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Social Security Reform

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Eric Olsen was nice enough to encourage me to post something here about a new study that I authored for the think-tank I work for, the Public Interest Institute, that examines Social Security reform. (And Eric is much too nice to for me to decline.) Entitled “Social Security Reform and Union Households in Iowa,” it takes on claims from union leaders that introducing a system of personal retirement accounts (PRAs) to Social Security will result in drastic benefit cuts. Needless to say, the union leaders’ dire predictions don’t hold water.

For the purposes of this post, I’ll simply reprint two parts of the study. The first describes the three reform plans I looked at:

The first plan is based on the “Retirement Security Act,” a new Social Security reform recently introduced by Representative Nick Smith. Referred to here as the “2.5% Plan,” it allows workers to invest two and one-half percent of their payroll annually in a PRA that can be invested in stocks and/or bonds. It also adds additional funds to the PRAs for low-wage workers, an additional $300 annually for those making between $5,000-$25,000, and an additional $150 annually for those making between $25,000-$35,000. In exchange for using the PRA option, part of the worker’s traditional Social Security benefit is “offset” based on a 3.7% return to the PRA. As long as the PRA earns more than an average of 3.7% annually, a worker will have higher monthly benefits upon retirement than he would under Social Security.

The second is modeled on Plan II in The Report of the President’s Commission to Strengthen Social Security. Referred to here as the “4% Plan,” it allows workers to invest four percent of their payroll annually, up to $1,000, in a PRA. Each year the limit on the amount workers can invest is indexed for wage growth. The offset rate for the traditional Social Security benefit is 2%.

The third plan is modeled on the plan detailed in “Large Accounts and Small Deficits,” a recent policy study by Andrew Biggs. Henceforth the “3%-Bond Plan,” it allows a worker to invest three percent of their payroll in a PRA. It also permits them to invest an additional two percent of payroll in their PRA, but that portion must be invested in federal government bonds. The limit on the amount that can be invested in the PRA is $2,100, indexed annually for wage growth. Furthermore, the 3%-Bond Plan has progressive offset rates for traditional Social Security. The offset rates are 2.5% for low-income workers, 3% for middle-income workers, and 3.5% for high-income workers.

The second part examines how union households would fare under these plans:

The study examined what the PRAs would return when invested in both funds from Fidelity, a well-respected investment firm, and the Thrift Savings Plan, the retirement program for Federal employees. The results show that a system of PRAs is a much better deal for today’s workers. A couple age 25 making the median income for a union household in Iowa would have under the 4% Plan an average of $1,717 more per month in retirement income over what Social Security promises, an average of $870 more under the 2.5% Plan, and $1,152 more under the 3%-Bond Plan. A low-income union household in Iowa also fares much better, netting an average of $423, $377, and $256, respectively, under the three plans.

The benefits are by no means limited to union households. The same methods employed in the study can be used to estimate benefits for any household in America. A 25-year-old household making the median income ($42,228) could expect under the 4% Plan to have an average of $1,366 more in monthly benefits over what Social Security promises to pay, $2,295 more under the 2.5% Plan, and $1,842 more under the 3%-Bond Plan. A household making just under the poverty level ($18,000) can expect $798, $648, and $558, respectively, under the three plans.

The key tables in the study are on pages 11 and 13. The methodology is on page 18, if you care to check that.

Two last things: I need to make a little plug for the group that helped PII put this study together, For Our Grandchildren. Go visit their site for more information on Social Security reform.

Also, if anyone is interested, I’ll be happy to calculate what you could expect to receive under a system of personal retirement accounts. Yes, I could get swamped with requests, but I doubt it. For me to calculate it for you, I need to know your income and your age. That most people find those things to be very personal likely ensures that my workload will be light.

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About David Hogberg

  • Bob Greenspan

    David, I saw your post, which is a few years old now. I had an idea and I wonder if you would look it over and send me your comments. Thanks.

    I recently watched a news conference with President Bush and some investment guru whose name I did not catch. This guru was saying that he could guarantee a return of at least 3.75% to 4.0% on the private accounts the President wanted to create. The President then turned to the cameras and said that is a lot better than the 1.75% to 2.0% you (the American People) are currently getting and thus seemed to be endorsing this guys plan. But that plan involved placing the money in the stock market, which as we all know involves substantial risk. I think I have a better plan.

    1. Place the Social Security Private account money into federally chartered Savings & Loans or Banks.
    2. Loan this money out to Americans to purchase homes. It cannot be used for any other purpose!
    3. The interest rate will be set at 5.0% for 30 years.
    4. Pay the S & L’s and Banks 1.0% return for their administration of the program.
    5. Pay the private account holders 4.0% on their money.
    This guarantees money for Americans to purchase homes at 5.0% interest and it stimulates the economy by boosting home sales at a fair rate plus grows the private Social Security accounts by 4.0% per year. And remember if a retiree has a private account in his name he can pass it on to his heirs. Under the current system you could work and pay into Social Security for 50 years, retire and drop dead or get run over by a truck and killed. If you are a widow or widower with grown children, they get NOTHING! With the private accounts your adult children or your alma mater or favorite charity could get the money in your account.

    Sure, I know, everyone says the stock market is a better deal and should in the long run provide more than a 4% return. But the argument against that is that the market has peaks and valleys. If you are lucky and retire at a peak and pull all your money out good for you. But what if your private Social Security account has (for example) $400,000 in it when you are 2 years away from retirement. But when your retirement time arrives the market is in a valley and your $400,000 has dwindled to $200,000! Think back to the last few years in the stock market. That is exactly what happened to millions of people.

    Why would a Savings and Loan or Bank want to participate? How much is 1% of a Billion? Ten Billion? It would be found money for them. If they don’t want to do it then let the Social Security Agency administer the program using the 1% to pay the salaries and overhead of the Agency. Anything left over can be put back into the Social Security fund.

    The hard part is figuring out how to apportion the money that is currently coming in through payroll taxes between the payments needed to sustain current retirees and the new private accounts? I don’t have the answer to that part, yet.

  • Investing in home loans is just as speculative as the stock market and more speculative than a good broad indexed stock fund would be.

    Why not invest the money solely in the bond market? Bonds have yielded returns over 3% historically over extended periods of time – often considerably higher than 3%. For that matter a simple money market or a CD is likely to yield over 3% over the course of any 20 year period. In fact, almost any investment, including those with virtually no risk will produce better returns than social security over a 20 year period.