Privatize Social Security…???

We would like to state first that in no way should the U.S. privatize Social Security.

This article is simply pointing out that changes must happen within the Social Security program, as the benefits do not reflect the reality of basic math—yes, basic math.

How Social Security Works:

Before highlighting the basic math that has led to calls to privatize Social Security, let’s examine how Social Security operates.

With every paycheck you receive, you and your employer each contribute 6.20% to FICA, which stands for the Federal Insurance Contributions Act. FICA funds the Social Security benefits you will receive at retirement.

When you retire, the Social Security Administration (SSA) calculates your benefit by averaging the largest of your last 35 years of contributions to FICA.

• If you paid the maximum amount of FICA each year for 35 years, you will receive the capped maximum Social Security benefits based on the age you enroll in the program.
• If your FICA contributions did not meet the maximum annually, the SSA determines your monthly benefit amount and notifies you before enrollment.

To learn more about how the SSA calculates Social Security benefits, click [here].

Ultimately, you are contributing 12.40% of your income (combined employee and employer shares) to FICA. To maximize your Social Security benefits, you must contribute at this rate for 35 years.

Self-employed individuals pay the full 12.40% on their earnings directly to the government through FICA.

Why Basic Math Leads to Calls to Privatize Social Security:

To understand why there is a growing call to privatize Social Security, let’s examine the differences between the current program and a hypothetical privatized system.

Example #1: Current Social Security Program

Person A:

• Age: 70
• Retiring this year to maximize Social Security benefits

Work history:

• Began working in 1990, earning the national income average of $29,000 per year
• Received the national average pay increase of 3.30% annually
• Paid a total of $230,512 into FICA, including employer contributions

Benefits:

• According to Social Security’s Quick Calculator, Person A will receive $2,538/month or $30,456/year.
• With a 3% annual cost-of-living adjustment (COLA), the total benefits over time would be:
  • $197,002 by age 75
  • $390,074 by age 80
  • $613,898 by age 85
  • $873,371 by age 90
  • $1,522,882 by age 100

While this may appear favorable, note that if Person A passes away before age 75, they will have contributed more to the program than they received. Additionally, Social Security does not pay benefits after death.

Why  some want to Privatize Social Security:

If Person A had instead invested their contributions into the S&P 500 starting in 1990, with a 1.50% expense ratio, their retirement savings balance at age 70 would be $1,241,594.

Assuming:

• An average annual rate of return of 12.12% before expenses
• A 3% withdrawal rate in retirement

Person A could generate:

• $3,104/month or $37,248/year, with savings growing over time.
• If the account earned a 5% return after expenses, the outcomes would be:
  • $234,964 in income by age 75, with $1,476,558 remaining in savings
  • $453,258 in income by age 80, with $1,966,754 in savings
  • $694,273 in income by age 85, with $2,365,295 in savings
  • $960,372 in income by age 90, with $2,805,316 in savings
  • $1,578,542 in income by age 100, with $3,827,517 in savings

In a privatized system, individuals would not only generate more income but could also pass their remaining savings to heirs upon death.

Why Calls To Privatize Social Security Should Be Rejected:

While privatization might look appealing on paper, it is important to consider the following:

1. Behavioral Economics: Many people struggle to save for retirement, often prioritizing immediate spending over long-term investments. Without mandated contributions, many might end up without sufficient savings.
2. Employer Contributions: Under FICA, employers currently contribute to employees’ retirement. If Social Security were privatized, many employers might stop contributing to retirement programs altogether.
3. Historical Evidence: The variability of the stock market and lack of universal financial literacy could leave many retirees vulnerable in a privatized system.

While Social Security needs reform, privatization is not the solution. It is essential to implement changes that preserve the program’s integrity while ensuring it meets the needs of future retirees.