Risk: Social Security vs. personal accounts

December 23, 1998

People skeptical of personal retirement accounts say financial markets are too risky for most Americans. But an analysis of relative risk shows that personal retirement accounts would be less risky than today's unfunded system.

The Risks of the Current Social Security System

• No legal rights: The Supreme Court ruled in Fleming v. Nestor (1960) that workers have no legal right to Social Security benefits. Congress and the president can change Social Security benefits any time they choose, as they have many times over the years. A young worker entering the Social Security system is gambling on what a Congress and president 45 years from now will decide to do with their benefits.
• Unfunded: Social Security faces a $9 trillion unfunded liability. If the program is not restructured, young workers will face estimated benefit cuts of 30 percent or tax increases of nearly 50 percent.
• A guaranteed bad investment: Even if all promised benefits could be paid without raising taxes, Social Security would still be a lousy investment. According to a study by the nonpartisan Tax Foundation, most young workers will receive a negative return on their Social Security taxes--they will get less in benefits than they paid in taxes.

A System of Individually Owned Accounts

• Investment selection: Individuals would not have to be experienced investors to benefit from private accounts. The history of 401(k) plans, IRAs, and mutual funds has proven that experienced account managers can help workers manage their accounts. As are IRAs or 401(k) accounts, personal accounts can be structured to keep out scam artists and restrict investment strategies that are too risky.
• The stock market: Personal retirement accounts do not require individuals to invest in the stock market. An individual can choose to invest in risk-free bonds. Moreover, the market is not "risky" when investments are held for long periods of time. Of course, in any given year, stocks can go up and down. But the market's year-to-year fluctuations are irrelevant. It is the market's long-term performance that counts. Given that long-term perspective, there is no time when the average worker would have lost money by investing in the U.S. stock market. The worst 20-year period in our stock market history, which includes the Great Depression and the 1929 crash, produced a real return of more than 3 percent. The worst 45-year real rate of return was 7.32 percent.
• Safety net: All privatization proposals being considered by Congress include a safety net. If an individual reaches retirement with insufficient savings, the government will make up the difference, up to a minimum benefit level. Most proposals set the minimum benefit at or above the poverty line.

For more information, please see Melissa Hieger and William Shipman's report Common Objections to a Market-Based Social Security System: A Response.

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