The Social Security Trust Fund will face shortfall after 2032, according to the estimates of The Twentieth Century Fund (TCF). TCF also estimates that, over 75 years, the gap between payroll tax revenues and payments would be about 2% of the projected income subject to the payroll tax. Therefore, this shortfall will only finance close to 75% of the payments. This is the result of more lifetime benefits than lifetime taxes collected on the average. For example, estimates generated by C. Eugene Steuerle and Stephanie Rennane of the Tax Policy Center show that one earner couple, earning an average wage of $43, 100 in 2010 and turning 65 in 2010, will collect lifetime SS benefits of $534,000 and would pay lifetime SS (OASDI) taxes of $392, 000; a shortfall of $138,000 for this average couple. A similar gap occurs for two earner couple both at the same average wage of $43, 000 in 2010.
President George W. Bush’s administration attempted to fix shortfall by proposing personal retirement accounts, like 401k accounts, where 2 to 4 percent of the payroll tax would go into government certified investments, such as stocks, bonds, and mutual funds. The government would have managed those personal accounts for a modest fee. AARP and many Democrats and Republicans rejected this proposal, even though many working Americans do participate in 401(k)-type retirement plans tied to financial markets. Elderly people in this country represent the third rail of politics, and politicians are too afraid to annoy this voting block. The problem has not gone away; solutions like increasing age limit, increasing payroll tax, changing COLA adjustment and increasing the income limit are not popular with the electorate. However, some of these changes must be made in addition to the following proposal, meant to increase retirement income of Social Security recipients.
Following is an outline of my plan:
1. A bipartisan commission, appointed by the President with the approval of the Congress, should select a list of best index funds with a history of good management and returns.
2. Automatically deposit 2% of the total payroll tax for each employee (1% each from the employee and employer) and put that amount in an escrow account for later investment in one of the funds chosen by the enrollee from the list of the index funds. Any worker will have the choice to opt out if he or she so chooses. The worker-enrollee has 3 months to decide the funds with the assistance of a government certified financial planner. It has been demonstrated that most people have to be nudged into making many decisions, especially financial decisions. As Professors Richard Thaler and Cass Sunstein state in their book, Nudge, “When people have a hard time predicting how their choices will end up affecting their lives, they have less to gain by numerous options and perhaps even by choosing for themselves. A nudge might be welcomed.” Similar default rule could be used for self-employed.
3. Any shortfall in SS Trust Fund when the new plan is implemented will be made up by other sources of revenue. The government (Social Security Administration) will also charge enrollees of personal retirement accounts a fee for the services and management of the accounts. The fee has to be enough so that government breaks even over a period of time on this plan (most likely within a decade).
4. Those who choose the new option will open a personal retirement account with the government that cannot be cashed until the employee is eligible for Social Security. They will have the option to transfer funds in other index funds from the list within certain limits and after consultation with a financial planner. Retirees will get an annuity from their investments, in addition to their social security benefits based upon the rest of the payroll tax contributions, at the age of 65.
5. Government would guarantee enrollees in the new plan that they will receive benefits from their investment and social security at the age of 65, at least equal to full benefits of social security had they not chosen personal retirement accounts. This guarantee will allay fears of those who are afraid to lose money in personal accounts in index funds. However, if the funds earn higher returns, beneficiaries will receive their benefits based upon those returns plus benefits from SS Trust Fund based upon the rest of contributions in payroll taxes. The history of index funds shows that an average investor should expect an average of 4% return per year on their investments; it is a much higher return than what they would receive from traditional Social Security Trust Fund
6. Issues regarding death benefits under the plan for children, widows and former spouses will need to be determined.
7. After 5 years the new scheme will be subject to a performance review by the bipartisan commission. Its recommendations should be evaluated and approved by the Congress and the President before implementation. The government guarantee will end if recommended and approved by the Congress and the President.
Professors Thaler and Sunstein found that in companies where the default is opt-in in 401k types plans, participation jumps significantly, thus confirming the view of many behavioral scientists that nudging works. That is the reason Congress passed the Pension Protection Act in 2006, allowing business to automatically enroll employees in 401k and other retirement savings plans. Saving for retirement is a difficult decision for many, hence most people do not have to make any decision about their contributions in social security. Government makes a decision for them. Professors Thaler and Sunstein sate that saving for retirement “is an ideal domain for nudging.” I would add that a fractional contribution of payroll taxes in personal retirement accounts also requires nudging.