night, President George W. Bush finally presented his full Social
Security plan. The President outlined a new method for calculating
benefits that will improve the Social Security system's solvency.
Many critics have been quick to focus on the pain from necessary
benefit adjustments that lead to solvency. But like taking a sip of
lemonade before you've had a chance to stir in the sugar, critics'
puckered responses to the President's plan leave out the sweetener:
personal retirement accounts (PRAs). Add personal accounts into the
mix, and younger workers have the chance to enjoy more comfortable
retirements than under the current system.
Today's Social Security
workers, today's Social Security system is broken. Younger workers
will get a worse deal from Social Security than their parents and
grandparents because Social Security cannot afford to pay the same
generous benefits to today's younger workers that it did to
consider the case ofa 25-year-old worker, earning $27,500 today,
who is expected to retire in 2047. That year, under current law, he
would receive only about 75 percent of the benefits that Social
Security now promises to pay. If Congress continues to do nothing,
the benefits would continue to decline over the years of his
retirement. Chart 1 shows that he would receive a smaller
proportion of the promised benefits from Social Security every year
of retirement. Even as the cost of living rises, his Social
Security check could actually shrink.
Under the current
system, this worker would receive a $1,664 monthly check from
Social Security at retirement. That is what today's Social Security
can afford to pay.
Security's looming insolvency is responsible for this state of
affairs, raising taxes or cutting benefits alone isn't the answer.
Any fix for Social Security that replicates 1983's "permanent fix"
reform package-which cut benefits and raised taxes-would just make
Social Security a worse deal for younger Americans than it already
is. Tax increases combined with benefit cuts would force younger
Americans to pay more into the system while getting less out of it.
Social Security needs reform, but passing its costs on to younger
workers is not a fair was to achieve solvency.
A Fairer Alternative
plan is a fairer alternative than just raising taxes or cutting
benefits. Critics have focused on how the President's plan would
change the benefits formula, but they tend to overlook that it
would restructure how a retiree receives benefits. Under the
President's plan, retirees would receive their benefits from two
sources-think of them as Part A and Part B.
Part A is the
traditional Social Security benefit, which is the sole component of
the current system. While the President's plan would slow the
growth of younger workers' traditional Social Security benefits, a
worker's personal retirement account-that is, Part B-would also
contribute to his or her monthly benefits. Younger workers would be
most affected by the change in traditional benefits, but they would
also benefit the most from their PRAs thanks to the power of
compound interest. The earlier an investment is made, the more time
it has to grow and compound its earlier gains to create even larger
later ones. The power of compounding and time is why financial
planners advise their clients to invest early in their careers for
retirement, so that their money can work harder for them.
President's plan, the 25-year-old worker discussed above would
receive traditional Social Security benefits-Part A-of $1,216,
about three-quarters of the benefit under the current system. He
would also have a PRA balance of $162,965 at retirement. By using
some or all of that account to purchase an annuity-Part B of the
total monthly benefit-a retiree could achieve higher benefits than
are possible under today's Social Security. A retiree could also,
if he or she chooses, keep part of the PRA as a nest egg, something
that is not possible under today's Social Security.
If our example
retiree used his entire PRA to purchase an annuity, the annuity
would provide a Part B payment of about $1,131 each month, for a
total monthly benefit-Part A and B together-of $2,347. That is $683
more per month than today's Social Security can afford to pay. Even
taking into account that the President's plan would slow the growth
of traditional benefits to make the system solvent, this typical
worker would still do better under the President's plan than under
today's Social Security.
Many retirees will
want to leave a nest egg in their accounts that they can use during
retirement, as they see fit, or pass on to their children or
grandchildren. Today's Social Security does not give workers the
choice to create a nest egg at retirement. If our example retiree
uses only part of his PRA to purchase an annuity that provides a
Part B payment of $808 each month, he would be left with a nest egg
of $43,615 in his PRA. If he chooses not to spend this money during
retirement, it would remain in his account, continuing to compound,
and eventually grow to a sizeable nest egg for his children or
grandchildren. Taking together Part A and Part B benefits, he would
receive a total benefit of $2,044 each month. In terms of monthly
benefits, he would be slightly better off than under the current
system, but his heirs would enjoy a nest egg-a small jump-start on
life-that he could not have created under the current system.
plan to reform Social Security would bring the system to solvency,
but it does more than that, too. The President's plan also would
help retirees achieve greater benefits than are possible under
today's Social Security and let them build up and pass on nest eggs
to their children and grandchildren, which most lower- and
middle-income households cannot afford to do today.
But critics of the
President's plan-especially in the time since he announced his
approach to traditional benefits-too often overlook the Part B side
of his proposal. While the President's plan would slow the growth
of Social Security's traditional benefits for most workers, a
retiree would also enjoy a new Part B income stream from his PRA.
Especially for younger workers, personal accounts are the spoonful
of sugar that makes the medicine go down. This is why personal
accounts are an integral part of any plan to bring Social Security
to solvency. Critics who focus solely on benefit adjustments and
ignore PRAs are taking a dishonest tack and add little to this
Rea S. Hederman,
Jr., is Manager of Operations and a Senior Policy Analyst
in the Center for Data Analysis at The Heritage