Social Security, as we know it, is going to go broke in a few short years.  Demographics guarantee this.  When Social Security was instituted, it was a supplemental income program for our retired, who were expected to continue to rely on their own resources and those of their families for their retirement years.  Moreover, at that time, there were roughly 7 workers paying into the system for every retiree and a retiree lifespan in retirement was about 6 years.

Today, Social Security is expected to be an income replacement program.  Moreover, the number of workers paying into the system is around 3 for each retiree, and that number is falling.  Then, each retiree is expected to live for 17+ years in retirement.

But one thing has remained constant.  Each worker paying into the system is paying for someone else’s current retirement—the money paid in is not set aside to accumulate for the payer’s benefit.

I propose to change this in the following way.  It will eliminate Social Security as we know it, but it also will preserve and strengthen the promise of social security: a reasonably comfortable retirement for the retiree.  Privatize, entirely, Social Security.

Eliminate the payroll tax for both employer and employee (think about the immediate stimulative effect from reduction in the cost of labor of 6.2%).  However, require the employee to set aside 6.2% of his income from all sources, not just from wage income (just to keep it simple, and consistent with a tax proposal nearby).  Why 6.2%?  That’s the current employee payroll tax for Social Security, absent any temporary reduction.  Eliminate, also, the present upper limit on income (wages) subject to the Social Security payroll tax.  However, instead of this money immediately being paid out to someone else’s present retirement, it will be put into an account owned and managed by the employee, and the money will accumulate for his own future retirement.

Let’s look at the effect of this on a hypothetical man’s retirement.  Let’s say the man earned $100,000 per year in his last years of working.

Under the current system, that man retiring at 66 will receive $25,800 per year until 2033, when the Social Security Trust Fund will be exhausted and payroll taxes will only be able to support payouts at 75% of their nominal rate—our man, after having been retired just 20 or so years (never mind the 17+ years of an actuarial retirement), will see his payout cut to $19,400 per year (note that for this, I’m ignoring inflation and cost of living increases).

Now suppose our man has been socking away 6.2% for his, let us say, 40 years of working life, and he’s still making $100,000 in his last years.  Again, we’ll ignore inflation, and we’ll take a naïve position of his having started out making $20,000 per year and received constant annual pay raises to reach his present $100,000 annual income.  With his 6.2% set-aside each year naively left to grow with the market (the S&P500 historical growth rate has been 9.77% since 1926—a period including the Great Depression, the Carter Recession, and the Panic of 2008), our man will accumulate enough by the time of his retirement to withdraw over $55,000 per year over the course of a nominal 18-year retirement, or more than $29,000 per year, if he expects to have a 34-year retirement (i.e., live to 100).  And he won’t have a reduction to 75% of that because the government ran out of money.  Of course, this table napkin analysis ignores inflation, also, and it ignores leaving the remainder of the man’s accumulated retirement fund still invested—now perhaps in bonds.

Notice one other critical factor here: with privatized retirement savings in place of Social Security, each man will be working for his own future instead of working for someone else’s present.  With his own money at stake, the man will do a far more careful job of managing for his future retirement than the government already has done—with OPM.

There is, of course, the risk that the man may invest foolishly, or he may invest wisely but have a run of bad luck in the market—downturns do occur.  What happens to him in this brave new world?

First, look at what happens in the present situation, where the impending failure of the Social Security System is an empirical fact.  In this scenario, where the government’s management of our retirement accounts has failed, the disaster affects all of us—every retired individual; every soon-to-be-retired individual; and each of the rest of us, who must find a way to support these unfortunates.

If the man fails, though, whether through his folly or his bad luck, the effects of his failure is limited to him and his family; it is not a national disaster.  And these individuals will be few enough in number that help—a hand back up, generally, or support if his failure comes too late for him to recover—can come from his family, his local community, church and/or charity, and, yes, as a last resort, state government.