The latest Social Security trustees report underscores the urgency of reform. The Social Security retirement trust fund is now projected to be depleted in late 2032, one year sooner than previously forecast. At that point, the system would be able to pay only 78% of scheduled benefits, resulting in an automatic 22% reduction in benefits for retirees, survivors and future beneficiaries unless Congress acts.

Since this trust fund is U.S. government debt obligations, using it to cover deficits only increases federal borrowing and debt. While policymakers may ultimately intervene to prevent those cuts, the latest trustees report demonstrates that the need for reform is no longer a distant concern; it is now only a few years away.

There are many ways to fix it and many different proposals. The best way is to privatize it. The difficulty of getting from where we are today to a private system lies in the cost of conversion. Because of the serious shortfalls of the current system, significant capital is required. It is too much to do at once, so it must be done over time.

The concept would be to move an increasing share of Social Security retirement payments into a privately owned account each year. The account would be professionally managed by a fiduciary and selected from a large group of approved funds, subject to specific investment criteria. The owners could draw from this fund only when there was sufficient funding to pay a minimum to each owner for the rest of their expected life plus three years.

In the current system, the payment is 12.4% of wages, split evenly between the employer and employee. Of this, 1.8% goes into the disability fund. The remaining 10.6% goes into a government trust fund used to pay current retirees. Of this, 5% of this would be diverted into private accounts in year one, 10% in year two, etc. for 20 years until 100% goes into the privately owned account.

Benefits would remain at current levels, as determined by the current formulas, and must be maintained until the system is fully converted and operational. As new people retire, they would receive the same payout as would be currently paid, in part from the Social Security trust fund and in part from their private account. When the payout from the private account covers or exceeds the current benefits, then there would be no more contribution from the government trust fund.

Diverting funds into private accounts will leave a shortfall in the trust fund to pay current and future beneficiaries before they have a private account that provides an equivalent amount to what they would have gotten under the current system. This shortfall would be covered by an additional 4% fee in the trust fund, divided equally between the employee, employer and government.

During the early years of the conversion, the trust fund would continue to grow, as the additional 4% fee would exceed the diversion of funds to the private account. As more is diverted in later years, the excesses will be depleted.

When the system is fully operational, this fee would be reduced to a minimal fee for a continuing “government support fund” to support people who do not achieve a minimum annuity from their private account and to support payments to those who outlive their private account.

Once fully converted and operational, all 10.6% of the payments will go into private accounts, 1.8% into the disability fund, and the small additional fee, not yet determined, will go into the new “government support fund.”

The retirement age for most employees becomes irrelevant, as the private account will fund an adequate annuity for most recipients before age 67. For those few who reach 67 and have not accumulated adequate funds, they could start drawing what was available from the private account, and the “government support fund” would provide the difference up to a specified minimum each year. For those who outlive their fund, a minimum would be paid from the support fund.

While this transition framework necessarily involves temporary additional costs during conversion, these would stop once conversion is complete. Also, there are several policy adjustments that could be made during conversion that would significantly reduce the overall financial burden of the transition, but are not required for the plan to work.

The latest trustees report makes clear that maintaining the status quo is no longer a viable option. A gradual transition to a privately owned retirement system offers a path toward long-term solvency, greater personal ownership, and the elimination of the recurring financial crises that have plagued Social Security for decades.

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ABOUT THE WRITER

Les Rubin is the founder and president of Main Street Economics. He wrote this for InsideSources.com.

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