A lot of suggestions have been put forward for fixing the Social Security problem. The two most prominent ones are to either raise the retirement age or lower the benefit. Instead of choosing one or the other and forcing it on everyone, what if we could offer both of these solutions and give every American the freedom to choose the one they want. Lines 5 and 6 of the table below does exactly that, it lets you choose, but donít jump ahead just yet, read about the solution first so you understand what the table is telling you.
Fixing the Problem
This is going to sound overly simplified, but the way to fix the Social Security problem is to insure that the amount of money paid out as Social Security benefits equals the amount of money collected by Social Security as taxes. The complex part is that this must be done as a percentage of current average income and not based on the absolute amount collected over 40 plus years of and individualís working lifetime. This allows the system to keep pace with inflation.
The primary problem with Social Security can be summed up
in a simple statement:
Each generation is living 4 years longer than the previous.
This longer lifespan results in each generation receiving more Social Security benefits for the same amount of Social Security taxes. The outflow from the trust fund continues to grow while the input to the fund remains constant.
Congress is forced into constantly adjusting the percentage of OASDI withholding and / or adjusting the retirement age. This is not a system that anyone can rely on, it is constantly being changed by the next elected group.
So let's get started, but, we should define our goals before we talk about how to fix the problem:
The solution is also simple:
The first thing we have to do is create a baseline, a starting point for this discussion. The 1983 legislation will eventually change the retirement age to 67.
Picking a life expectancy is more difficult. If new legislation is passed in 2014, and anyone under the age of 50 is not affected by it, we start with Americans born in 1964, add a 10 year phase in period and we end up with those born in 1974. The current CDC charts indicate that the life expectancy at the age of 65 for someone born in 1974 will be 79.
To make the math easy to follow in this example, let's set the begin working age at 19.
From 19 to 67 is 48 years and from 67 to 79 is 12 years. The ratio of 48 to 12 is 4 to 1; you work, 'make' OASDI payments, 4 years for each year of retirement benefits that you 'take'. Your make/take ratio is 4 to 1.
The current contribution rate is 6.2% plus another 6.2% from your employer for a total OASDI rate of 12.4%. The system is collecting $124 for each $1,000 that you earn or $496 every 4 years. The average benefit that we SWAG'ed on the 'How It Works' page was 40%, so the system pays you $400 in benefits for each $1,000 of your average earnings. Lower income Americans receive a higher percentage while higher income Americans receive a lower percentage, but the entire system is based on the average.
What if we split the contribution into 2 parts? A fixed 10% of the OASDI rate would go into Al Goreís lock box. For the sake of discussion letís call this the SSB fund, Social Security Benefit. The remaining 2.4% goes into the SIP fund, Supplemental Income Programs, to take care of things like disability insurance, etc.
Since 10% per year for 4 years will always equal the 40% average benefit, the SSB rate could be written into law and should be protected by the requirement of a super majority vote by both houses to ever change it. This would make the system stable and guarantee its benefits for every generation without the need for future changes.
The SIP fund is a different situation. The management of this fund could be changed by a simple majority or any other method decided by congress when writing the new law.
The primary advantage of the new system is that the only thing that the SSB fund will ever be used for is the benefits that everyone has earned based on their make/take ratio, so the fund remains stable and fixed. This does not mean that congress canít increase a personís benefits, but it they do, the benefit has to be calculated twice; once without the increased benefit and once based solely on the actual make/take ratio. The make/take portion comes from the SSB fund and any additional benefit has to come from the SIP fund.
So, how does this fixed make/take ratio work as things change?
Line 1: This is our baseline for discussion: your make/take ratio is exactly 4 to 1 so you are receiving your full 40% benefit. You paid in 10% per year for 48 years for a total of 480% of average income and you will get back 40% of average income for 12 years. Again, this is the same 480% of average income; as a percentage of average income, you get back exactly what you paid in.
Note that we keep using the term ďaverage incomeĒ not ďyourĒ average income. Like the current system, everything is adjusted for inflation, so the new system would be based on the current average American income each year, not your personal income 35 years ago when you were paying into the system. The plan also remains an anti-poverty program paying a higher percentage to the poor and a lower percentage to the rich.
Line 2: Let's say you decide to work an extra 2 years and retire at the age of 69. You work from 19 to 69, 50 years, and retire from 69 to 79, 10 years. Your make/take ratio is 5 to 1. 40% times 5 divided by 4 gives you a larger benefit of 50% of average income. You paid in 10% for 50 years, and got back 50% for 10 years. Adjusted for inflation, this person is getting a larger benefit check for less years, but also the same 500% paid back as the 500% paid in.
What if you decide to work less and retire for more years?
Line 3: If you decide not to start working till the age of 23 and retire at 63. You will be working for 40 years and retire for 16 years. This lowers your personal make/take ratio to 2.5 to 1.
Letís look at this one as inflation adjusted dollars. The 40% return occurs at about $60,000 yearly income. At 40% of $60,000, you are paying in $6,000 a year for 40 years for a total of $240,000. You are then getting back $15,000 a year ($1,250 a month) for 16 years for the same total of $240,000.
Everyone makes their own personal decision as to how long they work and how long they retire; and everyone gets back the same percentage of income as they paid in.
Oops, that was a mistake!
What if the person in line 3 looks at their potential retirement check and decides they made a mistake by not starting work until the age of 23? If they then decide to work till their normal retirement age of 67, plus one extra year to make up for the 4 years they didnít work (the 4 to 1 ratio). Their benefit goes back to the full 40% level, and in this case plus a little extra.
Line 4 shows they will now work for 45 years and retire for 11, just a little over the 4 to 1 ratio. As inflation adjusted dollars, they pay in $6,000 for 45 years for a total of $270,000 and get back $24,545.45 a year ($2,045.45 a month) for 11 years for the same $270,000. As with everyone else in the system, adjusted for inflation, you get back exactly what you paid in.
What about Life Expectancy for the Next Generation?
Lines 5 and 6: These lines show what happens as life expectancy increases from age 79 to 83. If you decide to work the extra four years, your make/take ratio will increase which increases your benefit check as shown in line 5. If you decide to retire for the extra four years, your make/take ratio will decrease which will decrease your benefit check as shown in line 6.
Adjusted for inflation, money in always equals money out so the system remains stable.
This is the primary benefit of the fixed ratio system; it automatically self adjusts to any changes in life expectancy.
Various government agencies are already defining average life expectancy. The system could merely lock in everyone's life expectancy at a fixed age. If that age is 60, then anyone born in 1953 would have their life expectancy locked in in 2013. 2014 locks in those born in 1954, and so forth. This life expectancy number is then used to determine the 'take' half of the make/take ratio based on your age on the month you plan to retire.
The government could publish an estimated life expectancy chart for ages starting at 20 or 25 so that each generation could start earlier in their retirement planning. The margin of error in the estimated life expectancies would be relatively small even at 10 to 15 years before the age 60 lock in.
How do we get started!
Before we can get started on a plan for a new system, we have to look at how the Social Security Administration is spending the tax dollars they are currently collecting.