RE: The dual purpose of Social Security and its impact

[Richard Arsinow <richard.arsinow@rauland.com>]

Thank you, Maureen West, for putting my question to Kilolo Kijakazi to a wider audience.

-----A correction:  In the example, I should have used, not 10.4%, but 12.4% of payroll, which is the amount of employee and employer withholding for OASDI.-----

A lot of the recent discussion on this board centers on compensation for years spent out of the paid workforce raising children.  To assist in the comparison between individual retirement accounts and the present Social Security system, it is helpful to examine the benefits derived from working years prior to years taken off to be with children.

Under Social Security, the covered wages earned during those years are indexed to an equivalent present value at retirement.  That is, each of those years' earnings are multiplied by a factor which accounts for the general increase in wages from the year of earnings to the year prior to retirement.  If wages rise in step with the cost of living, this factor will compensate for inflation exactly.  In practice, the correction is somewhat more or less than inflation.  The adjusted earnings for all years of employment are compared, and the highest 35 are averaged and divided by 12 to arrive at a figure known as AIME, the Average Indexed Monthly Earnings.  Yes, it's true that if there are fewer than 35 years with earnings, some zeros are averaged in.  Social Security then sets a benefit which replaces 90% of the first $505 of AIME, 32% of the next $2538 of AIME, and 15% of all remaining AIME.  An average wage worker will receive about 42% of AIME, a below average wage worker will receive more, and an above average wage worker will receive less.

Now suppose that a working woman has an individual retirement account instead.  Each working year, a percentage of her pay is directed to the account.  Some proposals suggest 5% from her and 5% from her employer.  For our example, we should use 6.2% + 6.2% since we wish to compare directly to Social Security.  Premiums for life and disability insurance are deducted each year from her account.  Since these are very large group plans, the cost is modest, estimated at around 1% of earnings for each.  For simplicity, let's say they cost 1.2% each.  Thus, 10% of earnings are invested solely to provide retirement income.  The entire holdings of the account increase each year by whatever return the investments bring.  Conservative investments such as government bonds still beat inflation.  Diversified equity fund investments, over any period of around 7 years or longer, have a track record of providing a still higher return.  Not only does this provide funds for a much higher replacement of income in retirement, but the earnings from the pre-children years continue to compound at this higher-than-inflation rate during the child-rearing years.  Contrast this with Social Security, where the factors are only on a par with the inflation rate, or less if average wages lag inflation.  As one of the other posters put it, her money continues to work for her while she takes time off for her children.

Estimates show that, even with conservative investment, virtually all workers will be able to build a higher retirement income than under Social Security.  This includes minimum-wage workers.

Other advantages of such a system include:

*It is perpetually self-prefunded, does not rely in any way on other taxes or appropriations, and will never need to.

*In the leading proposals, if a covered worker reaches normal retirement age and does not have sufficient funds to buy a life annuity with COLA to provide the minimum retirement income, the government will supply the difference, funded from general revenues.  This is the safety net.

*The worker decides his or her own retirement age, subject only to having funds sufficient for the minimum retirement income.  There is no minimum retirement age or minimum years of service.

*Of course the funds in the account are the property of the worker and can be inherited and used to supplement the heirs' own retirement funds.  In cases of divorce, the value is explicitly known in the year of divorce.

*Watching your own retirement funds grow is a powerful incentive to work, and, if allowed, to make additional contributions.  It makes people feel good about the program.  Few people feel good about their contributions to Social Security.