Your Financial Future:
Social Security Reform
Social Security reform: Understanding the politics of Social Security reform, plus why it’s important for women.
As directed by President Bush, the Commission to Strengthen Social Security, a 16-member bipartisan commission released its final report at the end of 2001. As expected, the commission members agreed that people should be allowed to redirect part of their payroll taxes into private investment accounts. The Commission also found that it would cost approximately $2 trillion over the next 75 years to cover the costs of starting the private accounts and making up for the deficits in the program. The report shows how difficult it is to both save the system and set up a new system of private accounts.
The commission did not reach agreement on one major overhaul plan. Rather the members came up with three alternatives to make individual accounts part of the Social Security system, leaving it up to Congress and the President to work out details. That is, when the political climate allows. As The New York Times noted, “…overhauling the retirement system is so complicated, painful and politically sensitive that it is almost impossible to get a consensus.”
The Stakes for Women
Women earn less and live longer so they need more income for retirement. Yet, they have fewer pension benefits and fewer assets. Social Security is of significant importance to virtually all Americans but is particularly important to women; nearly 40 percent of older women living alone depend on Social Security for almost all of their income and more than half would be living in poverty were it not for their Social Security benefits.
Private accounts that are taken out of the current Social Security system could expose women, as low earners, to greater financial risk. Women would have smaller investment accounts and no cost-of-living adjustment. The current Social Security system has a social insurance aspect, which helps lower earners by using a benefit formula that replaces more of their earnings than higher earners. The Commission’s proposals that include a minimum benefit could help some lower wage earners as it is pegged to the poverty level and is indexed to inflation.
Divorced women also have an unusually high incidence of poverty and serious health problems. The current system has protections for divorce women (or men) whose marriages last at least 10 years. She is entitled to half of her former husband’s benefit while he is alive; when he dies, she is entitled to the same widow’s benefit she would have received if they had stayed married. However, today the average marriage lasts only 8 years, so many women still lose out on benefits.
The Commission has included two proposals to increase widow’s benefits that some women’s organizations would likely support. The widow’s proposal would provide the widow with 75 percent of the total couple’s benefit. However, critics of the Commission’s proposal say that the couple’s benefit would have already been reduced by individual accounts so that most widows would experience a benefit cut.
Here are the basics of the current Social Security system and the implications of the broad changes that would likely occur with the adoption of individual investment accounts, based on the information contained in the Commission’s final report.
Social Security is Now a (Partially) Pay-As-You-Go Program.
The contributions that working people make to the system today are used to pay for the benefits of today’s retirees – our parents and our grandparents. Money left over, not used to pay benefits today, is used to purchase federal securities that earn interest and are saved in the Trust Fund. Currently, the Trust Funds have $1.85 billion in reserve.
This is important because any diversion of Social Security’s income – the FICA taxes you see withheld on your paycheck – to fund individual retirement accounts removes money that will be needed to pay for retiree benefits. But President Bush has promised that there will be no benefit cuts for those who are already retired or near retirement.
The concern about the Commission’s proposals is that they could worsen Social Security’s long-term solvency by diverting money into individual accounts. The money to pay retirement benefits would have to come either from the Social Security Trust Fund or from funds transferred from general tax revenues. The Social Security Administration’s chief actuary reported that the proposals would cost anywhere from $600 billion to $1 trillion by 2012, depending on which proposal is chosen.
Trust Fund Surplus
At the moment, there is still a Trust Fund surplus because of the current comfortable ratio of retiree benefits to worker contributions, but the excess revenues will be needed when the large numbers of Baby Boomers begin to retire and upset the retiree-to-worker ratio.
Despite various calls for reforms, it is likely that the current fiscal policy will continue, as no member of Congress wants to take the lead in making deep spending cuts in an election year. So, Congress is likely to vote to raise the ceiling on the federal debt again.
Social Security Benefits Have No Investment Risk and Cannot Be Outlived.
Social Security revenues are currently invested in Treasury bonds. While stock market returns are typically greater than the safer Treasury bonds, that higher return is linked to greater risk. The current rocky stock market illustrates the negative side of investment risk. Yet, studies find that the average individual is not aware that there is any risk in mutual funds invested in the stock market.
The Commission’s three proposals would reduce traditional Social Security Benefits based on the amount diverted to an individual account over the course of a worker’s career. It is assumed that earnings from the individual accounts would make up the difference. Women would have smaller individual account balances, be at risk of running out of their individual retirement account funds and have to live on less-than-traditional benefits. And minorities who rely more on Social Security disability benefits would be likely to run out of funds.
The need for long-term reform of Social Security has been debated for years. Any reforms are likely to require changes such as raising payroll tax levels, raising the retirement age, reducing benefits to some extent or finding a way to increase the rates of return on the Trust Funds. Members of Congress and our presidents have long avoided coming to grips with these choices.
The debate surrounding the Commission’s report helps raise reform issues and helps prepare the public to make their views clear to their elected representatives. As these are complicated issues, we all need to become educated so there are no surprises about future benefits.
Social Security Reform
Congress bailed out the Social Security program three months before the trust fund ran out of money by increasing taxes and gradually raising the retirement age from 65 to 67.
The trust fund is not forecast to run out of money before 2041. But in 2041 there’s a gap of 26 percent – only 74 percent of benefits can be paid out to retirees.
Many Republicans do not want to raise the payroll tax or raise the amount of money on which the tax is figured and they do not want the trust funds to be invested in the stock market.
Some Democrats support private accounts to supplement (but not replace) Social Security. They would be funded through a separate source, not through a portion of the Social Security tax.