Save for Tomorrow

John Lim · Nov 9, 2021 · 22 replies

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:

Parents, grandparents or legal guardians could opt to open and fund a Save for Tomorrow account for their children or grandchildren. The account would be triple tax-advantaged—contributions would be tax-deductible, funds in the account would grow tax-deferred and future withdrawals would be tax-free.
Contributions would be subject to a lifetime limit for each child—say, five times the annual IRA contribution limit. For a child born today, that would mean contributions would be limited to $30,000, equal to five times today’s regular $6,000 IRA limit. Contributions could begin at birth. The contribution window would close once the child reaches age 10.
Between ages 65 and 70—and no sooner—the beneficiary could claim her benefits. At that point, the funds in the account would be annuitized, with inflation adjustments, just as Social Security payments are. The beneficiary would then receive the higher of the annuitized income stream from her Save for Tomorrow account or the standard Social Security benefit. If the Social Security benefit is higher, the funds in the Save for Tomorrow account would be turned over to the OASI Trust Fund.
Save for Tomorrow accounts would be overseen by salaried professionals and would reside inside the highly regarded federal Thrift Savings Plan. Given the super long time horizon—anywhere from 55 to 70 years—the funds would be aggressively invested, with nearly 100% in stocks.
Upon a beneficiary’s death, any unused funds in the Save for Tomorrow account would be turned over to the OASI Trust Fund.

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:

Contributing $6,000 at birth (scenario No. 1) generates an annual payout of $19,505 at age 65. This is higher than the average Social Security benefit of $18,660 that I referenced earlier. By waiting until age 70, the payout increases to $27,357 a year.
For comparison purposes, the maximum Social Security benefits are listed in the table. Obviously, many retirees will receive far less than these numbers.
Contributing $12,000 at birth leads to annual payouts of $39,011 and $54,715 at ages 65 and 70, respectively. Both of these top the current maximum Social Security benefits.
The annual payouts are in real, inflation-adjusted dollars since I’m using a 7% real return for the calculations.
Remember that the Save for Tomorrow payouts are tax-free, meaning they’re significantly more generous than those from Social Security, which are potentially taxed. The upshot: Even if the two benefits were equal in dollar terms, the Save for Tomorrow benefit would win out once taxes are factored in.
The contributions are entirely funded by the private sector and are completely voluntary.
While the new accounts would cost taxpayers very little—there would be a small loss in tax revenue due to the tax-advantaged nature of the accounts—the Save for Tomorrow program would save the Social Security program a bundle over the long run.

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.

Want to receive our weekly newsletter? Sign up now. How about our daily alert about the site's latest posts? Join the list.

Save for Tomorrow

More On This Topic