these changes neglect to consider that the system is about more than just retirement income, so any changes must take this into consideration.

Lastly, Social Security enables people to invest in other asset classes without fear that if they invest poorly, then they will be unable to have income in the future. This security nudges people to invest in markets, rather than just hold their money in cash, which is a net benefit to the overall health of the nation’s economy, as more money is put to work: “’Since you’re guaranteed an inflation-adjusted income stream for life, you can think about your other sources of income and assets knowing that you’ll always have Social Security,’ said Melissa Favreault, a senior fellow at the Urban Institute.”[3]

RATIONALE FOR ACTION AND WHY SOCIAL SECURITY IS BROKEN

While Social Security has helped millions of retirees for decades, it is an unsustainable system that lacks funding and unfairly mandates what people must do with their money. Although in planning for retirement, investing in some safe assets is the smart financial decision, investing in an asset class with below risk-adjusted returns is not the smart decision. When planning for retirement, people often just want a safe investment that will give them livable returns, but when the government forces people to invest in an asset class that yields so little, it is an unfair mandate.

While a Treasury bond is considered to be the risk-free rate, Social Security cannot even manage to outpace that, “Social Security has a rate of return of about 2 percent above inflation, while Treasury bonds have a rate of return of 3 percent above inflation.”[4] If Social Security were truly about putting money away for peoples’ retirements, then the government would have made the program one that maximizes returns while having minimal risk, but this is not the case. In actuality these below-market returns work out to negative real returns for contributors: “Still, the Heritage Foundation study says younger workers are the biggest losers under the current Social Security system. The returns on Social Security taxes will be between negative 0.04% and negative 14.53%, it says.”[5] This study finds that with the money people put in compared to how much they will get out, it actually turns out that people are losing real economic value by investing via Social Security.

In addition to the low returns the system yields, it is also vastly underfunded for its current payout levels and in a matter of a few years, the fund with no longer exist. This is a result of the number of contributors per retiree continuing to decline as fewer people are paying into the system to support an increasing number of people who rely on the system: “There are now only 2.8 workers per Social Security beneficiary compared to 3.3 as recently as 2007. The Social Security Administration estimates Social Security benefits will start to exceed the program’s costs in 2020, and the program will deplete its $2.9 trillion reserve fund in 2035.”[6] Social Security cannot keep functioning in its current capacity and ignoring the problem until the fund runs dry is not a smart tactic, as it is important to act proactively in fixing the system. It is inevitable that the system will run out of money, so pretending that this is not a problem is not an option.

PRIVATIZATION: THE PREIMIERE ALTERNATIVE

As a result of the current system being unsustainable, there has been a recent push for the privatization of Social Security, where people will have greater optionality in what they invest in and the government does not decide peoples’ retirement plans for them. There is no financial advisor who would argue that Social Security is the best or even a good retirement plan, but the system with the help of a clear vision for real change possesses great potential.

While many retirees have other saved up income in the form of a 401k or an IRA, some people are reliant strictly on Social Security for income in retirement, but this might not even be enough to live off of: “It provides an average annual payment of some $17,000. The average recipient receives $1,461 a month, although most seniors pay a tax on these payments. They were untaxed until the 1980s.”[7] The low payouts that people receive are oftentimes not enough to even live off of, so fixing the system to generate higher payouts can change this so that people can actually meet their basic needs through their Social Security payments. The solution to this in the view of many people is to privatize Social Security, where using non-government mandated investment strategies, it is rather easy to generate higher returns, which using the same contribution method can enable greater, livable payouts.

By privatizing Social Security and having it managed by private investment corporations, it grants people more flexibility, as they can plan for their retirement in ways more tailored to their needs. Private retirement investments open up room for new investment vehicles, which is better for the investor and the overall health of the economy. In Henry Aaron’s argument, he highlights the benefits of the system, while at the same time recognizing that it is unlikely that these changes will ever be instituted:

“Unlike private pension funds, Social Security reserves cannot be invested in private securities. The prohibition means that Social Security will pay smaller benefits than private pensions can pay for each dollar of tax or contribution although the social returns to both forms of saving are identical. The differential guarantees invidious comparisons with returns on private savings and thereby jeopardizes long-term public support of social insurance.”[8]

The push for privatizing Social Security has the benefit of being able to outperform the returns of the current system, as fund managers are able to invest in a variety of private asset classes that the government is unable to invest in themselves. Privatizing Social Security leads to higher returns and allows people to invest using an investment strategy that fits their needs, thus improving the system compared to its current state.

ADJUSTMENTS TO THE CURRENT SYSTEM: ANOTHER POPULAR ALTERNATIVE

Some critics of Social Security, like Senator Rick Scott, do not want to go as far as privatizing the system but want to make a set of small adjustments to the current system in order to make it more sustainable going forwards, which is a plan with greater likelihood.

While completely overhauling the system to make it privatized is the best purely financial solution to the issues that Social Security has, that is unlikely to happen due to older (likely) voters who have already paid into the current system viewing it as unfair, making it unpopular for any elected representative to push for. Thus, in order to reform, the change likely would be a smaller adjustment to the current system, which can come in the form of raising the retirement age, so that more people are paying into the system for longer and people are receiving benefits for a shorter period of time: “Increasing from 35 to 40 the number of years over which average Social Security earnings are computed would reduce benefits because the additional 5 years, by definition, would be lower than the highest 35. Most members of the Advisory Council embraced an increase to 38 years. Going to 40 years would close 21 percent of the deficit.”[9] By pushing the retirement age back by either three or five years, it forces people to pay into the system for longer, thus paying for the benefits of retirees, while at the same time, fewer people are eligible to receive payouts. This change is doable, as Congress has already authorized the age to be pushed back to 67-years old in opposition to 65-years old, showing that these alternatives are passable through legislation. This change focuses on managing the debt of the current system but fails to address the financial return aspect of the issue.

On the other hand, an important change to the Social Security system that can address the low payout of the current system is simply continuing to raise the maximum contributions and payouts a person can receive from the system: “Social Security recipients will get a 5.9% raise for 2022, compared with the 1.3% hike that beneficiaries received in 2021. Maximum earnings subject to the Social Security tax also increased — from $142,800 a year to $147,000.”[10] This has the benefit of changing Social Security from supplemental income into actual livable income for retirees, as, under the current system, it is unthinkable that any retiree would be able to survive on the present low payouts. Increasing payouts increases the liability of the current system, but at the same time, raising the maximum contribution from current workers should offset this.

While these existing policy recommendations address some issues of Social Security, they do not go far enough in addressing the many issues that Social Security presently has.

POLICY RECOMMENDATION: PRIVATIZATION OF SOCIAL SECURITY

A proposed compromise that gives people more financial flexibility when planning for retirement and maintains the current funding aspect of the system is to allow people to invest in the asset classes they want, rather than being forced to invest in what the government mandates. Under this system, the proposal is that individuals can select different investment strategies that they want their money to be invested in within the Social Security system. These different investment strategies that the money is pooled into can either be based upon a given risk tolerance or can be investments into a particular industry. The rationale behind this proposal is that individuals deserve financial freedom and should not be constrained to invest in a low-yielding asset class for their retirement if they choose not to. The system additionally will be handled by contracted private funds that will carry out the investment strategy, as investment professionals are more qualified and specialize in retirement planning, as opposed to a broad federal government.

With this policy proposal, it is as simple as when people first contribute to Social Security, they are asked what investment strategy they want to utilize, but everything else remains the same until retirement, where they are then paid out higher monthly checks than under the current system.

DISADVANTAGES OF PRIVATIZATION

Despite having the benefits of the current system plus financial flexibility, this policy proposal has some shortcomings, including undermining the current guaranteed aspect of Social Security.

Under the current Social Security system, with its low yielding returns and investment in essentially risk-free assets, it is almost certain that the money put into the system will be there to pay out future generations, as the risk of a poor investment funneling money out is almost zero. This is a benefit of the current system that makes it such a safe vehicle for retirement planning. However, what this fails to acknowledge is that the current safe system lacks enough funding to pay out everyone who is owed money, and thus the risk of default is almost certain unless the government decides to print more money to artificially inject it into Social Security or institutes some of the proposed solutions. While the investment risk is low, the low yield increases the likelihood of default, making the system nowhere near as safe as it claims to be.

While the proposed changes would be entirely net beneficial to the financial health of society, it is likely not something that Congress or anyone in government would advocate for, as with people who have already paid into the system with low returns would find it unfair that younger generations are getting a better deal. This is in fact true, younger people would be getting a better deal through more flexibility and higher returns, but in order to make the country as strong as financially possible, this is the right thing to do, as for future generations it will have a vastly positive impact. If Congress wants to do the best thing for the future of the nation and eventual retirees, these policy proposals will be implemented, despite older generations not benefiting from these changes in any meaningful way.

ADVANTAGES OF PRIVATIZATION

Improving the financial flexibility of Social Security, it means that current beneficiaries of the system will still be paid out what they are owed, but at the same time, future beneficiaries can invest in a manner that suits their individual needs.

The most obvious advantage of this revised system is that people will be able to make tangibly higher returns compared to the returns that retirees presently receive, giving people an actual livable income in opposition to the mere supplementary income that Social Security presently provides. If people can invest how they see fit, there is a greater chance that they will make higher returns, thus making it a sounder financial tool, which can be something that people can actually retire on and not have to worry as much about saving income through other vehicles.

An additional benefit to the system is that it aids in fixing the underfunded nature of the current system, where presently, if the cycle of payouts continues, then the system will default on its promises, as it lacks the funding to sustain itself. As a result of the current system barely beating inflation each year, the funds people contribute are not actually investments but are instead glorified savings accounts with no real return to them. This disconnect means that the payouts are continuously getting more expensive, but the assets are not growing at a rate to meet these increasing demands. If the funds within the system were to generate some higher return, then it could help pay down the debt and provide greater funding to future generations in retirement.

CONCLUSIONS

The United States is a country rooted in freedoms and a government-mandated, poorly-designed retirement fund that cons people out of large, compounded returns is unfairly unamerican. If the government is to maintain Social Security as an institution, it must be adjusted so that people have the freedom to invest their own money how they see fit, as this is about the individual, not the collective.

In order to maximize peoples’ returns on their retirement funds, a switch to a privately managed Social Security system is key, where people can invest in ways that they see fit. The debt and low returns of Social Security have gone on for long enough, as it is now the time for Social Security to be a private investment vessel for retirement tailored to the needs of the individual.

[1] “Policy Basics: Top Ten Facts about Social Security.” Center on Budget and Policy Priorities, 13 Aug. 2020, https://www.cbpp.org/research/social-security/top-ten-facts-about-social-security.

[2]Furman, Jason. “Would Private Accounts Provide a Higher Rate of Return than Social Security?” Center on Budget and Policy Priorities, 2 June 2005, https://www.cbpp.org/research/would-private-accounts-provide-a-higher-rate-of-return-than-social-security#:~:text=Social%20Security%20has%20a%20rate,of%203%20percent%20above%20inflation.

[3] Miller, Mark. “What’s Your Rate of Return on Social Security?” Reuters, Thomson Reuters, 18 Oct. 2012, https://www.reuters.com/article/us-column-miller-socialsecurity/whats-your-rate-of-return-on-social-security-idUSBRE89H0YG20121018.

[4] Furman, Jason. “Would Private Accounts Provide a Higher Rate of Return than Social Security?” Center on Budget and Policy Priorities, 2 June 2005, https://www.cbpp.org/research/would-private-accounts-provide-a-higher-rate-of-return-than-social-security#:~:text=Social%20Security%20has%20a%20rate,of%203%20percent%20above%20inflation.

[5] Bresiger, Gregory. “Social Security Is a Bad Deal for Many Americans, Critics Say.” Financial Advisor, 11 Dec. 2019, https://www.fa-mag.com/news/social-security-is-a-bad-deal-for-many-americans--critics-say-53191.html#:~:text=Critics%20charge%20Social%20Security%2C%20as,deal%20because%20payments%20are%20puny.&text=It%20provides%20an%20average%20annual,a%20tax%20on%20these%20payments.

[6] Wasik, John F. “Why Social Security Is A Great Deal — And Why It’s Worth Expanding.” Forbes, Forbes Magazine, 20 Feb. 2020, https://www.forbes.com/sites/johnwasik/2020/02/20/why-social-security-is-great-deal--and-why-its-worth-expanding/?sh=2344a72d2ac2.

[7] Bresiger, Gregory. “Social Security Is a Bad Deal for Many Americans, Critics Say.” Financial Advisor, 11 Dec. 2019, https://www.fa-mag.com/news/social-security-is-a-bad-deal-for-many-americans--critics-say-53191.html#:~:text=Critics%20charge%20Social%20Security%2C%20as,deal%20because%20payments%20are%20puny.&text=It%20provides%20an%20average%20annual,a%20tax%20on%20these%20payments.

[8] Aaron, Henry J. “Privatizing Social Security: A Bad Idea Whose Time Will Never Come.” Brookings, 1 June 1997, https://www.brookings.edu/articles/privatizing-social-security-a-bad-idea-whose-time-will-never-come/.

[9] Ibid

[10] Probasco, Jim. “6 Social Security Changes for 2022.” Investopedia, Investopedia, 25 Jan. 2022, https://www.investopedia.com/retirement/social-security-changes/#:~:text=Maximum%20earnings%20subject%20to%20the,slight%20rise%20in%20disability%20benefits.

Works Cited

Aaron, Henry J. “Privatizing Social Security: A Bad Idea Whose Time Will Never Come.” Brookings, 1 June 1997, https://www.brookings.edu/articles/privatizing-social-security-a-bad-idea-whose-time-will-never-come/.

Bresiger, Gregory. “Social Security Is a Bad Deal for Many Americans, Critics Say.” Financial Advisor, 11 Dec. 2019, https://www.fa-mag.com/news/social-security-is-a-bad-deal-for-many-americans--critics-say-53191.html#:~:text=Critics%20charge%20Social%20Security%2C%20as,deal%20because%20payments%20are%20puny.&text=It%20provides%20an%20average%20annual,a%20tax%20on%20these%20payments.

Furman, Jason. “Would Private Accounts Provide a Higher Rate of Return than Social Security?” Center on Budget and Policy Priorities, 2 June 2005, https://www.cbpp.org/research/would-private-accounts-provide-a-higher-rate-of-return-than-social-security#:~:text=Social%20Security%20has%20a%20rate,of%203%20percent%20above%20inflation.

Miller, Mark. “What’s Your Rate of Return on Social Security?” Reuters, Thomson Reuters, 18 Oct. 2012, https://www.reuters.com/article/us-column-miller-socialsecurity/whats-your-rate-of-return-on-social-security-idUSBRE89H0YG20121018.

“Policy Basics: Top Ten Facts about Social Security.” Center on Budget and Policy Priorities, 13 Aug. 2020, https://www.cbpp.org/research/social-security/top-ten-facts-about-social-security.

Probasco, Jim. “6 Social Security Changes for 2022.” Investopedia, Investopedia, 25 Jan. 2022, https://www.investopedia.com/retirement/social-security-changes/#:~:text=Maximum%20earnings%20subject%20to%20the,slight%20rise%20in%20disability%20benefits.

Wasik, John F. “Why Social Security Is A Great Deal — And Why It’s Worth Expanding.” Forbes, Forbes Magazine, 20 Feb. 2020, https://www.forbes.com/sites/johnwasik/2020/02/20/why-social-security-is-great-deal--and-why-its-worth-expanding/?sh=2344a72d2ac2.