Making Social Security Stronger & Fairer

The debate over Social Security is, like many things, a debate over definitions. We have to agree on what it is in order to agree on what should be done to improve it. Is Social Security a retirement plan, or is it an insurance program? The most obvious and straightforward answer to this question comes from the program's official name: The Old Age, Survivor and Disability Insurance program (OASDI). Note the "Insurance" in the title. With that answered, the question becomes "what is being insured?"

At the program's inception, when the average life expectancy was the same as the benefits start age (65), it was reasonable to say that the program insured against longevity -- if you lived longer than average, then the program gave you an income to live off of. Partly due to the rampant success of Social Security, however, people are living much longer than the retirement age, and this definition no longer holds.

I propose that the program's new definition should be to insure against the risk of outliving your nest egg. Accordingly, several changes should be enacted to strengthen the program's ability to carry out it's purpose, reduce the number of people who need to rely on it to stay out of poverty, and to make it more fair to contributors. Everyone should support these changes whether they agree that the current program is in "crisis" or not.

Here is the 8-part proposal:
(1) Tie premiums to risk

In a typical insurance program, your rates are tied to the risk that you pose as an insuree. For example if you get in to a lot of car accidents, your automobile insurance rates will go up. But not so with Social Security. Regardless of how much you've accumulated in assets, your rate is 12.4%, even though you're not likely to need social security benefits if you're a millionaire. To increase the program's fairness, individuals who can show that they've accumulated sufficient assets in retirement accounts that their risk of requiring benefits is small should have their premiums dropped accordingly.

This implies additional "means testing." Those high net worth retirees that don't need social security benefits shouldn't get any payments. The legacy of confusion about Social Security's purpose has created widespread confusion that contributors are "entitled" to a "guaranteed benefit", an idea that is counter to the basic concept of insurance. Clearly, when you pay your health insurance premiums you do it with the expectation that if you need protection later, it'll be there for you. What you don't expect is that you'll get paid back every cent that you put in, no matter what. The nature of insurance is that you have to qualify first, and qualifying means you've suffered some sort of hardship. The idea of a guaranteed benefit is different and has a place in investment & savings, but not in insurance.

Some might suggest that the vagarities of the market may pose the risk of a large number of retirement account "catastrophes". As an insurance program, this risk will be built in to the premiums, and therefore mitigated. However, if it's believed that catastrophes will be a common problem, a provision could be included that if a contributor's retirement accounts dip below certain levels, they would be forced to put their money into safer investments -- a sort of margin call from the government.

(2) Eliminate the Cap on Earnings Subject to Social Security

As anyone who has looked at the consumer debt statistics or has read "The Millionaire Next Door" knows, there is little correlation between income & wealth. Wealth is what reduces a person's likelihood of needing Social Security benefits, and is accumulated by spending less than you take in, not by having a really high income.

(3) Clean up the Trust Fund Accounting

Congress has unnecessarily restricted the Social Security Administration from investing the current surplus in anything other than Treasury Bills, and "Special Issue" ones at that. As an individual, you wouldn't expect to be able to limit your private insurer to investing its momentary surplus exclusively in the safest, lowest yielding security around -- in fact, if a private insurer did this, their costs (and thus rates) would go up, and you'd find a different company to work with. The Social Security Administration should be freed to invest in a responsible selection of other monetary instruments like local bonds, which would increase the surplus' rate of return at the same time as helping communities improve their schools, parks, and infrastructure.

(4) Encourage 401K Rollovers

Whenever someone leaves a job and decides to spend the money they've accumulated in their 401k instead of rolling it over to another plan, the penalty that they pay for doing so should go to the Social Security fund, not to the IRS. This is only fair, since the money that was earmarked for retirement is no longer available. Also, at their next job, they would likely pay higher Social Security premiums since their accumulated retirement assets have been reduced & they pose a higher risk to the Social Security system.

(5) Strengthen the 401k Company Match

Another change that's needed to the 401k system involves the company match. Currently, employers who match employee contributions are given tax breaks in return. These tax breaks should be eliminated, and employers should be allowed to match from their Social Security contributions. To make this revenue neutral to Social Security, the company's Social Security obligation should be increased to match. Since tax breaks are only effective for companies that are profitable, but all employers pay Social Security premiums, so this change will make 401k matching available to more employees of companies that haven't achieved profitability yet or are working through troubled times.

Here's an example: Currently, ACME Industries pays an employee, the Roadrunner, $50,000 annually. In addition, they have a 401k plan where they match 100% of the Roadrunner's salary, up to 2% of his total annual salary. In this case, that's $1,000. The Federal government then gives ACME a tax deduction of $1,000. Under the proposed change, the tax credit is superceded by a 2% Social Security premium increase. So, ACME stops paying the $1,000 from its general compensation fund into Roadrunner's 401k, and starts paying $1,000 into it from its Social Security dues, which have been increased by the same amount. Since companies don't pay taxes on Social Security benefits, this is a neutral change for profitable companies that are good corporate citizens and currently matching employee contributions. Companies that aren't matching contributions would be forced to start, giving their employees a leg up in retirement planning.

(6) Add annuities to 401ks, and make them the default contribution offering.

Many people want to save for retirement, but are overwhelmed by the responsibilities of tracking mutual fund performance. Annuities are easily understandable and eliminate the problem of trying to manage money from a lump sum, an insurmountable problem for many. By making this the default option, it will reduce the "scariness" factor of retirement planning.

(7) Eliminate the Roth IRA.

The Roth was billed as a way to further encourage people to plan for retirement, but it's just being used by the already wealthy, while the poor & middle class largely ignore it. In the process, it's artificially inflating current tax revenues at the expense of the future, effectively harming future generations as much as the Social Security funding problem is.

(8) Mandatory education.

In order to maximize the number of people who take advantage of the additional freedoms provided by this simpler, fairer plan, an employee education program should be launched. Everyone who hasn't yet qualified for premium reductions should be required to complete a training course that covers basic retirement planning concepts such as "paying yourself first," and the magic of compound interest. Having the right programs in place isn't enough if people don't understand them.

Conclusion

While Social Security has been highly effective in protecting retirees & the disabled from the most devastating effects of poverty, the income it provides allows for subsistence, not the kind of dream retirement that most of hope to have during our Golden Years. With the proposals above in place, the program will be stronger and fairer. By tying premiums to risk, it will encourage workers to plan for their retirement, while leaving the safety net in place for those who encounter a catastrophe or otherwise would be in poverty during their old age.

This proposal is different than the idea of adding "private savings accounts" to Social Security in that an individual would have to have a proven track record of investment success in order to have their premiums reduced, rather then take money out of the program on faith that they know how to make prudent, diversified investments. For example, once a contributor has a 5 year history of meeting or surpassing savings goals that are reasonably projected to keep them out of poverty in retirement, they would start to see premium reductions. Since these reductions are delayed, this plan will reduce or eliminate the need to fund the program with additional money to pay current retirees versus the current "private savings account" plan. It also won't require new Federal programs, and will separate the insurance aspect of the program from the existing programs we have place to help workers establish a nest egg.

Social Security reform needs to be more than an accounting shell game to eliminate the existing wealth transfer aspect of the program. It's only fair to ask those who have made it to help out those who aren't there yet, since they've inherited significant value from their community. At the same time however, it needs to be more than just a "Robin Hood"-like taking from the rich to give to the poor, since it's savings, not income that creates wealth. By modifying the program as above, we'll strengthen the inducement for all Americans to create a retirement nest egg, resulting in reduced societal risk of poverty, and will take a strong step forward towards creating an ownership society. The wealth transfer aspect of the program can then be considered as an upside-down multi-level marketing (MLM) club of wealth. Those at the top of the wealth pyramid help the next level join, who then help the next, and so on. When there's no one left to join, by definition everyone is wealthy. Perhaps this vision is overly optimistic, even naive, but if wealthy is defined as "not in poverty," it's a goal that we can easily make significant gains towards. As America approaches this eventuality, dramatic reductions in Social Security Insurance premiums will be possible without ever endangering the principle of a safety net.

A stronger, fairer program that provides incentives for personal responsibility & helping to secure the common good… Isn't that what we're all after?