As America’s retirement program approaches insolvency, two Wagner business professors propose a ‘simple plan’ to reverse course. It would closely resemble the current system, but 'your account would be your money,' they say.
By Lee Manchester
“If you ask people — particularly our students — if they think Social Security will be around for them as a benefit, they are assuming that it’s not going to be there,” says Professor Tully.
And they may be right.
In 20 years, when the Social Security trust fund reserve is exhausted, ongoing contributions will cover only 75 percent of the system’s costs (see the Summary of the 2012 Annual Reports issued by the Social Security and Medicare Boards of Trustees) — and even the benefits of a fully funded Social Security system aren’t that great.
“Today, the average annual payout for Social Security is $18,756,” Professor Tully estimates — not a generous retirement income in most peoples’ books.
So, what about 401(k)s, the privately owned and managed pension funds everyone is supposed to be building to bridge the gap between Social Security (if it still exists) and their actual living expenses after retirement?
“The last number I read, just last week, is that the average person has just $30,000 in their 401(k) at the time they retire,” Tully says, “and $30,000 doesn’t get you very far today.”
“And that’s pre-tax money,” Professor Crooks adds.
“If the 401(k)s aren’t doing well, and we let Social Security go by the wayside, then what’s going to happen to people in their retirement years?” Tully asks. “We’ll be back to the way things were in 1935 when FDR created Social Security. Old people were starving in the streets, and that was unacceptable.
“I think that to make some changes, to reinvent the whole program in some simple, no-tax-increase, low-cost ways, will allow people to eliminate some of the uncertainty that comes with planning for retirement.”
Tully and Crooks sat down with Wagner Magazine to explain their program in more detail
REINVENTING SOCIAL SECURITY
Wagner Magazine: Tell us about your program.
Cathyann Tully: We call it STRAP — the Secured Transparent Retirement Account Program. In some ways, it would be very similar to what we have today. Each taxpayer would have their own account to which they would be contributing, and the employer would be matching that contribution, very much like what we have now.
Donald Crooks: The big difference is that we want to make it so that your account is your money — very simple. And instead of just sitting there, we would invest those funds in various financial markets.
Tully: In the first 20 years, you take an aggressive investment strategy. In the next 10 years, from years 21 to 30 of your working life, you take an intermediate investment strategy. And then in the last 10 years of your working life, from years 31 to 40, you take a conservative investment strategy, and stick with that conservative investment strategy during your retirement years. You have 40 years of pay-in, and then another 30 years of pay-out.
We used historically typical rates of return to figure their results — 10.5 percent for an aggressive investment strategy, 9.33 percent for an intermediate strategy, and 6 percent for the remainder.
If you were to follow that scenario through — and I followed it for someone my age, assuming regular salary increases over your work life — the payout would be $82,000 a year. The payout that person gets today under the system that exists in our country for Social Security is $18,756. That’s a substantial difference.
I also backed the investment returns down a little bit — I did 9.33, 5 percent and 3.9 percent. Some people might feel that’s a little more realistic, perhaps, though it’s not consistent with historical returns. Nevertheless, if you had a 40-year contribution [with those rates] and a 30-year payout, you would get an annual benefit of $36,301.
For STRAP to just break even with Social Security, you’d have to drop investment returns to 3 percent, 2.6 percent, and 2 percent for an $18,000 annual benefit. Now, the likelihood of the S&P dropping down to 3 percent over a 20-year span of time is slim to none. Anything a new system can get for beneficiaries above the current level is a bonus, and it would be difficult to see how our system couldn’t produce more for the taxpayer than $18,000 a year.
ISN’T THIS JUST PRIVATIZING SOCIAL SECURITY?
Wagner: Who does the person managing the investments work for? The government? A private firm?
Tully: These are private firms that would manage the funds.
Wagner: That the individual picks?
Tully: No, that the government picks.
Crooks: They send it out to the lowest-cost provider, whether it’s Fidelity or Vanguard …
Wagner: And the fund manager is paid how? On what basis?
Crooks: Just his execution fee. That’s it — so many basis points. Execution is so de minimis now that it’s under a penny a share. But if you’re Fidelity or Vanguard, the amount of money you’re moving is pretty damned good. It’s cheaper for us to have execution through these intermediaries than it would be if the government set up its own trading operation.
Wagner: And you think this would fly with the big investment firms, just on the basis of trades, no management fees?
Crooks: Absolutely. If you went to E-Trade or Charles Schwab and offered them this, they’d be licking your boots.
GETTING FROM HERE TO THERE
Wagner: So let’s say that we, as a nation, decide STRAP is where we want to go with our old-age retirement plan. How do we get from here to there?
Tully: Right now, although everyone has a Social Security “account,” the money we each pay in Social Security taxes doesn’t go into that personal account — it goes into the big Social Security “pool,” from which all current benefits are drawn. In order to transition from Social Security to STRAP, we’ll have to make up the difference between the amount in the Social Security “pool” today and the total value of what current Social Security account holders have paid into the system over the years.
Crooks: Our proposal solves everything — but it’s not cheap.
Wagner: So, where will the money come from?
Tully: Currently, Social Security taxes are withheld only on the first $106,000 of income. We suggest that the money to cover the Social Security deficit come from lifting that cap for a specified period of time — just until the system is completely charged up.
LIFTING THE CAP
Crooks: Everybody wants to fix Social Security, but nobody wants to take the bull by the horns and actually do something. It’s going to be painful in the short run, but that pain is going to be borne mostly by those most able to bear it — and now I’m talking like a socialist!
Wagner: And, as you said earlier, that pain would go away as soon as the system was fully funded again. Have you calculated how long it would take, under your plan, to fully fund the Social Security system again so that the cap could come back?
Crooks: In the first paper I did on this, I figured that in the first four to six years, you would raise half a trillion dollars, and that would go a long way toward covering the shortfall. If you got a little more efficient in the administration of the whole thing, the shortfall could be covered more quickly. In the meantime, you can start phasing in the new system.
POLITICS, POLITICS, POLITICS
Wagner: Have you given any thought about the likelihood of this kind of plan being passed through Congress and signed into law?
Crooks: The Democrats would love it!
Wagner: Because it would stabilize Social Security?
Tully: Without a tax increase!
Wagner: Except on the higher income earners.
Crooks: Only in the intermediate term, until the shortfall is covered.
Tully: The battle we’re having right now is, do we cut services and/or increase taxes? Democrats don’t want to cut services; Republicans don’t want to raise taxes. What we have is a plan to bring stability to Social Security without increasing taxes — except for a very short term — or cutting benefits in some other entitlement program.
Wagner: Bipartisan? Nonpartisan? How do you two see this proposal?
Crooks: I’d call it bipartisan, because on the one hand you’re raising revenue, and on the other hand you’re cutting the program’s deficit.
Donald Crooks and Cathyann Tully are associate professors in Wagner College’s Department of Business Administration. Tully is director of the traditional MBA program, and Crooks serves as director of business internships and the executive and accelerated MBA programs.
Is Anybody Listening?
Over a period of three years, professors Crooks and Tully have presented their thoughts on Social Security solvency and reform six times at the annual conventions of four scholarly societies. Their most recent presentation, at the Academy of Business Research conference last September, won them recognition for Best Session Paper. A mailing last fall to the top candidates for the two major political parties, however, elicited no response.