As I See It: Social Insecurity

by Victor Rozek

Back when I was beginning my first career in what was then called Data Processing, I was befriended by a woman who inadvertently changed my life with a single observation. At the time we met, she held the highest ranking position of any woman in the company. As an executive riding the crest of the Silicon Valley boom, I figured her future was bright, limitless, and secure. But then she did the damnedest thing. She resigned.

She told me she wanted to start her own business and was studying to become a financial planner. To fully appreciate the gravity of her decision, I should also mention that she was a single parent and that the financial planning industry was still in its infancy and therefore by no means a sure bet as a vocational alternative. So I asked the obvious question: Why?

Because, she said, she knew many women who, like herself, were single mothers but did not necessarily hold privileged executive positions. They worked hard all of their lives, obeyed all the rules, but when it came time for them to retire, very few had enough money saved to live comfortably. In fact, she said--and this is the phrase that changed the course of my life--only 2 percent of the people who retire have enough money to live on.

I remember being stunned by that statistic. How could that be possible? Of course I was young then, and retirement wasn't even on my radar screen. Without giving it much thought, I had somehow assumed that if people entered the workforce broke, they would, after 40 years of effort, come out solvent on the other end. At least that had been my plan. But what if that wasn't true? For the first time I began to seriously ponder what life might be like after the paychecks stopped.

As if to prove her point, she asked me how much of my income I was saving each month. I admitted I wasn't putting aside anything to speak of, and she just nodded, giving me time to connect the dots. Right then I decided I didn't want to be among the 98 percent of the people who retired without sufficient resources, and I started saving and investing in earnest.

Well, it took her years of effort and nearly every dime she had, but she got her business off the ground, and is now the president of a very successful company that has helped thousands of people prepare for their retirement. I was one of her first clients.

This all came to mind because of the recent hubbub about privatizing a portion of Social Security. In the shrill shrieking fraud that passes for political discourse these days, privatization has been hailed by one side as the only means to avert impending bankruptcy and save Social Security; while the other side denounces privatization as a form of social Darwinism that will cut gaping holes in a safety net particularly vital to the poor. As usual, the truth is somewhat more complex and no single variant of it will satisfy all stakeholders.

Social Security was established in 1935 as a means to reduce poverty among seniors while the nation was still reeling from the stock market crash of 1929. It is not an investment program. Essentially, it is a guaranteed insurance plan that now provides retirement, disability, and survivor's benefits to 47 million seniors, widows and widowers, disabled workers, families, and children. It was never intended to be the sole or even the primary source of retirement income. Rather, it was envisioned as being one part of a three-pronged retirement strategy, the other two being private savings and investments and employer-provided pensions. However, since many corporations are now reneging on their pension obligations, Social Security has assumed an importance in retirement planning that it was never intended to have.

In terms of achieving its original goal, Social Security has been wildly successful. Prior to Social Security, more than half of seniors lived in poverty, while today less than 11 percent fall below the poverty line. But that's not the entire story. While the system did its part, the people participating in it were not always able to hold up their end. According to data obtained from my congressman (referenced throughout this article), seniors with a median income of $19,000 per year depend on Social Security for two-thirds of their income, while for 20 percent of retirees, Social Security is their only source of income.

But the proposed changes to Social Security will not have much impact on current retirees or those nearing retirement. The greatest impact will be on workers 35 years old and younger and on the solvency of the system itself. Currently, the Social Security system is financed by a 12.4 percent tax on wages up to $90,000 a year, divided evenly between employers and employees. About 70 percent of the monies collected are immediately paid to eligible recipients. The rest goes into the Social Security Trust Fund, which invests the money in government bonds that pay interest to the fund. This year alone, Social Security will collect $180 billion more in payroll taxes than is needed to fund benefits. In fact, the Trust Fund has assets of over $1 trillion, which will grow to $6.6 trillion by 2027.

So the fund isn't broke, nor will it go broke in the near future. According to the trustees of the Social Security system, without any changes whatsoever, the system will be able to meet 100 percent of its obligations through 2042, and 75 percent thereafter. The Congressional Budget Office is even more optimistic, predicting full solvency through 2052. So the current talk of crisis is greatly exaggerated. Privatization is not so much an issue of reform, but of ideology, and ideological objections to the system are historically rooted.

Since its inception, Social Security has been attacked by those who view it as evidence of creeping socialism. Steven Thomma, writing for Knight-Ridder, offers this perspective. "The promise of secure retirements," he writes, "is a 'hoax.' Taxes paid by workers are 'wasted' by the government rather than prudently invested. And 'the so-called reserve fund ... is no reserve at all' because it contains nothing but government IOUs." The speaker Thomma quotes is not a modern day TV talking head, but Alf Landon, Republican presidential candidate of 1936.

Having said that, there is nothing inherently wrong with private investment accounts. As I indicated earlier, I learned the value of investing many years ago and would not want to deter anyone from its benefits. The devil, however, is in the details. Under the current proposal, there is a potential cost to the pensioner, and a real cost to the system, both of which need to be fully understood by the workers most likely to be affected.

The potential cost to the pensioner is both a reflection of the unpredictability of the stock market and the result of dollars being diverted out of the system for private investment, thereby leaving a less solvent system. Making up the loss is what is referred to as the transition cost which, according to Congress, will cost at least $1 trillion in the next decade, $3 trillion over the next 20 years. Since we are already a nation of debtors, where will the money come from? Likely from benefit cuts. So if the argument is that Social Security will be less than fully solvent in 40 years, then privatization won't fix that shortfall and in fact will only make matters worse.

Further, how much money will actually be available at retirement will largely be a matter of timing. That is, the value of private accounts will vary based on what the stock market is doing at the time an investor leaves the workforce. Granted, any investment carries a degree of risk, but it is sobering to note that a worker who had the misfortune of retiring in 2001 after 40 years on the workforce would receive a monthly check 40 percent smaller than a worker who retired just two years earlier. So one strong argument in favor of keeping the system the same is that Social Security isn't vulnerable to the vicissitudes of the market. Another argument against privatization is that the philosophical camp that champions privatization also advocates market deregulation. Given the looting of the S&Ls, the looting of pension funds, the looting of mutual funds, and assorted corporate accounting fraud, the small investor has good reason to be skeptical of deregulated markets.

Then there is the little matter of "clawback." In spite of the effusive rhetoric about being able to invest "your money," the government is actually planning to lend you your money at 3 percent interest. At the time of retirement you will be required to repay it by receiving proportionately fewer benefits. So if your investments reap a 4 percent return, and the total in your private account at retirement is $100,000, the government will take back just under $80,000.

If saving the system in its current incarnation was truly a priority, it could easily be fixed by lifting the cap on FICA taxes currently set at $90,000. Presently, if you make less than 90K, you pay FICA taxes on every dollar earned, but if you make more than 90K, all additional income becomes magically exempt. So the people that least need Social Security also pay the least as a percentage of total income. Alternately, if projected over 75 years, Social Security's financial shortfall is estimated to be $3.7 trillion. Coincidentally, that is almost exactly the 75-year cost of the tax cuts given to those who earn $311,000 or more. So, if saving Social Security for the poor, elderly and disabled were really a priority, there are less risky ways of ensuring it.

In countries where pension systems were privatized, the results are not encouraging. In Chile, the World Bank found that half of the pension contributions to the average account go to management fees, and the entire system costs three times as much to administer. The New York Times recounts the experience of 66-year-old Dagoberto Saez. His privatized pension fund, after nearly 24 years of contributions, will finance a 20-year annuity paying $315 a month. That compares with coworkers who stayed in the old system who get almost $700 per month, good for life. In Britain, partial privatization consumed up to 20 percent of worker's contributions in administrative fees. The investment firms did much better than investors, however, reporting profits of over 22 percent. Conversely, the administrative costs of our Social Security system are less than 1 percent of benefits paid out.

The real question is: Is it prudent to change the fundamental nature of Social Security. From its inception, Social Security was intended to be an insurance program, not an investment plan. Investment was to be a separate part of a three-pronged retirement strategy, along with pensions. Mixing the two strategies will needlessly weaken an insurance program that has worked exceedingly well for 70 years. Ultimately, workers will have to decide whether they are best served by a system of shared contributions and shared guaranteed benefits or a system of individual risk and uncertain benefits.