President Bush has ventured into several areas of both domestic and global policy that few politicians have dared to go before. While it seems that he has received more criticism than praise for most of his proposed policies, he deserves thanks for bringing the issue of Social Security reform into the national spotlight. It has long been considered political suicide to even discuss making any changes to the current Social Security benefits formula or how to pay for it.
Social Security, like most government programs, is a complex and bloated program that is not going away. Although the current administration has shown courage in raising the issue, it is doing a poor job of explaining the breadth of the problem and what needs to be done to fix it. As a private investment advisor, I’ve come to realize, in my client interviews, that most people are very unclear about how the current system operates and even more confused about how this new system proposed by the administration will benefit them. Most are doubtful that there will be sufficient funding in the system for them when they retire, and as things stand now, they’re correct.
In the Marin and Sonoma counties, close to 25% of the population is over 55. By 2010 the first wave of Baby Boomers start to draw benefits, and by 2017, when the bulk of those born between 1945 and 1963 hit the system, Social Security will have to pay out more than it brings in. By 2010, there will be over 100,000 people in Sonoma County alone who will be either on Social Security or eligible to begin receiving benefits. Currently, 62 is the earliest age that anyone is eligible for benefits; at age 67, you receive 100% of eligible benefits. If you’re willing to wait until age 70, you would receive 110% of eligible benefits. Don’t be surprised when those age limits are increased.
Currently, the $1.5 trillion in Treasury bonds that are held in the Social Security trust fund generates $80 billion per year. That, combined with current payroll tax revenues, creates an excess each year. Congress has been borrowing that excess annually to balance the budget, thus adding to the future debt load that all Americans will share. Starting in 2018, Social Security will have to start selling its Treasuries to meet its obligations, and by 2042, it will only be able to pay out 75 cents for every dollar of eligible benefit.
The annual rate of return that Social Security is currently collecting from the U.S. T-Bills that it owns is approximately 3%. Allowing for inflation, anywhere from 1% to 3% annually depending on who you believe, the net return on our Social Security contributions, in terms of buying power, is zero. The current program is completely funded by debt, and that debt has to be paid back by the American taxpayer.
Two-thirds of Americans feel they will reach their savings goal by the time they retire, yet only 51% are on track to do so. That would mean that 49% of us are going to be dependent upon Social Security to supplement all or part of our retirement. With the cost of living increasing at a faster pace, fewer dollars will be going into retirement plans, reducing further the number of us who will reach our savings goals. Some form of forced retirement savings plan that allows each individual some discretion over investment risk and prevents Congress from raiding those funds to balance the budget needs to be implemented. Younger workers would be the biggest beneficiaries of personal retirement plans: they can be assured that there will actually be something there when they retire; it will be in their control; and they will be able to pass it on to their heirs.
I believe some form of President Bush’s plan needs to be adopted, but that alone will not solve the problem. As I mentioned earlier, 49% of working adults are not going to reach any form of financial independence and will be dependent on the taxpayer for some or all of their post-employment living costs. Using President Bush’s plan, a 21-year-old earning $35,000 per year and allowed to direct 4% of his Social Security taxes into a private pension plan would have approximately $250,000 at retirement.
Unfortunately, adjusting for 2% annual inflation, an amount closer to $550,000 in future value would be needed to purchase $250,000 of goods and services in today’s dollars. With that in mind, it’s apparent that those under 50, the age for eligibility in the private pension plan, are going to need to accumulate considerably more in their savings plans if they hope to retire completely from working.
Obviously, something else needs to be done.
I think the most sensible approach to this problem is to institute both an increase in the taxable income thresholds and implementation of personal pension plans. Let me explain. The current Social Security payroll tax of 12.4% only applies to the first $90,000 of adjusted gross earnings. Approximately 6% of the population makes over $90,000, leaving $845 billion untaxed. If we increase the taxable threshold to just $120,000, an additional $203 billion would be raised over a 10-year period. In addition, it makes better sense to me to allow those people under age 55 to increase the annual contributions that they can make to their self-directed retirement plans such as IRAs, Roth IRAs and 401(k)s. These programs have been functioning well for years. In this way, people under the age of 55 would be getting private pension plans, but we wouldn’t have to create an entire new bureaucracy to deal with it.
This plan should have bipartisan appeal. By increasing the income threshold for Social Security contributions, President Bush should get the Democrats on board. Allowing workers to put part of their Social Security contributions into IRAs and other personal retirement plans should appeal to the Republicans. Politically, each side would give a little and get a little. In the end, all of us would win.
As fair and logical as my solution may sound, the reality is that any tax increase to pay for a reformulation of Social Security is politically unbearable for both parties. Bush has recently suggested that future benefit payouts could be indexed to income. Starting at $20,000 of earnings, there would be a reduction in the payout. The more you make, the less you get. Those with incomes of approximately $50,000 or more would receive a 49% reduction in their scheduled benefits. His intent is to insure that the poorest workers receive their full share while everyone else only gets a portion of the benefits they’re entitled to. This turns Social Security into nothing more than another welfare program.
Obviously this is a volatile issue because it affects all of us, and it will not be easily fixed. Reducing benefits for upper income retirees is a lame attempt to appease the Democrats, and raising the taxable income limits goes completely against the Republican doctrine regarding taxation. Look for the Democrats to start throwing out ideas in the near future on how they would save the system.
The Òhead in the sandÓ approach that Congress has adopted for far too many years is going to hit all of us very hard if action isn’t taken sooner rather than later. Eventually, this issue will reach a crisis, and the solution will be to dump it in the taxpayer’s lap. It doesn’t have to be that way. We need to elect politicians that care more about the people they were empowered to protect and less about empowering themselves.
Ken Macheras is president of Private Capital Management, a Registered Investment Advisory firm specializing in comprehensive asset management as well as estate and financial planning matters. Mr. Macheras can be contacted at 817 College Ave., Santa Rosa, CA 95404 or call 707-526-7282. E-mail: ken.macheras@callatg.com
