Should We Privatize Social Security? The Pros and Cons
Privatizing Social Security is controversial—here's what you need to know
Privatizing Social Security is a hot-button topic that has fallen by the wayside in Washington in recent years, but it's still an issue that comes up when people talk about reforming the system.
The trillion-dollar question is: Would it work? Could privatizing Social Security be what saves the program and makes it a better retirement vehicle for retirees? Let's weigh the pros and cons of both sides.
Pro: It Could Offer Better Returns
Today, the Social Security trust invests in special-issue bonds. It can invest in public, marketable securities, but as of 2018, it doesn't. This means that the trust invests in itself—all government-issued debt.
As a result, returns tend to significantly underperform the market. In 2017, the average rate of return for all investments was 2.988%—far lower than the 19.4% return seen by the S&P 500 the same year.
Nobody believes that the trust should take on the risk of being in all stocks, but if some portion of a person’s Social Security balance was available for personalized investment, the account holder could choose to take on slightly more risk, according to those in favor of the plan.
Proponents believe that if 401(k) accounts were mandatory for all citizens, more flexibility in how the money is invested creates a higher rate of return. Even a few percentage points higher is a substantial amount of extra income over years or decades.
Just like most current 401(k)s, citizens could have a list of mutual funds or ETFs to choose from. With the help of a financial professional, citizens could choose a mix of funds that fits their risk profile.
Con: It May Not Boost Retirement Income Much
Opponents of privatization of Social Security argue that the country already has a privatized retirement system that citizens control—it includes the 401(k), IRA, and other tax-advantaged accounts. But with Americans now shockingly behind on retirement savings—39% of Americans 56–61 years of age don't have any retirement savings, according to a report from the Economic Policy Institute—the idea of giving them more control over their retirement money may do very little while risking what they already have.
Although the total investment value of 401(k)s continues to rise, the median value of an account of somebody age 65 or over is about $60,000. If they live another 20 years, that’s $3,000 per year before taxes. Add the current average Social Security benefit of approximately $1,360 per person, and that comes out to about $20,000 per year before taxes. That's not exactly a comfortable yearly income.
Pro: It Could Boost the Economy
Proponents argue that by allowing people to invest their Social Security funds in private investments, that could provide a shot in the arm to the American economy and spur growth that could further benefit workers saving for retirement. Social Security is less of an investment program and more of an intergenerational transfer of wealth. By changing it to something more investment-focused, those dollars could be put to work, proponents say.
A potential benefit of Social Security privatization is that it helps boost private savings and therefore increases the pool of capital that can be invested back in the economy.
Con: There Are Better Alternatives
Opponents point out that privatization is not as easy as diverting funds elsewhere. Social Security has liabilities that the current system has to pay, and the earnings that come in from today’s earners help to pay those liabilities. Putting any portion of the trust into private accounts would almost certainly doom the system.
Also, because the Social Security trust invests in the federal government, the administrative costs of the fund are exceedingly low. Recipients aren’t paying the high fees that sometimes come with private, market-based investments. Creating a privatized option means more costs—and cost is one of the largest sources of lost performance over time.
Finally, the AARP argues that Social Security is not an investment program and should not be treated as such. As an insurance program, its role is to generate safe and stable returns for the life of the person and potentially their families, not to create investment gains.
What Do Americans Think?
The issue hasn't been polled in a while, but in 2005, during the Bush Administration, polls indicated that Americans were fairly divided on privatization. It's hard to say how Americans would feel in the absence of an actual, actionable plan.
What’s clear is that, with 64 million Americans relying on Social Security, any attempt to make substantive changes to the program should be approached with great caution.