TMFBro (< 20)

They're baaaaack: Social Security personal accounts

March 18, 2011 – Comments (8)

Given the crash of 2008, you might have thought that this was a dead issue. But all it takes is a couple of years of good stock-market returns to bring it back. The latest person to call for personal accounts is Peter Ferrara in Forbes ("A Winning Plan for Social Security Reform"), who's been making this argument for years.

Let's start with this line: "Last year, for the first time since President Reagan saved the program in 1983, Social Security began running a cash deficit."

Permit me to make a political detour right off the bat:

*Why do presidents get all the credit/blame? Ferrara here is referring to the Greenspan Commission, which involved politicians and experts of all stripes (and a future Fed chair), and the recommendations were approved by Congress.  Why do we refer to things such as the "Bush tax cuts" or "Obamacare" when it takes Congress to first initiate legislation and a majority to pass it? The second major tax bill of the Reagan Administration was sponsored by two Democrats. Just sayin'...

*This is a great example of all the weird, amnesiatic Reagan worship. The contemporary hagiographers will sing his tax-cutting praises, but the Social Security Reform Act of 1983 raised taxes (and the aforementioned tax bill cut the top marginal tax rate, but raised the lowest tax rate). The truth is, during the years Reagan was in office, taxes were lowered for some, raised on others (perhaps the majority). There are plenty of legitimate reasons to admire Reagan (such as his courage to take on the problem of Social Security). Why make stuff up or exagerate what happened? Reagan didn't "save" Social Security in 1983; otherwise, why is Ferrara writing about reform now?

Now, onto personal accounts. Ferrara writes: "Workers could be allowed to save and invest what they and their employers would otherwise pay into Social Security in personal savings, investment and insurance accounts.  Studies show that at standard, long term, market investment returns, for an average income, two earner couple, over a career the accounts would accumulate to close to a million dollars or more."

The problems here should be obvious:

1) Anyone counting on "standard, long term, market investment returns" over the past decade has been sorely disappointed. Who knows what future returns will look like?

2) We at The Motley Fool are champions of the individual investor, but plenty of other studies -- and my own experience interacting with hundreds of readers -- indicates that the average worker is no Warren Buffett, and (very understandably) finds it challenging to grow a family, manage a career, and also become an investment expert. Even if future investment returns are like what we've seen over the past 80 years or so, that doesn't mean investors will actually capture them, once behavior and costs are accounted for.

Next: "Another virtue of these personal accounts is that with workers financing their own benefits through their own savings and investment, they can be free to each individually choose their own retirement age.  Moreover, they would have market incentives to choose on their own to delay their own retirement ages as long as possible, because the longer they wait the more they would accumulate in their accounts, and the higher benefits those accounts could pay."

Pluses and minuses on this one. I like the idea of more choice, and Ferrera makes a great point about the benefits of delaying beyond 70 with private accounts (there's no benefit to delaying beyond 70 under the current program). But I am also of the opinion that too many (perhaps most) people retire too early, and allowing them to tap their Social Security accounts in their 50s or earlier could result in their running out of money before they run out of life. Whether or not the government should protect Americans from their own mistakes is a worthy discussion. Maybe it's just the price of freedom.

Next: "Moreover, all those funds [the personal investment accounts] would pour into our economy as a mighty river of increased capital investment, rapidly expanding economic growth.  Those funds would finance the practical implementation of our rapidly advancing science, leapfrogging our economy further generations ahead."

I don't know enough about economics to know if this is true, but it sounds good. Perhaps we could look at a similar experience: Did the emergence of the 401(k) lead to "rapidly expanding economic growth"? Or is that different, since that was essentially a transfer of defined-benefit assets to defined-contribution plans? Perhaps you have an expert opinion, or could cite one.

One benefit of personal accounts that wasn't mentioned: You could bequeath money you accumulated to heirs. You can't do that under the current program (except for spouses who earned less than their deceased spouses). If you die before claiming benefits, your family gets nothing (though they benefited from the disability insurance provided by Social Security, something that should be accounted for in any reform). 

Another thing personal accounts do, theoretically, is solve the funding/shortfall problem. The benefits are based solely on what the worker accumulated, and not on some future benefit. (There would have to be a transition time, so that those in or near retirement received their currently expected benefits.) This is the challenge of Social Security as well as traditional pensions: You're making future promises without knowing what the future economy, investment returns, health breakthroughs, and longevity will look like. With personal accounts (in the words of the mother in the children's book "Pinkalicious"), you get what you get and you don't get upset. 

My informed hunch is that personal accounts would work out better for some, not as well for others (perhaps most). But I'm open to being convinced otherwise. 

Robert Brokamp, CFP®, is the senior advisor for the Fool's Rule Your Retirement service.