Social Security has always been a hot-button political topic. Designed as a social insurance plan for America’s seniors, changing demographics are threatening to reduce promised benefits in as little as 10 years from now, in 2033.
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To combat these funding issues, numerous politicians and think tanks over the years have proposed privatizing some or all of the Social Security system. Proponents say it will increase the savings rate among Americans and provide a more prosperous retirement, while opponents of the plan say it will prove too costly, particularly for lower-income Americans. But what exactly does it mean to privatize Social Security, and what are the potential outcomes? Read on to learn more.
What Does Privatization of Social Security Mean?
Social Security is a social insurance program managed by the U.S. government. Most Americans look to Social Security as a retirement income program, although it does pay out other types of benefits. To fund the payouts, the government assesses payroll taxes on workers. Excess money is invested in U.S. Treasury securities in the Social Security Trust Fund. Income from the Trust Fund and incoming payroll taxes from workers are used to pay benefits to current recipients.
Under privatization, workers would be allowed to invest some or all of the money they currently pay in taxes into private investment accounts. Like an IRA, workers could choose their own investments in their privatized Social Security account, buying and selling as they please. Workers could even contribute more to their account if they so desired. In other words, the U.S. government would no longer invest worker payroll taxes into Treasury securities to make payouts — at least, in the case of total privatization. Workers would be responsible for their own investment management.
How Could Privatization Potentially Help?
Proponents of privatization claim that American investors could potentially outperform the relatively meager return that the U.S. government is earning for them by investing solely in Treasury securities. Advocates further suggest that when left to their own devices, workers will likely contribute even more to their retirement savings accounts, making for larger nest eggs.
Others suggest that workers will find it more palatable when money is taken out of their paychecks in the form of retirement contributions instead of as payroll taxes.
What Are the Potential Drawbacks?
Opponents of the move to privatization suggest that it will unfairly enrich wealthier workers at the expense of those with lower incomes. The way Social Security is currently set up, lower-income workers can actually receive more in benefits than they contribute in taxes. This will likely change if privatization kicks in. Wealthier workers are also more likely to be in the position to contribute greater amounts to their privatized Social Security accounts, while lower-income workers might use that money for other purposes.
Another potential drawback is that Americans might not prove to be better investors if they manage their own money after all. According to a study from DALBAR, for the 30 years from 1989 through 2019, equity investors only averaged a return of 5.04% per year vs. the S&P 500’s annual return of 9.96%, or nearly double. Bond investors fared even worse, eking out just 0.38% per year vs. the Barclay Aggregate Bond Index returns of 5.91%. Thus, leaving investment management in the hands of individual workers might actually decrease returns, according to those opposed to the idea.
What Are the Obstacles to Privatization?
One of the biggest obstacles to privatization is that Americans simply don’t generally want the government to tinker with Social Security. One survey conducted by Data for Progress in Dec. 2022 showed that just 15% of Americans were in favor of Social Security privatization. Many fear that changes to Social Security will only result in lower benefits for recipients, regardless of how they are handled. This makes Social Security a political football that Congressional leaders are reluctant to pick up.
Another big obstacle to privatization is the cost. According to the Brookings Institution, any transition to a privatized system would require funding the trillions of dollars in existing liabilities that Social Security has promised to workers. This would result in either increased taxes on current workers or a reduction in promised benefits. Most transition plans would also include massive governmental borrowing.
The Bottom Line
There hasn’t been much of a push to privatize Social Security recently, as political issues, cost concerns and general uncertainty about its potential outcomes are hard to overcome. But with the Social Security Trust Fund slated to expire in 2033, new proposals are likely to appear at some point.
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