Private Social Security—Boon or Bust?

Physician's Money Digest, March15 2005, Volume 12, Issue 5

One of President Bush's most significant initiativesfor his remaining administration isto create private investment accounts for aportion of your Social Security contributions(ie, your withholdings). The immediate problemwith this concept is that the money workers woulddivert to these private accounts is currently being usedto pay current Social Security retirees. To continue fullretirement benefits to current retirees, our governmentwill have to borrow funds. This will likely increase thedeficit by trillions of dollars.

Opponents argue that the newly created deficit willcause our economy to go into a tailspin and burden ourchildren with a tax bill they will not be able to affordto pay. Advocates of the private accounts point out thatSocial Security is headed for bankruptcy within thenext 15 to 20 years based on its current path and thatthe additional deficit can be handled over the longterm. What seems clear to everyone is that SocialSecurity needs fixing. It's the how-to that is at the centerof the controversy.

Corporate Replay

Corporations faced similar problems years ago andapproached a resolution using a similar remedy. Beforethese reforms, many large corporations had defined-benefitplans that provided a retirement income forretiring employees based on a percentage of their pay.There were various formulas used, but most includedweightings based on years of service and averagewages during the final 5 to 10 years of service. Moneyto fund these obligations was invested in stocks andbonds, and each year an actuarial review determined ifthe plan was overfunded or underfunded.

During the long bull market in stocks, many ofthese plans became overfunded and corporations usedthis as an opportunity to raid the retirement plans ofcash that would be needed in the future when the stockmarket entered a bear market period. Ultimately, manyof these companies opted to terminate their defined-benefitplans in favor of defined-contribution planssuch as the 401(k). This has shifted the responsibilityfor providing for retirement away from the companiesand back to the employees. There are obviously differencesbetween the Social Security system and corporate defined-benefit plans, but the core issues are similar.The solution President Bush is proposing resemblesthe solution used by corporate America: Shift thefinancial burden to the workers.

For the People?

Would Social Security private accounts be a goodfinancial strategy for workers? It depends on whichworker is in the crosshairs of the debate. On one side ofthe issue, you give people more say in their financial destiny.Instead of being limited to Treasury-type returns,they could choose among several choices that wouldinclude allocations to stocks. Over longer periods of time,stocks have typically outperformed bonds by a wide margin.It would also allow retirees to leave something fortheir children—their remaining account balance.

The problem is that multitudes of workers barelyunderstand how the stock and bond markets work andwill often make poor decisions that result in poor long-termperformance. These people would be better offunder the current managed system. Remember, too, thattoday approximately two thirds of retirees depend onSocial Security as the foundation of their retirementincome and an astonishing 50% depend on SocialSecurity as their sole source of income. This is a sad commentaryon financial literacy in America, but it is a trendthat is likely to continue for future generations.

Working-class Woes

Clearly, there are pros and cons to both sides ofthe argument as well as an agreement that somethingmust be done. The current system is not viable overthe long term. To maintain it, the government willhave to continue to raise the wage base that is subjectto Social Security taxes (currently $90,000) and/orincrease the tax itself (currently 12.4%). I favorallowing private accounts and beginning to wean thegovernment from the retirement funding business. Animportant element in the long-term success of the programwill be better financial education for workers.The workers who will be contributing to these privateaccounts must understand how the accounts workand the best ways to use them.

is the founder of the

Welch Group, LLC, which specializes in providing

fee-only wealth management services to

affluent retirees and health care professionals

throughout the United States. He is the coauthor

of J.K. Lasser's New Rules for Estate and

Tax Planning (John Wiley & Sons, Inc; 2001).

He welcomes questions or comments at 800-709-7100 or visit This article was reprinted with permission

from the Birmingham Post Herald.

Stewart H. Welch III