Thursday, May 15, 2008

Social Security: Some basic points

While my teenagers may think that I am ancient. I am still more than 20 years away from retirement age. Despite this I still get queries from people close to retirement about social security benefits, so I have an active interest in this government program.

Social Security is a “pay-as-you-go” system. Money paid in by current taxpayers is spent to pay benefits to current retirees. The system is not a “trust fund” in which portions of your paycheck goes earning interest until you retire and are ready to withdraw the funds. This demonstrates why the Social Security system is under stress. As the number of baby boomers retire while at the same time the number of current workers drop, there will be less people paying into the system as a larger number make withdrawals. This, of course, is a recipe for disaster. If I ran a private retirement fund like this, the government would label it as a “pyramid scheme” and promptly toss me in prison. For some reason in the public sector, managing retirement funds in this manner appears to be acceptable.

While politicians in Washington often debate the matter, no concrete reform steps have been taken. Most other leading nations, including Britain and the “socialist” Scandinavian countries have privatized their social security systems. Workers manage their own funds, similar to a 401K, and select from an allowed list of bond and equity instuments offered by the administration.

This is the best path for the U.S., a complete and immediate conversion to a privatized system. Existing retires would have to be paid out via borrowing from the U.S Treasury each year, something the government is already fond of doing. The reality is this type of radical proposal would not make it through Washington and most retiree groups such as the AARP would oppose it. Or oppose it until they woke up one day and found no checks arriving as the current system flounders.

Investopedia touches on these subjects and some Social Security basics in a recent article that is worth reading - 10 Common Questions About Social Security.