Unexpectedly Intriguing!
August 31, 2005

Gerald Dwyer of the Federal Reserve Bank of Atlanta has written an excellent overview (available as a 557KB PDF document) of the risks associated with Social Security reform, focusing on the risks to individuals whether the current system reformed to add a personal account option or if the current system is never reformed.

Dwyer begins by correcting a misconception that Social Security retirement benefit program, as it is presently structured, has no risk, which is frequently

While the existence of risk may seem like a difference between Social Security and private accounts, it is not. All plans for the future involve risk, and the further out the plans, the greater the risk. Private accounts and Social Security are no exception to that rule. Private accounts just have difference risks than Social Security...

Dwyer proceeds to note the risks of private accounts and the risks of the current Social Security system. The risks of private accounts to individuals include the following:

  1. The private account may not have enough funds to pay for planned expenditures, depending on the amount of gains or losses over time.
    • The investment options that would be available for individuals would not have the idiosyncratic risk of owning individual stocks, but would have the possibility of recessionary risk, which affect diversified stock portfolios.
    • Inflation may reduce the effective rate of return on a private account.
  2. Money set aside in a private account as part of Social Security could only be used to finance retirement, and could not be withdrawn for other purposes.

On the other hand, there are inherent risks in Social Security that face the program's individual benefit recipients, of which many are unaware, which include:

  1. Participants in Social Security do not have ownership rights.
    • Congress may change the level of benefits at any time, without any restriction regarding the level of benefits previously provided in the law.
    • The recipients of Social Security benefits have no recourse in the courts if benefit levels are reduced.
  2. The possibility of never receiving any retirement benefits.
    • The individual benefit recipient must live to retirement age.
    • The U.S. Supreme Court has ruled that Congress may deny Social Security benefits to people who would otherwise be eligible (Flemming v. Nestor, 1960).
  3. The level of taxes to support Social Security may change, as might the level of benefits.
    • Congress has acted to reduce retirement benefit levels in the past, including having scaled back the benefit formula in 1977, making benefit payments taxable in 1983, increasing the retirement age from 65 to 67, and increasing the amount of benefit payments that may be taxed from 50% to 85% in 1993.
    • The Social Security Administration has projected that it will begin running annual deficits as early as 2017, which will lead to the depletion of the trust fund supporting retirement benefits in 2041. At that time, the level of benefits will be automatically adjusted to meet the level of money coming into the program, reducing the level of benefit payments by 26%.

Dwyer concludes that in adding personal accounts as part of reforming the current Social Security system is really trading one kind of risk for another:

A private account trades the risk of future reductions in Social Security benefits and the risk of dying before retirement for the risks associated with holding financial assets.

Dwyer notes the risks of holding financial assets is already known to roughly 60% of the working households of the U.S., who already have access to such investment accounts. For the remaining 40%, the option to have private accounts would make the opportunity to accumulate assets possible for the first time. These accounts would allow these families to "diversify their retirement plans away from reliance on scheduled payments from Social Security, especially for those with relatively little in the way of likely retirement income other than Social Security."

Isn't the opportunity to have true ownership of a portion of one's lifelong contributions from their work combined with the reduction of risk to the individual that comes with diversification reason enough to support having personal retirement accounts within Social Security?


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