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Is There a Stock Answer To Social Security Worries?

If you were betting your retirement money, where would you rather put it -- with the government or in the stock market?

In the growing debate over the future of Social Security, that is the choice Americans may ultimately be asked to make.

Three decades ago, when Social Security was getting going, turning to the stock market was never an option. The 1929 crash was fresh in the minds of Congress and the public, and the idea of pinning long-term economic security to stocks would have been about as popular as asking today's workers to put their pension money into real estate tax shelters.

But, as so often happens in public policy, yesterday's solutions are today's problems.

Effectively a pay-as-you-go system, Social Security worked well in years when the number of active workers vastly exceeded the number of retirees. Today, the ratio of workers to retirees has shrunk to 3.3 to 1 (from 16 to 1 in 1950), retirees are living longer, and benefits continue to rise with inflation. As a result, the day is nearing when Social Security won't have enough income from those working to pay those in retirement. It will have to cut benefits or raise its taxes even more.

It is now fashionably cynical among younger Americans to say they expect to get nothing from the program when their turn comes 40 or so years from now -- with good reason: Future retirees on average will get back little more than what they paid in, plus a very low rate of interest. In contrast, a single-earner couple who retired last year could expect to get back 2 1/2 times their lifetime contributions.

At the same time, the stock market and other financial investments are doing quite well, thank you. When you compare what you might get if you put the 12.4 percent you and your employer are now paying into some other investment tool, the results make private alternatives to the government program look pretty good.

Even if you were able to invest only your own half of the tax, the payoff would be pretty nice. If you earn $50,000 a year today, your 6.2 percent Social Security tax amounts to $3,100 annually. Invest that at 10.5 percent, the historical stock market return, and over 40 years it will turn into $1.57 million.

A special panel known as the Social Security Advisory Council, made up of pension experts, has been eyeing the current system and some potential alternatives, and some of its members endorsed the idea of creating private accounts within the Social Security system. The group ended up badly split, but there was considerable support for a plan that would have allowed workers to put 5 percent of the 6.2 percent tax they now pay into special retirement accounts. The rest of their tax, plus the employers' tax, would stay in the system to provide a minimum benefit plus disability and survivor benefits.

These "personal security accounts" ultimately would raise the ratio of return on your tax "and thus increase the perceptions of fairness in the program across generations," Sylvester J. Schieber of Watson Wyatt Worldwide, principal architect of the plan and a member of the advisory panel, told a Senate Finance subcommittee recently.

Schieber and advocates of similar plans, such as Sens. Alan Simpson (R-Wyo.) and Bob Kerrey (D-Neb.), would allow workers to keep any remaining balances from these accounts. "You own it. . . . You can leave it to your heirs," Kerrey said earlier this month.

Social Security, by contrast, guarantees monthly payments as long as you or certain survivors live, but no more. This means that a person who lives to a very old age will get a large total benefit under the current program, but one who dies before retirement or shortly after can end up getting little or nothing.

Backers also argue that these accounts, which would be real investments that each beneficiary would make instead of government IOUs, which the current trust fund amounts to, would stimulate economic growth that would benefit all society. Further, the payoff would be a retirement system whose benefits would be largely funded and controlled by those who receive them, rather than by younger workers.

This issue is certain to find its way into the political arena in the next few years, and ultimately the voters through their elected representatives will have to decide whether this is the way they want to go. Today, it might look like a no-brainer for younger workers, but there is much to consider in such a decision:

Risk. The reason 401(k) retirement plans are so popular with employers these days is that they shift the investment risk from the company (under traditional pension plans) to the worker. The same would apply to Social Security. To the extent Social Security is privatized -- which is essentially what these personal security accounts would mean -- workers will exchange political risk for market risk. Political risk is that the government will be unable or unwilling to pay you the benefits it promised; market risk is that you will make poor investments or the market generally will not perform well. Which are you more comfortable with?

Cost. Only young workers, who have many years to see their money grow, can depend heavily on private accounts; today's middle-aged or older workers won't have enough working life left to build up enough in a private security account to retire on. So the system will have to have adequate reserves to pay promised benefits to older workers and to retain its "social insurance" features -- benefits for the disabled and for widows and surviving minor children. Since today's system doesn't have enough reserves for its current obligations, and since it would have even less if part of its revenue was privatized into personal security accounts, higher taxes or more government borrowing would be necessary for decades.

Schieber figures that under his plan the payroll tax would have to climb to 16.2 percent from the current 12.4 percent to account for the transition to a private or semi-private system that retains survivor and disability benefits and a minimum pension benefit. This would "taper down over time," but "would be substantial for 35 to 40 years." Would this system be worth paying extra for now in order to create one that would be self-funding in the future?

Income equality. The current system is heavily weighted toward lower-income workers, replacing a greater share of their pre-retirement income with Social Security benefits than that of higher-income workers. Currently, Social Security replaces on average about 42 percent of prior wages, according to former Social Security commissioner Stanford G. Ross. The privatization plans would retain a minimum benefit of about half that, with the rest to come from the new personal accounts.

Higher-income workers would have more dollars to save, and would end up with larger accounts, whereas lower-paid workers would have less, and those who go through protracted periods of unemployment less still. Ross cautions that cutting the minimum too much could place new burdens on welfare programs.

On the other hand, Schieber notes that "under current law, the baby boomers who earned average wages throughout his or her career could expect to get back [in Social Security benefits] less than half the value of the payroll taxes paid on his or her earnings." And that is likely to get worse, since "we know current law is unsustainable," Schieber said.

The private accounts would thus restore value to the system for better-paid workers while perhaps increasing the risk for the less well-paid workers. Would that be politically acceptable?

With support from younger and higher-income workers growing shakier, it is likely that some form of private accounts will be enacted in the coming years. Since we haven't been able to devise a system that remains workable for more than half a century so far, it's quite possible that today's solutions, enticing though they sound, may be only tomorrow's problems in the making.