Show me the money
By Mark Weisbrot
Center for Economic and Policy Research
President Bush is waving the carrot of private Social Security accounts in front of millions of Americans who, perhaps too young to remember what happened to stocks five years ago, still think they are going to get rich quick in the stock market.
If you could just take some of that money that Social Security drains out of your paycheck every week, he says, and put it in a private account where you could invest in stocks, how much better off you would be when you retire!
Or would you? This is a case where it really helps to read the fine print. Although President Bush hasn't announced a comprehensive plan, he did have a "senior White House official" spill some details of the plan just before his State of the Union address.
One of the details: the money that will go into the private account isn't really yours. At the end of your working career you will have to pay it all back to the government. Plus interest: at the rate of U.S. Treasury notes.
The difference between what you made in your private account and what you have to pay back, with interest, is your "profit" -- or loss. But that's not the end of the story. There are administrative costs that will reduce your accumulation by another 5 percent (according to the President's Commission to Strengthen Social Security). Or possibly a lot more: in a typical private 401 (k) account it's about 3 times that much.
You're still not home free. The President's plan will require you to convert some or all of your accumulated sum to a lifetime annual payment. But the cost of this conversion is not cheap: in the private sector it is 10-20 percent of accumulated savings; if the government does it maybe it can be kept to 5 percent.
Now let's do the numbers: say you are a 27 year-old worker with average wages when the plan takes effect for you in 2011. Assume that you put the maximum allotted amount into the private account. Let's also assume that the administrative costs, and the cost of converting the lump sum to an annual payment are the cheapest imaginable.
When you retire after 40 years, your combined benefit from the private account and the traditional Social Security system will be $1371 per month. This compares to $2127 that the current Social Security program, if left alone, has promised to pay.
Supporters of privatization would reply that the system can't pay all promised benefits. If absolutely nothing is done to increase Social Security's revenue -- a very remote possibility -- then benefits will be cut by about 24 percent in 2053. But even then, the monthly benefit in the above example would be $1,625 -- still 19 percent better than in the privatization scheme.
Interestingly, when the government takes back the money that it loaned you, it doesn't come out of the private account that it went into. Rather, it is deducted from the benefit that you receive from the traditional Social Security program. This will create the illusion that most of your benefits come from the private account -- rather than from the traditional system. This indicates that the people who designed this privatization scheme want to undermine support for the traditional Social Security system -- so as to get rid of Social Security as we know it altogether.
In the mean time, privatization won't make many dreams come true. The next time you hear someone telling you what a great deal it is, just tell them: show me the money.
Center for Economic and Policy Research
President Bush is waving the carrot of private Social Security accounts in front of millions of Americans who, perhaps too young to remember what happened to stocks five years ago, still think they are going to get rich quick in the stock market.
If you could just take some of that money that Social Security drains out of your paycheck every week, he says, and put it in a private account where you could invest in stocks, how much better off you would be when you retire!
Or would you? This is a case where it really helps to read the fine print. Although President Bush hasn't announced a comprehensive plan, he did have a "senior White House official" spill some details of the plan just before his State of the Union address.
One of the details: the money that will go into the private account isn't really yours. At the end of your working career you will have to pay it all back to the government. Plus interest: at the rate of U.S. Treasury notes.
The difference between what you made in your private account and what you have to pay back, with interest, is your "profit" -- or loss. But that's not the end of the story. There are administrative costs that will reduce your accumulation by another 5 percent (according to the President's Commission to Strengthen Social Security). Or possibly a lot more: in a typical private 401 (k) account it's about 3 times that much.
You're still not home free. The President's plan will require you to convert some or all of your accumulated sum to a lifetime annual payment. But the cost of this conversion is not cheap: in the private sector it is 10-20 percent of accumulated savings; if the government does it maybe it can be kept to 5 percent.
Now let's do the numbers: say you are a 27 year-old worker with average wages when the plan takes effect for you in 2011. Assume that you put the maximum allotted amount into the private account. Let's also assume that the administrative costs, and the cost of converting the lump sum to an annual payment are the cheapest imaginable.
When you retire after 40 years, your combined benefit from the private account and the traditional Social Security system will be $1371 per month. This compares to $2127 that the current Social Security program, if left alone, has promised to pay.
Supporters of privatization would reply that the system can't pay all promised benefits. If absolutely nothing is done to increase Social Security's revenue -- a very remote possibility -- then benefits will be cut by about 24 percent in 2053. But even then, the monthly benefit in the above example would be $1,625 -- still 19 percent better than in the privatization scheme.
Interestingly, when the government takes back the money that it loaned you, it doesn't come out of the private account that it went into. Rather, it is deducted from the benefit that you receive from the traditional Social Security program. This will create the illusion that most of your benefits come from the private account -- rather than from the traditional system. This indicates that the people who designed this privatization scheme want to undermine support for the traditional Social Security system -- so as to get rid of Social Security as we know it altogether.
In the mean time, privatization won't make many dreams come true. The next time you hear someone telling you what a great deal it is, just tell them: show me the money.
posted by Hans Riemer at 11:47 AM
10 Comments:
I think there's an important typo in Weisbrot's article. Administrative costs in a low-cost stock index mutual fund are 0.5%, not 5%. Likewise, 1.5% is a reasonable figure for a 401(k) account (though Vanguard and Fidelity charge less); 15% certainly is not.
I don't know -- because he doesn't spell it out -- how Weisbrot came up with the figures according to which the personal account pays out less than Social Security. What return is he assuming on the funds in the personal account? Social Security's implicit "rate of return" is only around 2% for an average wage earner, so I'm baffled as to how investing in a stock index fund is supposed to do worse. Unless Weisbrot really did subtract 5% per year for administrative costs!
Lawrence,
That's no typo -- when you say 0.5 percent, you are saying that administrative costs eat up 0.5 percent of the amount that is in the account in a given year. That is measuring the costs as a percentage of the stock of savings. However Social Security's administrative costs are measured as a percentage of revenue, which is a flow (per annum). [For those who have forgotten their Intro Econ, recall the difference between wealth (a stock) and income (a flow)]. In order to compare the two costs, you have to express them both in the same terms.
The administrative costs for the private accounts on which our calculation is based are actually lower than the 0.5 percent you suggest -- it's 0.3 percent (of the stock), as assumed by Reform Plan 2 of the President's Commission to Strengthen Social Security. If you do the arithmetic (or put it on a spread sheet), you will find that 0.3 percent of your account value each year, added up over the 40 years of contribution to the private account, takes about 5 percent of your savings. As you point out, a typical 401 (k) account has administrative costs that are several times higher. It is, of course, the hope and dream of the financial industry that Reform Plan 2 might evolve, up the road, into something more like a typical 401 (k).
Your second question: The rate of return on stocks assumed in this calculation is 4.35 percent annually, which is derived from the profit growth projections of the Congressional Budget Office. You can see how all of this adds up, and experiment with different rates of return, with the CEPR Accurate Benefits Calculator, on the web at
http://www.cepr.net/pages/sscalculator.htm
You can see, for example, that if you put in higher rates of return for stocks you will start to get price-to-earnings ratios that are not very believable. But in any case, all of the assumptions about the proposed changes are taken from the President's Reform Plan #2; economic assumptions from the non-partisan CBO; and current Social Security benefit structure from the Social Security Trustees.
Best,
Mark Weisbrot (http://www.cepr.net)
Oh dear. The assumptions you make for the President's plan for private accounts inaccurate. Here are social security calculators and assumptions explained for those truly interested:
Social Security Calculator 1Social Security Calculator 2Remember the Democrats' motto - Government reliance is good! (so we can bribe you with government handouts to vote for us)
Use some common sense folks. Would you rather
1) keep and own more of your money, invest it though a private account, get positive stock/bond returns, and be able to pass that money to your family, or
2) get a guaranteed negative rate of return from the government?
I would choose a private account.
The siren call,Big riches await you
in the stock market! BEWARE.. the stock market is only for the educated and the rich....they are in control ..you are the lambchops.
EYE B. THERE
The siren call,Big riches await you
in the stock market! BEWARE.. the stock market is only for the educated and the rich....they are in control ..you are the lambchops.
EYE B. THERE
The siren call,Big riches await you in the stock market! BEWARE.. the stock market is only for the educated and the rich....they are in control ..you are the lambchops.What are you talking about? Everyone with a 401K or other savings plan invests the money. With personal social security savings accounts, it'll be a simple one step process to choose which one of the authorized investment groups you want to participate in. There is no evidence whatsoever (look at history) that over time you'll loose money this way. It is GUARANTEED that you'll be getting a NEGATIVE return on money with the status quo.
I haven't heard any better ideas, just a lot of bitching and complaining from people who want you reliant on the government for everything.
Social Security is NOT insurance. Insurance is a financial protection against an unlikely but expensive event. With life expectancy pushing 80, you shouldn't take out insurance for the slim possibility of reaching 67 -- you should do legit financial planning.
Moreover, the original writer of this post is being intellectually dishonest, claiming that private account holders have to repay the original principle in their accounts plus 3 percent interest. That was stated in a WP article that was retracted hours later as being completely wrong. Add back in the principle and 3 percent, and see who does better.
Why is Rock the Vote spreading such distortions and lies? What's the REAL purpose of this group????
Looks to me like the Center for Economic Policy Research is pretty weak on economic policy research.
I find it interesting that you seem to think that you are guaranteed the funds that are being put into Social Security. There are no guarantees!!!
As a wise old 40 year old rocker, I can tell you my view: There are many,many plans around the country where the employer has opted out of SS 25 years ago. They set up alternative PRIVATE ACCOUNTS for their employees. They have been hugely successful. Why isn't the media talking about it. I personally know of many school systems where teachers have private accounts, with LIMITED options(asset allocation funds,etc). The doom and gloom scenario simply hasn't played out.
I would gladly walk away from my 25 yrs of contributions into SS (over $100,000) if I were allowed to invest my 14% in private accounts going forward!
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