Iím not a fan of big government. Being an honorary Chicagoboy, I think given any task, chances are, the private sector will do it twice as well for half the cost. So obviously, I think Social Security is a joke, and that private accounts are the way to go. Since itís the Christmas lull, I put some ink to paper, which me being a financial analyst, means putting it on Excel. I did a simple spreadsheet to see how a private account for a baby boomer household retiring in 2004 would have fared against the government. This is based on commonly available information, so is not a fine tuned model, but itís enough to make my point.
I took the Census bureauís household income from 1967 to 2003. I assumed 2004 income levels are the same as 2003 for simplicity sake since itís not available yet. I assumed the current 6.2% Social Security tax rate is the same from 1967 to 2004 also for simplicityís sake. The assumption is that the 6.2% tax would go into a government administered private account instead of the general pot. I then took the Dow Jones Industrial Average from July 1, 1967 to July 1, 2004, and calculated the compounded annual returns for the private account. I picked the July 1st mid-year point to correct for year-end fluctuations. I based the returns on the DJIA because itís available. I would have preferred the S&P 500, or a broad market index such as the Wilshire 5000, but they arenít available. The good is that the DJIA represents the best of American industry such as GE, Coke, and Boeing. The bad is that it doesnít truly reflect the technology revolution as say the S&P 500 would. But itís life.
Assume also that after retirement the account shifts to a low risk interest bearing account earning 5% a year on the unused account balance.
According to their website, the current, unfunded, maximum payout for 2005 Social Security payments is $869 a month; which translates to $10,428 per year.
Assume someone had a stroke of genius in 1967, and enacted the Social Security Reform Act of 1967, shifting all contributions to private accounts and invested the accounts in the DJIA.
Assume further that Incognitoís worker bee household began contributions to the account at age 25 in 1967, retiring in 2004 at age 62. If Nitoís household has always been in the mid-tier household income bracket, his final 2004 household income would be $54,453 a year. Under the plan, his monthly payout from the plan would be $1,417 a month, or $17,000 a year. This is 63% more than the current Social Security payout. The huge difference is that the private account is funded for 20 years of retirement, or to age 82.
Say Nitoís household is in the top income bracket for all or most of his life. His final 2004 household income would be $154,120 a month. His household payments for retirement would be $3,583 a month, or $43,000 a year. Again, this would be fully funded for 20 years of retirement.
Second tier 2004 household income would be $86,867 a year. Monthly payments would be $2,167 a month or $26,000 a year.
Say Nito wasnít very successful in life. Fourth tier ending 2004 household income would be $34,000 a year. Social Security payments would be $950 a month, or $11,400 a year. Fifth tier ending 2004 income would be $17,984 a year. Social Security payments would be $504 a month, or $6,050 a year. Again the big difference being that itís fully funded.
So the only time youíll be below the current Social Security maximum is if both husband and wife make minimum wage all their lives.
Change the number of retirement years from 20 to 15 or 10, and youíll be living well.
What-if numbers amount to exactly zero ($0). But it makes you think.
Maybe 37 years from now weíll still be talking about reforming Social Security. Maybe someone will say wow, wouldnít it have been a great idea to put it in private accounts?
More thoughts: Based on the Census Bureau, there are 112 million households in the U.S. If you take the current annual mid bracket Social Security contribution of $3,376 a year as the average, that’s $378 billion a year. Investing private accounts for Social Security in a broad market index would imply putting 98% of the amount back into the economy (index funds charge about 1% for management fees, going by my rule of thumb for government implies a 2% management fee for lazy bureaucrats.) You can argue that putting $370 billion back into the economy would create a tremendous amount of new jobs, which in theory would cascade into more income, more contributions, etc etc. lifting all boats.
Update: Looks like good ol’ Cato Institute was way ahead of me:
For example, assuming historical rates of return, if individuals born in 1970 were allowed to invest in stocks the amount they currently pay in Social Security taxes, those individuals could receive nearly six times the benefits that they are scheduled to receive under Social Security, as much as $11,729 per month. Even a low-wage earner would receive nearly three times the return on Social Security.
Update 2: Thanks to Cole for pointing out the correct historical rates.
I’ve updated the excel and the numbers blow away the current Social Security payments. Even the lowest bracket is comparable to the current unfunded maximum payout: