Personal Retirement Accounts Are Investments in the Individual

by Carrie Lips

Carrie Lips is project assistant for the Cato Project on Social Security Privatization.

During this election season, beware of people who would squelch talk of Social Security reform with rhetoric about the plight of the poor. The present system must be changed precisely because it leaves more than 1 in 10 elderly people in poverty and prevents today's working poor from building savings. In fact, it is the poor who would benefit most from a chance to invest their own payroll taxes.

Social Security simply costs too much and pays too little. Each worker loses 12.4 percent of income to the FICA tax. After paying that and other taxes and providing for necessities, low-wage workers often struggle paycheck to paycheck with no extra money for savings. Those individuals, as well as nearly one in three of today's seniors who depend on Social Security for more than 90 percent of their income, will rely on the government for retirement security.

Because of their dependence on Social Security, the program's approaching fiscal crisis is a real problem for low-wage workers. By the Social Security Administration's own projections, the program will run a deficit in 2013 and be able to pay just 75 percent of promised benefits by 2032. That means that the average low-wage worker's benefit will drop from $565 to $424. Obviously, such benefit cuts will be devastating to the elderly poor.

To balance Social Security's checkbook with tax increases, tomorrow's workers would have to turn over almost one-fifth of their income. Those high taxes would leave future workers with even less of a chance to accrue private savings and even more dependent on the crumbling federal retirement system.

Social Security's paltry benefits are even more tragic when you consider how much better off a low-wage worker would be if he could put payroll taxes in a real savings plan. Take, for example, a 28-year-old making $13,500 per year and paying $1,674 in Social Security tax. When this worker retires at age 67, Social Security currently promises to provide a monthly payment equal to $815 in today's dollars. That stream of payments would represent a rate of return of just 2.75 percent on the worker's lifetime contributions -- well below the return one could expect from a private savings plan.

If this worker could instead put his Social Security taxes in a conservative savings program that invested only in bonds and earned just a 4 percent return, he would accrue $177,147 by age 67. That money could purchase an annuity that would pay $1,243 a month -- over $400 more than the benefits promised -- but not yet paid for -- by Social Security. If he chose instead to participate in a more typical savings plan with a mix of stocks and bonds that earns a 5.75 percent return, his monthly benefit would be $2,292 -- almost three times Social Security's payment. That additional revenue would have a substantial impact on his standard of living.

The cost of participating in Social Security instead of a system of personal retirement accounts cannot be measured as simply the difference between two retirement checks. It is also the difference between financial independence and the whims of politicians.

A system of personal retirement accounts would give individuals ownership of their retirement security. The elderly would no longer be beholden to politicians. Low-wage workers who today struggle from paycheck to paycheck would have access to the financial markets and would accumulate wealth.

Moreover, it is simply fair that workers own the products of their labor. Today, how much you get from Social Security depends on how long you live, and the sad truth is that individuals with lower incomes tend to die younger than do those in higher income groups.

Take, for example, a low-wage single mother who was born in 1960, earns $15,000 a year, and contributes to Social Security her whole life. But she dies at 64. Her children are over age 18, so she has paid FICA taxes for nothing. Her years of contributions disappear and, most likely, she has no other savings to pass on to her children. With a personal retirement account, the same woman could have accumulated $300,000 by investing in a fund that earned 5.75 percent. That nest egg would be particularly meaningful to families who are otherwise unable to leave to the next generation an inheritance that could be used for education, health care or starting a family business.

Today's Social Security system is anathema to real savings and wealth creation. It provides dismal benefits in return for a lifetime of high taxes and leaves the elderly dependent on the government. This campaign season, all workers -- low-wage workers, in particular -- should demand reform that returns the ownership of payroll taxes to those who earn them.

This article originally appeared in Insight Magazine, November 2, 1998. It also appeared as a Cato Daily Commentary, Help the Poor: Allow Individual Investment of Social Security Taxes, October 1, 1998.