The future of your Social Security benefits is at great risk and trapped in a system hurtling toward bankruptcy. Or maybe your government-sponsored retirement benefits are just fine. It all depends on whom you ask. Uncertainty about the financial health of the Social Security system is playing a huge role in Americans' retirement planning -- and likely will work its way into the fall election season. President George W. Bush and the presumptive Democratic candidate Sen. John Kerry of Massachusetts, as well as candidates for the Senate and House of Representatives, will offer their ideas for fixing a retirement benefit system some critics say is beyond repair. The recent release of a key government report that says the system is in better shape than generally believed brings the debate into focus once again, though it doesn't directly address the issue of private retirement accounts, support for which is pretty much split along partisan lines. About 47 million people now receive some form of Social Security benefits, but the projected increase of 30 million more baby boomer beneficiaries has observers of every ideological stripe concerned the system won't be able to keep up. The Congressional Budget Office said the Social Security trust fund will be depleted by 2052, a decade later than the long-term predictions issued by the trustees of the retirement system. The latest report also says Social Security spending will jump from its current 4.4% share of the gross domestic product to more than 6% by 2030, while current federal revenue dedicated to the system will remain steady at about 5% of GDP. The CBO report was intended to update lawmakers on the state of the Social Security system, and complement its reports on Medicare and Medicaid spending, issued at the end of last year, a spokesman for the office said.
Bush and many Republicans long have advocated the creation of individual retirement accounts using part of workers' Social Security taxes to allow people to invest in stocks and bonds on their own. Variations on this theme would divide worker contributions between the existing Social Security system and private investment accounts, with some curbs on how the money is invested. Kerry and many Democrats believe the current system is in need of repair, not renovation. Democrats argue there's no need to put retirement benefits at risk in the stock market if the system can be fixed, while Republicans and critics of the current system say debating the difference in the reports fails to address Social Security's fundamental flaws. Critics say the report's finding that Social Security will need more money from the general revenue fund by 2019 is more important, because that will siphon money from Medicare and Medicaid. Expect to hear from each side frequently in the run-up to the July 26 start of the Democratic National Convention and the Aug. 30 kickoff of the Republican National Convention. "The latest talk from behind the scenes in Washington is that President Bush will begin laying out a second-term agenda from the convention on," says Michael Tanner, director of health and welfare studies at the Cato Institute, a libertarian think tank that supports private retirement accounts. "I think Bush needs a big domestic idea, and I think he wants to do this. If he wants to do this in 2005, he needs to talk about it now." There is currently a host of reform proposals in various stages of legislative development, led by a trio of models from the Bush administration, which tackled the issue through the President's Commission to Strengthen Social Security.
The first leaves the current Social Security system, in which workers are taxed 12.4% of their income up to $85,500, unchanged, but would allow them to voluntarily dedicate another 2% of their taxable earnings to individual investment accounts. The second and most closely watched proposal, according to experts, would allow workers to put up to 4% of their Social Security tax contributions -- up to $1,000 -- into individual investment accounts. The remaining portion would go into the existing fund. Under the proposal, the government would track the rate of contribution to the individual account, and reduce regular Social Security benefits proportionally. Investment options for the retirement accounts would be limited to a quartet of investment funds -- a stock index fund, a bond index fund, a fund of Treasury Inflation-Protected Securities, or TIPS, and a fund investing in government securities. That's similar to the model used by the federal Thrift Savings Plan used by retired government employees. The new Social Security program would allow investors to spread their allocations however they wish, but would create a 50% stock, 50% bond portfolio if they did not make any active allocation, says Olivia Mitchell, who served on the 16-member bipartisan commission and professor at the Wharton School of the University of Pennsylvania. "This is still a payroll tax, as members of the commission pointed out," she says. "We want to make sure that people don't squander their money and invest it all in the latest high-tech stock that then collapses in a bubble." That plan also would tinker with the existing benefits system. Benefits are currently indexed to real earnings growth, and would be indexed to the rate of inflation under this plan, which would lower people's initial benefits. Michael Kitces, a financial planner in Columbia, Md., says the voluntary contribution concept is fine in principle, but won't have much impact in practice. "It's not terribly useful for most Americans, because they don't have the cash to save in the first place," he says. "Our country has a terrible tendency to spend, and spend and not save, and when we can't spend more, we use credit and go into debt." Under the second plan, benefits also would shrink because of changes to the system's longevity index, which would pay benefits on the assumption people will live longer, but they'll receive less money each month as a consequence. But people who earned low wages and the survivors of low-wage earners would see their benefits increase.
Kitces says these adjustments get to the real heart of Social Security reform -- they cut benefits, which is the only way to fix an unworkable system. People receiving benefits now are getting a much better rate of return than their contributions warrant, and workers now paying into the system are bankrolling those benefits. It will take 10 to 20 years for individual retirement accounts to provide returns that would offset shrinking benefits from the Social Security trust fund. This gives me a real incentive to contribute to these accounts, because that's money I can keep," he says. "The rest of the money that you're putting into the fixed-income portion of the system is still going to be subject to reduced benefits." Even if you put money into one of these accounts, Kitces warns there's no guarantee that you'd prosper. "A lot of people aren't good investors," he says. "They make decisions based on fear and greed, and that's the same as buying high and selling low. This is an opportunity to undermanage that money and have even less." Under the third plan, workers would have to increase their own contributions to the system -- contributing another 1% of their taxable income to individual investment accounts -- in order to divert 2.5% of their existing Social Security taxes to the investment accounts. This so-called carve-out also would be capped at $1,000. This plan would have similar provisions for low-wage earners and adjust for beneficiaries' longer life spans. Kitces says that national savings habits will make this plan useless for all but those who can afford the voluntary contribution, but that anyone who could manage it would be protecting more of their money as the rest of the system weakens. "It's very much the worst of the first two
proposals ," he says. "It's almost a hidden trick against people who keep their money in the regular system. " Backers of reform say it will serve several generations. "What we were doing on the commission was trying to not merely design a personal account plan, but to make the system more reliable and stable for us, our children and grandchildren," Mitchell says. "I'm a baby boomer, I'm 50, and I'm looking ahead to 15 years from now. I don't want the system to run out of money, and I'm focused on the near and dear." Robert Ball, a Social Security commissioner from 1962 to 1973, says Bush's plan for retirement accounts is flawed.
"You just don't need to do what the president suggests," he says. "It would cost $1 trillion, and some people would wind up with more because they were lucky investors, while some would be getting much less, or even nothing." Chad Kolton, press secretary at the Office of Management and Budget, says the trustees' report figures are used in its budget projections, but that the slight differences between that report and the CBO's findings share one basic conclusion. "Whether it's 2018 or 2019, there will be a point where Social Security would require money from the general treasury, and that would continue for 40-some years until the program becomes insolvent," he says. "In order to maintain Social Security for the long term, changes would need to be made." Tanner says Bush will have a chance to make a virtue of necessity at the convention. "Both of those reports concluded the same thing -- Social Security is unsustainable in its current form," he says. "There are only three options: raise taxes, cut benefits and invest privately. I think raising taxes and cutting benefits is unacceptable."