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Each year at about this time you can receive an updated social security benefits statement from the Social Security Administration (https://www.ssa.gov/myaccount/). This document will tell you what you can expect to receive on a monthly basis when you retire.

We currently pay 6.2% of our wages towards our retirement (social security). Our employer matches that amount so together 12.4% of our wages are “set aside” for our retirement. Well here is the rub. Even though politicians constantly refer to the “Social Security Trust Fund”, there is no such thing. The trust fund is basically a promise to pay us something in the future.

It is helpful to look at this like a 401K plan. A 401K plan is a form of retirement whereby employees set aside a certain percentage of their earnings for retirement. This set aside is invested in a personal account that you own. Typically the investment choices are high quality mutual funds or ETFs (Exchanged Traded Funds). Many employers will match some or all of the employee deduction. Over a lifetime of employment this can add up to a nice retirement nest egg.

In essence social security is doing the same thing with some very important differences. First, the money that you pay in taxes and the amounts that your employer pays does not belong to you. If you would work for 40 years and die before becoming eligible for benefits, the money is lost; your surviving family has no rights to the money even though you paid into it for 40 years. The same goes if you collect a benefit for a couple of years then die, there is no surviving benefit for your family. Second, your money is not invested and does not grow. In addition, there is a maximum benefit amount that is capped by the social security administration regardless of the amount of taxes that you pay.

There have been efforts by Republicans to privatize social security. This would mean that you would own the money just as you do your 401K. You would decide how to invest it. And you would determine who your beneficiary is if you die. Under Social Security the government is everyone’s beneficiary. When social security was put in place in 1935 the retirement age was 65. The expected life expectancy at that time was 62 years for women and 58 years for men. This should be very telling.

There is always a big fight over privatization when it is proposed. The Democrats argue that individuals lack the ability to choose investments and would be at risk of losing their entire benefit. They say the stock market is too risky. They also argue that there would no longer be a guaranteed benefit (a legacy union concept). In reality the reason these politicians fight to keep it is one to preserve big government, but also since inception the taxes collect have far exceeded the benefits paid. This has created a slush fund to help balance the budget and provide money to spend on other projects. The problem with this is that the pendulum is about to swing the other way. When the baby boomers begin to retire in great numbers benefit payments will far outweigh taxes collected. And since the surpluses were spent rather than put in a lockbox or trust fund as you are told there will be major shortfalls which will have to be funded. From 2000 thru 2009 the taxes collected exceeded the benefits paid by an average of $164 billion per year, from 2010 thru 2016 that number dropped to only $34 billion.

To illustrate just how bad a deal that Social Security let’s look at how private accounts would work. I used a sample case from the SSA website. I assumed that the employee and employer taxes would be invested in an account that you own. The money would be invested in an S&P 500 fund to keep it simple. An administrative fee of 0.17% is used which is consistent with these funds. In this example the person began to work in 1975 and earned $14,100 and retired at age 66 making $137,100. The person would begin receiving $3,064 per month until his death.

If the employee was able to invest his taxes as described above, he would have an account with a balance of $1,299,737 at retirement. With this he could do a number of things. He could purchase an annuity which would give him a guaranteed monthly payment of $9,767 (assuming 2.5% rate over 13 years), or he could leave it invested and draw out money as needed. Even if it earned zero interest, he could take a monthly payment of $8,332 over 13 years. And when he does die his beneficiary gets to keep the money. In this example the taxpayer’s benefit was $1,045,660 less than a private account would have been.

Opponents to privatization always point to the riskiness of the stock market. Yes it is risky and you can lose 100% of your investments. But plan design and education can greatly limit risk. If you look at the returns over all of the years (link below) you see that years with negative returns are highlighted. In 2008 when the internet bubble burst you see a 40% loss. Despite this over this time period the average return was about 7%.

This is a travesty and all tax payers should be able to own and manage their retirement accounts. It is too late for the baby boomers to benefit from privatization but we owe it to our youth to address this.

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