Retirement Planning for Social Security

(The following was originally published in December 1998 as the executive summary of "Saving Retirement in Michigan: Responsible Alternatives to Social Security," a Mackinac Center Policy Study. Social Security’s 70th birthday was Sunday, Aug. 14, and we reprint the piece below to illustrate how the program could be restructured to improve retirement benefits, stimulate economic growth and enhance personal freedom and responsibility.)

On Aug. 14, 1935, President Franklin Roosevelt signed the Social Security Act into law, declaring it to be "a law that will take care of human needs and at the same time provide for the United States an economic structure of vastly greater soundness."

Today, politicians and citizens alike are discovering that the government-funded retirement system begun by Roosevelt is not only financially unsound, but is increasingly incapable of meeting the human needs of America’s growing elderly population.

Many Americans believe that their Social Security taxes go into an account from which they will draw when they retire. In reality, Social Security is a "pay-as-you-go" system whereby taxes on current workers are directly transferred to current retirees in the form of benefits. This system worked when there were 16 taxpaying workers to support each individual retiree. Today, however, the ratio of workers to retirees has fallen to 3-to-1 and is expected to drop to 2-to-1 by 2030.

In addition, the Social Security Trust Fund will begin paying out more money than it takes in as early as 2015, when the wave of retiring Baby Boomers is expected to double the number of retirees drawing Social Security checks.

These facts mean that the current Social Security system can be maintained only if benefits to the growing ranks of elderly retirees are slashed dramatically or payroll taxes are raised to confiscatory and immoral levels on younger workers. Fortunately, there is a third alternative to dealing with the looming Social Security crisis: opting out of the system in favor of privatizing retirement planning.

The idea of privatization — allowing individuals to privately invest their own retirement savings — is not new. Chile, Great Britain, Australia and other countries now allow workers to invest all or part of their payroll taxes privately, and the results have been impressive. Chilean retirees, for example, now enjoy three times the benefits that they would have received under the old government system.

Here in America, three Texas counties chose to leave the Social Security system in 1981 when Congress allowed state and local governments to opt out. The alternative private investment plan designed by the counties for their employees has also yielded greater returns and increased benefits for its participants.

More than 65 million Americans now choose to supplement their retirement nest eggs with private investment instruments like Individual Retirement Accounts and employer-sponsored 401(k) and 403(b) plans, which also outperform Social Security.

Social Security privatization would benefit all workers, especially the bottom 20 percent of wage earners who cannot afford to invest part of their paychecks and must rely mostly on Social Security for their retirement. Workers who were allowed to invest even 2 percent of their paychecks (as opposed to the 5.26 percent of their payroll taxes that go toward retirement) could earn instead 9 percent to 35 percent more than what they would receive from Social Security, depending on their income level.

A number of plans to privatize all or part of the Social Security system have been proposed, but one kind of so-called privatization should be avoided: having the federal government manage retirement fund investments. Direct government investment in the stock market versus individual private investment would lead to unprecedented politicization of the American economy. "Politically incorrect" companies and their customers and stockholders would suffer as important market decisions were made by politicians and bureaucrats, not by workers and retirees, the people with the largest stake in the investment.

Critics of Social Security privatization suggest that private investment of retirement funds is too risky. They warn that market downturns could wipe out the nest eggs of workers who are ready to retire. But this fear is unsubstantiated. Although it is true that markets experience short-term fluctuations, retirement savings are invested over a lifetime. An analysis of the performance of stocks shows that since 1800, there has never been a 20-year period in American history when stocks produced a net loss in real terms.

In May 1997, the Oregon Legislature passed a resolution urging Congress to grant waivers to let states opt out of the federal Social Security system and design their own retirement plans for both private-sector and government employees. Since then, Colorado has adopted a similar measure and six other states — Arizona, Indiana, Missouri, New Hampshire, South Carolina and Washington — are also considering opt-out proposals. The Michigan Legislature should adopt a resolution that asks Congress to do either of the following:

• Partially privatize the existing Social Security program by allowing workers to shift all or part of their current 5.26 percent Social Security retirement payroll taxes into privately owned and managed accounts up to the allowable limit of $10,000 per year; or

• Grant the state of Michigan a waiver to opt out of the federal Social Security system and design a sounder and more beneficial retirement plan for its citizens.

Many countries have already increased millions of citizens’ retirement security by turning to private investment to restore fiscal soundness and improved benefits to their pension programs. With a strong economy and government surpluses forecast for the next decade, the United States is in a solid position to move to a privatized pension program that stimulates economic growth, promotes private savings and restores individual freedom.

Michigan should join with Oregon and Colorado to demand that Congress take the correct course and privatize the Social Security system or allow states to opt out and design their own pension plans.

Kent R. Davis is senior adviser for science, environment and technology issues for the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich. Permission to reprint in whole or in part is hereby granted, provided that the author and the Center are properly cited.