Social Security Solutions, Part 1: The social contract

Back in the mid-1980s I visited an elderly cousin of mine. She would have been in her mid to late 70s at the time and she had a number of health problems. Nothing major but her vision was very poor and she was generally weak. They - whoever “they” were at the time - were talking about reducing Social Security, possibly across the board, possibly through means testing. My cousin had a pension from her husband and money in the bank - she and her husband had worked hard to make sure she had both - but her Social Security money was something she had counted on when planning for retirement. When we discussed the possibility of her Social Security being reduced she was almost in tears. “They can’t take that money away from me,” she said. “I have no way to make more.”

I went home and wrote a letter to Bill Bradley, one of my Senators at the time, saying that I realized Social Security was unsustainable but that I thought it would be criminal to suddenly cut Social Security for people already over 65 or for those close to 65. Instead, I said, we should start telling younger people that their Social Security would be means-tested. Perhaps, I suggested, we could say that for everyone over 55, Social Security would not be means-tested. For everyone under 55 Social Security would be means-tested when they were old enough to qualify but the reductions would be phased in. For example, let’s say you were between 50 and 55 when the new rules went into effect. When you started receiving Social Security, means-testing would be done to see if your Social Security should be reduced. However, if the means-testing said your Social Security should be cut by $100, it would only actually be cut by $25. For someone 45-50 when the new rules went into effect, the cut would be $50; 40-45, the cut would be $75; and for those under 40 the cut would be in full effect. Knowing head of time that Social Security would be means-tested would give those younger people a chance to save more of their own money for their retirement while not unfairly taking money away from those who were counting on Social Security and no longer had the time or the ability to earn and save more.

Needless to say, nothing like this happened (I got a very nice form letter from one of Senator Bradley’s aides) and here we are twenty years later. Unfortunately the great bulge of baby boomers who would have been subject to means-testing if we’d done this twenty years ago are now so old that we can’t give them advance warning of means-testing. That means we can’t cut their Social Security without great unfairness. How would suddenly beginning to means-test Social Security be unfair to the well-off elderly who would lose money as a result of it? Well, here’s how Megan McArdle puts it when talking about a different entitlement, higher education in California (emphasis mine):

... shutting down prior entitlements suddenly is a very bad thing, even if you're the kind of heartless conservative who hates entitlements ...

People plan their lives around public programs. Allowing an unsustainable program to run until it comes to a screeching halt is often worse than having no program. The UC system is very good, and I am in no way suggesting that we would be better off if it didn't exist. But many, many California students, and their parents, planned their lives around a reasonable expectation of what in-state tuition would be. The protests are childish, but the rage underneath them is understandable: if you suddenly have to leave school because legislators have broken your implied social contract, you're probably going to be pretty mad.

And that, of course, is the problem with a change to Social Security that involves cutting benefits for those already receiving them or for those on the verge of being eligible for them. It’s all very well and good to say that well-off old people shouldn’t be getting money from less well-off younger people but those well-off old people made plans based on those Social Security payments. When they decided what job to take, how much money to save for retirement, what to buy and what to forego so they could have the kind of retirement they wanted, the money from Social Security was always in their calculations. To see how this works, let’s take a look at two hypothetical couples.

Ann and Bob have worked hard their whole lives. They married right out of college and bought a three-bedroom ranch house in a nice enough subdivision; both sets of parents helped them out with the down payment. They lived close to the bone - no dinners out, modest Christmas presents, no getting away on vacation - until they paid back those loans. Once they were making a little more money they had a couple of children but they still watched their pennies. Vacations were driving trips, often to visit relatives; they shopped at discount stores for clothes and food; Christmas and birthday presents were still modest and always included a little extra cash tucked away in their kids’ college accounts. And they always, always put away as much as they could for their retirement. They figured they’d have the house paid off and the kids through college by the time they retired and they calculated that with the $2000 per month - $1000 for each - that they’d get from Social Security plus the $2000 per month they planned to have from their own retirement investments, they’d have enough money to do all the traveling and wining and dining they weren’t doing now.

Carol and Dave have also worked hard their whole lives. They, too, married right out of college and bought a three-bedroom ranch in a nice enough subdivision with the help of their parents. They, too, scrimped and saved to pay back their parents. After that, though, they saw no need to continue to be frugal. They never ran up a lot of debt but except for saving for their kids’ college they spent every penny of their income on trips and clothes and restaurants and just plain stuff. As soon as they got halfway decent equity in their ranch house they traded up to a McMansion. There was no way they could save for retirement after that but they figured that the $2000 - $1000 for each of them - that they would get from Social Security would be plenty: they’d be so old when they retired that they wouldn’t want to do much of anything anyhow.

Now both couples are retiring. Ann and Bob will get $24,000 a year from Social Security plus $24,000 a year from their own retirement investments; their house is long since paid off. Carol and Dave will get $24,000 a year from Social Security but they have no retirement savings and not only is their house not paid off, the lousy real estate market means the value of the house is just barely enough to cover the outstanding mortgage.

The government decides to means-test Social Security. What’s going to happen? Why, Ann and Bob are going to lose their Social Security because they’re financially secure without it. Carol and Dave are going to keep theirs because that’s all they’ve got. And that’s not fair.

So are there ways to keep Social Security solvent without unfairly penalizing those who counted on their Social Security benefit when they planned for retirement? Yes and I’m going to discuss three of them: the three-month solution; the 10% solution; and the Lifetime Endowment. As always, I’ve created a new category to group together the posts in this discussion.