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SOCIAL SECURITY benefits are fairly modest—the average retiree receives $1,555 per month or $18,660 a year—but they’re a vital source of retirement income for countless retirees. Today’s burning question: How can we shore up the program’s finances?
It’s estimated that Social Security provides some 30% of the income for the elderly and that nearly nine out of 10 people age 65 and older receive benefits. Social Security is even more important for women, 42% of whom rely on it for half or more of their income.
Unfortunately, the Old-Age and Survivors Insurance (OASI) Trust Fund, from which Social Security benefits are paid, faces imminent shortfalls. The fund’s reserves are projected to be depleted by 2033, at which time continuing tax revenue will be sufficient to pay just 76% of promised benefits.
There are no easy solutions. Both higher payroll taxes and lower benefits may be necessary. But how about some out-of-the-box thinking? Meet my suggested solution: the Save for Tomorrow program.
The program would cost the federal government very little in the short run but save it vast sums in the long run. It involves the creation of a novel, completely optional retirement account. Here’s the basic framework:
Let’s run some numbers to see how this new program might work. I’ll assume the Save for Tomorrow account earns a 7% real return over its lifetime. For simplicity’s sake, I’ll also assume the account is funded by a lump sum contribution at birth. Finally, I’ll use the 4% rule to annuitize the account balance at ages 65 and 70. You can see the results in the accompanying table.
Some observations:
How so? If someone died at age 64 with $1 million in his Save for Tomorrow account, that money would go to the OASI Trust Fund. In addition, anyone receiving the higher Save for Tomorrow payout isn’t drawing a cent from Social Security. If the Social Security benefit is higher than the Save for Tomorrow benefit, the latter dollars are returned to the OASI Trust Fund. Finally, any money left over upon the death of a beneficiary goes into the OASI Trust Fund.
The biggest criticism of the Save for Tomorrow program would be that it primarily benefits the rich and their progeny. While this may be true, I could envision significant numbers of middle-class grandparents funding these accounts for their grandchildren.
More important, the Save for Tomorrow program is a win-win for everyone. While beneficiaries would certainly benefit from the generosity and foresight of their parents and grandparents, so would everyone else. Every dollar contributed to the program would mean more money for the OASI Trust Fund, which would shore up the Social Security program.
As I see it, the Save for Tomorrow program draws on many strengths, both financial and behavioral:
The program maximizes compounding’s enormous power. Allowing money to compound uninterrupted for up to seven decades can achieve wonderful things. At a 7% real growth rate, $1 turns into $114 in 70 years. In the extreme case, $30,000 contributed at birth could swell to $3.4 million by age 70, providing $137,000 of annual income for life—or millions of dollars for the OASI Trust Fund should the beneficiary not receive the benefits for whatever reason.
While it may seem unfair that a parent or grandparent could ease their progeny’s retirement in such a manner, consider that much of that money might eventually benefit society, should sizable funds remain when the beneficiary dies.
The long time horizon enables taking much greater risk and achieving commensurately greater returns. A 100% stock portfolio is exceedingly risky over short and even intermediate time frames, but over six to seven decades, not so much. A globally diversified 100% stock portfolio may actually be less risky than cash or bonds over such time horizons, once inflation is taken into account.
The program would reduce behavioral risk. The tectonic shift from company-sponsored pensions to individual 401(k) accounts failed to factor in the human element. We are humans, not “econs,” as Nobel Prize winner Richard Thaler says. Many of us simply don’t possess the knowledge, self-control or temperament to successfully save and invest for retirement—not to mention the even thornier task of drawing down assets in retirement.
One of the great benefits of the Save for Tomorrow program would be that both tasks would be professionally managed, removing this burden from individuals ill-equipped to perform them. Will members of Congress read HumbleDollar and act on my suggestions? Probably not. I’m a realist. But perhaps farsighted families could find a way to build the notion of extreme compounding into their generational planning.
John Lim is a physician and author of “How to Raise Your Child’s Financial IQ,” which is available as both a free PDF and a Kindle edition. Follow John on Twitter @JohnTLim and check out his earlier articles.
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I offer that the simple solution to the Social Security solvency issue is to treat it simply as a tax, and not a contribution-related retirement plan.
In 2021, the maximum SS benefit is $3,148 a month ($37,776 annually) for those retiring at their “Full Retirement Age (FRA)” of 66 years and 2 months.
The maximum wage that is subject to social security tax in 2021 is $142,800.
So, someone making this amount is taxed on 100% of their wages for their SS retirement benefit, while someone making $250,000, $500,000 or $1,000,000 are taxed on 57%, 28% and 14% (rounded) of their income, respectfully, for the same retirement benefit.
In other words, Social Security is a regressive tax.
Let’s simply end this result, and make it a 6.2% flat tax on every dollar of income earned — as is the case currently with anyone making $142,800 or less — with no change in the benefit received (except for the Cost of Living Adjustments)
Now the benefit is regressive, rather than the tax, and there would further talk of a Social Security solvency issue.
If the wealthy want to feel better about this change, I’d encourage them to consider the guaranteed “yield” of the social security payments to the yield on their stock and bond investments.
There are various ways to consider the math, but even if we took an extreme example – a lucky sole earning $500,000 a year for 40 years, paying a total of $1,240,000 in SS taxes over their career ($31,000 of tax annually for 40 years) — the $37,776 annual payment today would equate to a guaranteed annual yield of 3.04%, if they want to consider their social security tax their bond portfolio.
The equivalent yield for us average folk would be much higher.
The “Medicare solvency” issue is a real problem. The “Social Security Solvency” issue is a problem of our own choosing.
You are ignoring the fact that payouts are also limited. If you want unlimited withholding, there should be unlimited benefits.
I love this idea. It’s great to hear a creative idea to a thorny problem. Even if only a small fraction of the population takes advantage of this approach, it would ease the burden on Social Security, which would help all of society. As a grandparent it is appealing to think that I could substantially help my grandchildren with their retirement and help my country at the same time. I understand and accept the tradeoff: I contribute till the child is age 10; the money goes to the OASI trust fund if the child dies early; but the child could receive MORE than Social Security if they make it to age 65.
I think a major flaw of your idea is that “Save for Tomorrow” funds are forfeited to the OASI trust fund upon the death of the beneficiary – that alone will be a non-starter for the vast majority of people who will expect fund balances to pass to a second generation heir – not the government.
So does a person have one save for tomorrow account, or multiple (can each parent/grandparent fund an individual account? If there are multiple accounts, can one be traded for SS and the rest be kept?
I would say each beneficiary can only have one account to ensure that the limits are not exceeded.
I really like John’s proposal but like many others have commented, very few people in our society are likely to recognize or take advantage of the opportunity. People that have real interest in personal finance information like Humbledollar.com are in the vast minority.
Another way to achieve a similar objective for those having the interest and resources to do so is detailed in the following article from Paul Merriman:
https://paulmerriman.com/turn-3000-into-50-million/
Why save when you can vote yourself deficit money from the treasury…yuck it up future socialists.
Considering that only 8% of eligible Americans contribute to their own IRAs, I don’t think this idea is realistic. Those who least need it would be vastly more likely to take advantage of it than those with low to moderate incomes who, unfortunately, are all too likely to be living paycheck to paycheck.
https://www.fool.com/retirement/2018/04/28/only-8-of-americans-are-making-this-smart-retireme.aspx
But 32% of eligible Americans contribute to a 401(k) plan. Then there are also 403(b) and 457(b) plans.
Other than the initial tax deferral on the contribution, I don’t see why I would do this. I could take the $30,000, put it into a brokerage account in my name, invest it in a total stock market index ETF, and then gift it to my grandchild when they have income with the stipulation that they use it to fund their Roth IRA. At retirement, they would then get both the balance in the Roth IRA (which they could choose to annuitize) plus Social Security. What am I missing?
I have become a strong believer that annuitization is required for the majority of us. Having put many thousands of dollars and a Roth IRA for my son only to see him pull it out and spend it, shows me that John’s plan is far superior to any plan that allows our progeny control over the money. My second concern is that Congress is always looking for large piles of money to do with as they please.
The other benefit of the “Save for Tomorrow” plan is that it takes financial decision making out of the hands of individuals, most of whom are far less sophisticated than the readers here. The importance of the behavioral component cannot be understated as it likely hampers returns of even sophisticated investors and professionals.
Finally, “Save for Tomorrow” would force the annuitization of assets upon retirement. Given the “annuitization puzzle” (https://humbledollar.com/2021/09/an-age-old-puzzle/), it’s clear that many people fail to annuitize retirement assets, even when there’s strong evidence it would be beneficial. One variation of the “Save for Tomorrow” program that I considered was the formation of an annuity pool, which would provide even greater benefits to participants in the form of mortality credits (but it would mean providing less benefits to shoring up the OASI trust fund).
If you gift the fund to your grandchild, he or she would have to sell it first, triggering capital gains taxes. The child would need earned income to fund the Roth — and the contribution in any given year would be limited, currently set at $6,000.
Paul Merriman’s idea, mention in an earlier comment, avoids paying capital gains taxes and gets around the earned income requirement:
Maybe I’m missing something, but it seems like there are various ways the plan you describe by Paul Merriman could be derailed. Like when Brendon is a young adult, he could just take the money out and spend it. Or even if Brendon’s not a spendthrift, by the time he’s grown up the parent or grandparent who made the initial investment and planned to later make the ongoing Roth contributions may be long gone. What I like about the plan John Lim described is that it’s set-it-and-forget-it after the initial investment.
I don’t disagree with any of that (although it may be possible to spread the sales and keep the child in the 0% CG bracket), but wouldn’t the child still end up with a couple million dollars plus Social Security at retirement?
Perhaps — but I wouldn’t be so quick to discount the value of the initial tax deduction and the chance to invest as much as $30,000 for a newborn and have it grow tax-free.
I have to disagree here on two points. There are easy solutions to fixing current Social Security. I wrote about some of them back in 2018 on HumbleDollar The problem is the changes should have been made gradually over time. The failure is solely on Congress.
I think the suggestions you make here are misguided. No plan that relies on voluntary actions by Americans is a solution to anything, especially related to lower and middle class Americans, but you already noted that.
Aside from fixing SS, we need to clean up the complicated mess of all the savings vehicles currently available and simplify with one vehicle and one set of rules, contribution limits and tax advantages. The confusion is what stops some people from doing anything.
Thank you for your thoughtful comments, Richard. I enjoyed your 2018 piece on this topic. As you illustrated in your article, a multi-pronged approach to saving Social Security is necessary. My point is to enlist the help of the private sector in creative ways. The government has been slow to act on this issue as raising payroll taxes, lowering benefits or raising the benefit age are all unpopular. While I share your frustration with the patchwork of savings/retirement vehicles, that is the world in which we live. The bottom line is that the “Save for Tomorrow” plan would be an entirely optional plan and I believe that many would contribute to it; I certainly would. Those contributors would be shoring up the plan for everyone else.
“…enlist the help of the private sector…” to get people in high ER funds and only charge them 1%+ AUM. No thanks.
The Thrift Savings Plan funds have rock-bottom annual expenses.