Posts Tagged ‘Baby Boomers’

Saving Social Security

Because Social Security impacts the lives of so many people, reforming the Social Security system is probably going to be one of the greatest fiscal and political challenges facing this generation. 

Nearly one-sixth of the population is receiving benefits, and this percentage will grow as the Baby Boomers move into retirement.   The increasing number of beneficiaries will also make it harder for the government to pay the promised benefits.  Social Security and Medicare already consume over one-third of the federal budget, and cost over $1 trillion each year.  The cost will only increase, and despite what politicians say, there is no Social Security Trust Fund to draw upon.  It’s only a bunch of paper IOU’s from the government to itself.  The excess Social Security taxes have been spent on other programs.

Unless some significant reforms are made, I predict a crisis will occur in the next decade.  Here are a few examples of modifications that will help sustain Social Security.

  • The retirement age should be adjusted every decade.  As the average life expectancy goes up or down, so should the age for receiving benefits.
  • Benefits should be adjusted based upon financial need, especially for disability and survivor benefits.
  • Increase taxes, but only after other benefit reductions have been enacted.  In the 75-year history of Social Security, benefits have not been curtailed, but the tax rate has nearly quadrupled.

I don’t see any way that current beneficiaries can be paid if money is taken out of the system, so complete privatization is off the table.  However, there needs to be a lot more transparency of the amount of taxes you pay on an annual basis, and the calculation of your projected benefits.  If Social Security must benefit everyone paying into the system, then let’s treat it more like a private pension plan. 

Having squandered nearly $2 trillion of excess Social Security taxes that was intended to pay benefits to the Baby Boomers, politicians and the Social Security administrators need to be held more accountable for their management of our money.  Social Security is not a 401(k), but more information can be provided than simply showing how much you have earned each year and the estimate of your future benefits.

Ideally, I think Social Security benefits should transition back to a program that is primarily a benefit for people who have little retirement assets or other income to support themselves.  Stop treating it like a private pension plan, where you pay a lot of money into the system, and expect to receive it back with a rate of return.   There will need to be a grandfathering for those who are currently receiving benefits and those close to retirement, but over time, the benefit structure can change.

Allow Social Security to be part of the safety net for those who are vulnerable and in need.  The benefits may not be great, but that’s okay.  It’s not intended to give you a lavish or comfortable lifestyle.  The purpose is to provide basic sustenance so that you can still live independently.  The cost of such a program should decrease dramatically, which should also reduce the tax burden and free up more money for you and I.  Therefore, the reduction in benefits should also be coupled with greater incentives for people to put more money into their own retirement plans.

 In the past few articles, I have made my case for why Social Security is in trouble, and offered some ideas of how to reform the system.  I hope that I’m wrong and the system won’t face a major crisis within the next few years, but from what I know I don’t see how that’s possible. 

I doubt you have agreed with all of my analysis, opinions and ideas.  Good.  My intention was to provoke your thinking and encourage a discussion.  The problem is enormous and no one has all the answers, especially not me, but I do believe that by working with all different types of people, we can avert a crisis and keep Social Security sound for many years to come.

Social Security Reform: Privatization

Of all the issues concerning the potential reforms of Social Security, nothing is as controversial as the topic of privatization.  The mere mention of it will likely spark a fierce debate from people of all walks of life and political persuasions. 

The history and issues of privatization are much more extensive than can be covered in this short post.  If you want an in-depth discussion of the issues, read this Wikipedia article.  For a quick synopsis, check out this side-by-side comparison on

President Bush made a push for privatization in his 2005 and 2006 State of the Union addresses, but Congress showed little interest in tackling this issue.  Given that President Obama is strongly opposed to this concept, there has been little discussion of the matter in the past 18 months.  The debate over the future of Social Security will continue, and as the pressure for reform mounts, expect privatization to be part of the discussion, even if it doesn’t become part of the solution.

It may be a good thing that a portion of everyone’s retirement benefits remain fixed and secure.  As most retirement and pension accounts have been battered over the past couple of years, the lure of placing more money in the stock market has lost some of its luster.  However, when you consider that the projected rate of return for people born after 1965 is less than 2%, you can understand why people want a greater level of control and rate of return.  Many Gen X’ers and Millennials doubt they will ever get back what they paid into the system, let alone receive a rate of return.

One of the greatest barriers to privatization is dealing with the short-term deficits that would occur in trying to pay current Social Security recipients.  When Social Security is referred to as a huge Ponzi scheme, advocates quickly point out that Social Security is a pay-as-you-go system.  Since current tax collections are paying present benefits, there would be a huge deficit if taxes were re-directed into private accounts and invested outside of Social Security.  Given the number of Baby Boomers set to retire in the next 10-20 years, I doubt the government could raise the revenue necessary to meet this obligation without retaining current Social Security taxes.

A primary purpose for enacting Social Security in the 1930’s was to help provide a basic retirement benefit for elderly people who were suffering through the Great Depression.  They either had no pension plan or were wiped out when the stock market crashed.  Allowing for complete privatization with self-directed accounts would be an abandonment of the original purpose of Social Security and risk having another group of retirees with no money.

You may feel like you are a savvy enough investor to take on such a risk, but the failures of the past 2-3 years should prove that anyone is at risk.  Many unsophisticated financial consumers got burned with subprime and option ARM mortgages.  At the same time, veteran Wall Street traders lost big too, which proves that everyone is susceptible to massive investment losses.

Unlike the other three reform options (raising the retirement age, reducing benefits and raising taxes), I’m not going to proffer an opinion on privatization… at least not yet.  I want to discuss reforms to the perceptions and politics first.  After that, I’ll tell you what I think about privatization.

Social Security Reform: Raising the Retirement Age

One option for extending the life and solvency of Social Security is to extend the retirement age.  This has a two-fold benefit.  By working longer, more taxes are paid into the system, and less money is paid between retirement and death.

Since Social Security was passed in 1935 the retirement age has changed only once – in 1983.  The change was not implemented immediately, but phased in for people who were less the 40 years old at the time of enactment.  For the first 74 years of Social Security, you could retire with full benefits at age 65.  Starting in 2009, retirees had to wait until they were 66, and for those people who turned 50 this year, they will have to work an extra year… all the way to 67 to get their full benefits.

By the time the retirement date of 67 is fully implemented, Social Security will have been in operation for 92 years.  The average life expectancy of Americans has increased well in excess of 2 years during that period.  That’s not a bad thing, but Social Security was not originally designed to pay benefits to people for multiple decades.

The average life expectancy in 1930 was 58 for men and 62 for women; both below the retirement age of 65.  According to Social Security data, these statistics were skewed by a high infant mortality rate, and the life expectancy for those who reached 65 in 1935 is only 5 years less than those who reached 65 in 1990.  Aside from statistical arguments, common sense tells us that medical advances are allowing people to live longer today than they did 75 years ago.

Ida May Fuller received the first monthly Social Security check in 1940.  She had paid $24.75 in Social Security taxes.  Her first check was for $22.54.  She lived to be 100 and collected checks totaling $22,888.92.  Ida May Fuller received a 92,480% rate of return on her money. 

Most of us hope we have the genes like Ida May and enjoy a long life.  That’s all good, but Social Security was not intended to be a long-term pension system for large numbers of people.  It could be, but it would take a lot more tax dollars to support the system.  While Ida May is an extreme example, many current retirees have received money far in excess of their contributions, plus a reasonable rate of return.  In contrast, many Generation X’ers don’t believe they’ll see any of their money back.

With the future of Social Security on a perilous path, I believe that periodically increasing the retirement age to receive Social Security benefits is necessary.  Social Security was not supposed to be a mechanism to help you retire early and live as many years in retirement as you worked.  “Early retirement” was not common in 1935.  It’s great if you can afford to retire early, but don’t rely upon Social Security to do it.  It’s your choice to stop working early, but it’s also not up to the rest of us to help subsidize your life of leisure.

You may think it’s great if you get a rate of return similar to Ida May Fuller, but remember, the money isn’t just created.  Someone else’s tax dollars is the source of providing you an exceptional rate of return.  A few people can reap huge rewards, but eventually the system will collapse like an illegal Ponzi scheme if everyone wants to take out of the system far more than they paid in.

The retirement age shouldn’t change annually. It makes more sense to change it every decade after the census is completed.  Like the change in 1983, don’t change the deal for current beneficiaries or those very near to retirement.  Change it for those who are 50 or younger, which still gives you 15+ years to plan and prepare for the age you can receive your Social Security retirement benefits.

As the life expectancy goes up or down, it makes sense for the age to receive full Social Security benefits to change accordingly.

Is Social Security Sustainable?

“This report is yet another reminder of what we have known for some time: Social Security’s long-term financing problems are very serious, and will not be fixed by wishful thinking alone.”

This quote probably sounds like it comes from some radical right-winger warning of the pending doom of Social Security.  However, this statement was issued by Jo Anne Barnhart, Commissioner of Social Security on March 17, 2003 when the 2003 Social Security Trustees Report was issued.  The press release for the report stated, “The Social Security Board of Trustees today declared that the Social Security program is not sustainable over the long term.”

For years, economists, politicians and citizens have expressed concern about the longevity and future of Social Security, but little has been done to address the problem.  Social Security has been the third rail of politics. Touching it is tantamount to political suicide.  The brave souls who have tried to address the looming crisis have met with such resistance that little has been done to change the system.

You don’t have to be a rocket scientist to recognize the unsustainable structure of Social Security, which is probably why I can understand it.  People will banter around sophisticated arguments about comparisons to GDP, the Social Security Trust Fund, the lockbox, actuarial infinite horizons, pay-as-you-go, etc.

Beyond intellectual arguments, when you consider a few simple facts about Social Security, the picture is not rosy, but fairly clear.

  • The Social Security Trust Fund has no real money; it’s just IOU’s from the government to itself
  • When Social Security was passed in 1935, the average life expectancy at birth was age 60; by 2000, it had grown to 77
  • Social Security initially had 42 workers paying into the system for every one receiving benefits; the number has dropped to approximately 3:1 and is expected to decline to 2:1 over the next four decades
  • Social Security and Medicare currently consume about 40% of all federal spending; expect the percentage to increase as the Baby Boomers move into retirement

What do you conclude after considering these four simple points?

Is Social Security sustainable?  The quick answer is yes.  Like most spending, if it’s a high enough priority, you will find a way to make it happen.  Social Security may continue to consume a larger amount of the government revenue, but it can be sustained if it’s a high enough priority.

Probably the better question is whether or not Social Security can be sustained in its current form? In my opinion… No.  As was stated by the Social Security Board of Trustees in 2003, the program is not sustainable over the long term.  It can be maintained, but only if changes are made. 

Social Security may be the third rail of politics and addressing it could end a political career.  However, the continued failure to address the systemic problems of Social Security could cause economic and social peril for millions of Americans if something isn’t done soon. 

Having addressed the problems with the Social Security system, it’s time to consider some solutions. Coming up next…

Social Security: A Legal Ponzi Scheme?

A Ponzi scheme is a fraudulent investment structure in which “returns” are paid to investors with money from subsequent investors. No actual money is made.  It all works fine as long as new investors continue to contribute money.  Once the payment of returns exceeds new investment, the whole thing collapses like a house of cards.

Politicians and Social Security administrators loath for anyone equate Social Security to a Ponzi scheme.  The first line of defense is that Social Security is legal system of collecting taxes and paying benefits, versus an illegal scheme where no money is made.  They also argue that Social Security is a pay-as-you-go system, in which current workers are paying the benefits for a prior generation.

Clearly there is a difference between a bona fide government program and an illegal investment scheme.  Rather than summarily dismissing the arguments as political rhetoric, we should examine if legitimate correlations can be made.

The sustainability of Social Security is primarily dependent upon existing workers paying taxes to support the current beneficiaries.  Social Security is dependent upon a continuous stream of “new investments” to pay “returns” to prior “investors”; much like a Ponzi scheme.  If new money stopped flowing into the Social Security system, it would likely collapse like a Ponzi scheme.  Of course, it’s illegal for you to voluntarily stop making contributions.

Another similarity between Social Security and a pyramid-type scheme is the number of people contributing in comparison to the number of people receiving a benefit.  Social Security was designed to have many people paying into the system to support the few who are receiving the benefits.  This is probably the greatest challenge the Social Security system faces.

When implemented in 1937, checks were issued to 53,000 beneficiaries.  The U.S. population at the time was approximately 128,000,000.  The current U.S. population is about 310,000,000, and there are nearly 51,000,000 Social Security recipients.  Social Security recipients have grown from 0.04% of the population to 16.45%.

Dr. Walter E. Williams wrote an article on this very topic.  He points out that in 1940, there were 42 workers paying in to Social Security for every person receiving a check.  That ratio has steadily dropped through the years.  The current ratio is approximately 3 workers for every retiree.  As the Baby Boomers retire in droves, this ratio will grow even narrower.

This situation is going to present major challenges for political leaders in the near future.  Since there is no real money in the Social Security Trust Fund, the only way the pay-as-you-go system can be sustained is to raise taxes and/or curtail benefits.  I suspect it won’t be long before you see both being enacted.

Social Security is not a Ponzi scheme.  However, the system parallels a Ponzi scheme; current contributions return money to prior beneficiaries, and it takes funds from multiple people to return money to a few.  Aside from the political rhetoric and emotions attached to this issue, the U.S. government is going to face significant challenges raising revenues from a shrinking workforce to pay benefits to an increasing population of retirees.

Social Security may not implode like a Ponzi scheme house of cards, but only because Congress can force continued contributions to keep it afloat.

Social Security Solvency and the Crossover Date

Most of the discussion surrounding the solvency of Social Security is focused on the year in which the so-called Social Security Trust Fund is depleted.  In my opinion, the projected insolvency date is much less important than the crossover date.  The crossover date is the point in time when Social Security tax receipts are less than the Social Security benefits being paid.

Did you know that this is going to happen this year (three years earlier than expected)?  Social Security payments in 2010 will exceed receipts by $41 billion.  The Social Security Administration attributes the acceleration to the economic recession.  High unemployment and falling wages have reduced tax receipts.  Additionally, more seniors have been forced to file for benefits as other sources of income have fallen.

Politicians have not expressed any concern and noted that the last crossover date was in 1983.  However, I don’t see any comfort in knowing that this happened for a short time in the early 1980’s.  The situation today is a lot different than it was 27 years ago.

The primary difference is demographics.  In the 1980’s, the Baby Boomers were heading into their peak earnings period.  Thus, there was a burgeoning group of wage earners who could help keep the system afloat.  Nearly 30 years later, those same people are moving towards retirement and will start drawing unprecedented dollars from the Social Security system.   

The significance of the crossover date stems from an understanding of the government’s fiscal management.  For years, the government has collected tens and hundreds of billions more in Social Security taxes than it paid in benefits.  This resulted in the creation of the Social Security Trust Fund, which was supposed to have saved trillions of dollars to pay future benefits.  See my post on why the Social Security Trust Fund does not exist for an explanation of why this means little in real economic terms.

 The excess Social Security taxes were not saved, they were spent.  Thus, the U.S. has been funding part of its programs and spending through the extra Social Security taxes collected.  Once the crossover becomes permanent in 2014, there is going to be an increasing burden on the budget, spending and deficit of the country.  Despite being able to balance the budget for decades, the federal government will need to simultaneously work towards balancing the budget and raise additional funds to pay Social Security benefits.

Think of it in these terms.  It’s like a person who has been consistently overspending for years and has been financing their lifestyle with credit cards that have minimal or no monthly payments.  Eventually, the credit lines will run out and they have to start repaying their debts.  Not only do they have to reduce their spending to balance their budget, they have to curtail it even further to service the debt.

This is exactly the situation the U.S. government is facing.  It has to raise taxes or reduce spending by hundreds of billions of dollars ($1.4 trillion for fiscal year 2010) to balance the budget.  They will have to cut spending or raise even more revenue to fund Social Security benefits ($41 billion this year).  The more Baby Boomers retire, the wider the gap between receipts and expenditures, which will make this task even more difficult.

Can this be done?  Absolutely… but it’s going to be painful.  For years, Washington politicians have shown little resolve to balance the budget.  Although the current recession has generated a lot of talk about deficit reduction and balanced budgets, the red ink flowing out of Washington is about as controlled as the oil that spewed out of control into the Gulf of Mexico.

For me, the solvency and potential crisis of Social Security is not determined by some hypothetical date 20+ years into the future.  It’s coming shortly after the crossover date becomes perpetual.  Finding a way to pay for current federal spending while simultaneously meeting the mounting obligations to seniors for Social Security and Medicare are monumental tasks.  It will likely result in a political crisis, and could lead to an economic crisis.