Social Security Solutions, Part 2: The 10% solution

In my (much) earlier post, I talked about the need to fix Social Security without unfairly penalizing people who had worked hard and saved their money. I said I was going to discuss three possible solutions: the three-month solution; the 10% solution; and the Lifetime Endowment. I’ve already discussed the first of these here. This post is about the second solution.

This is pretty much my variant of George W. Bush’ plan. It’s been tumbling around in my head so long I no longer remember how much it differs from Bush’ plan nor everything I’ve read that has informed it. So if the same plan exists elsewhere, let me know and I’ll credit it.

We replace Social Security with Retirement Savings Accounts (RSAs). (Note to self: Come up with snappier name and/or better acronym.) Right now the Federal government takes the following percentages (download “Tax rate table” pdf from Q16 at this site) from your paycheck (or half from your paycheck, half from your employer):

10.6% for OASI - Old-Age and Survivors Insurance; this is the retirement benefit portion of Social Security plus the payments that the Feds will make to survivors after a breadwinner dies

1,8% for DI - Disability Insurance; if a worker is disabled he may qualify for disability benefits from the Feds; I’m not concerned with that here.

2.9% for HI - Hospital Insurance; this is Medicare; I’m not concerned with that here.

Under RSAs, the Feds will stop taking 10.6% of your salary for OASI. Instead they’ll take 10% of your salary and place it in your own RSA account. If the country so desires, they can continue to take some additional portion of your salary (not to exceed 0.6%) for Survivors’s benefits. Each RSA earns interest: inflation plus 3%. Your RSA account is yours; it’s not part of a pool of money that the government may or may not decide to pay out when you retire. Rather, you own it.

When you elect to start drawing benefits, your RSA stops earning interest. The government determines what your expected lifespan is then adds one year. Your RSA pays out to you at a rate that will get you back all your money if you live that long. If your life is shorter, your leftover money reverts to the government. If your life is longer, the government keeps paying at the same rate even after your account is depleted. RSA payments are not subject to an RSA tax (duh). If you die before you begin to draw down your RSA, it becomes part of your estate just like a savings account. You can will it to whomever you want.

Let’s look at some numbers. I’m using the income tables I’ve used before: the Congressional Budget Office Data on the Distribution of Federal Taxes and Household Income (hereinafter “CBO”). The Website is here; I’m using the pdf you can download via the “All of the Above Information” link under “Historical Effective Federal Tax Rates and Income, by Income Category (1979-2006)”. On page 7, the CBO tells us that average household pre-tax income looks like this:

Lowest quintile: $17,200
Second quintile: $39,400
Middle quintile: $60,700
Fourth quintile: $89,500
Highest quintile: $248,400

Let’s make some simplifying assumptions. You work for 45 years. The average household income is the average income you make throughout your working life; you make less when you start working and more just before you retire. There is no inflation so we can just use 3% as our interest rate. Interest compounds annually which almost certainly understates the resulting amounts.

So for someone in the Lowest Quintile, we assume the first year he worked he made $760 and his salary went up by $760 each year after that. Midway through his 45-year working life - year 23 - he was making $17,480. His average annual salary was $17,480. This is a little lower than the actual Lowest Quintile amount but it serves as an illustration.

If I’ve done my math right (please feel free to check me), after 45 years of working our Lowest Quintile worker will have saved $78,660 and earned $53,115 in interest, giving him a total of $131,775 in his RSA. If we assume he’s retiring at age 65 - having worked since he was 20 - he can expect to live for another 16.8 years (download “Source: Deaths: Final Data for 2006, table 7 from this site). Add one to get a 17.8 year distribution period. This means he will receive $7,403 per year from his RSA or $616 per month. This is 42% of his average salary over the course of his working life but it is only about 22% of the $34,200 per year I postulate he will be making by the time he retires.

The greatest advantage to this plan is that the money belongs to the person from whom it was taken; it is not an entitlement that is paying for someone else’s retirement and can be taken away or altered without warning if funds run short.

The greatest disadvantage is that it may be less generous than our current Social Security especially for those at the lower end of the income scale.

The greatest problem is how to get from what we have now to this scheme. We need to find the funds to pay people already on Social Security what they expect to get; we need to find the funds to pay those close to Social Security - say over age 55 - what they expect to get; we need to fill up the RSA accounts for those under 55; and we have to stop using Social Security contributions from current workers to do all this.

The only solution I’ve been able to come up with is a lottery. Anyone who wanted to could play except those already receiving Social Security and those old enough to receive Social Security when they retire (over 55). Once there’s enough money to fund everything we need to fund, the lottery shuts down.

And that, of course, is the rub. Once let the Federal government decide it can fund its spending by levying a tax on the mathematically challenged and it will never end. Plus the simple truth is that I agree with George Washington:

It [gaming] is the child of avarice, the brother of iniquity, and the father of mischief.

I like the 10% solution. I like the fact that the money the government takes is in an account with my name on it. I like the fact that it can be inherited if it’s never drawn against. But unless someone can come up with a way to make the transition from what we have now to Retirement Savings Accounts without selling our soul to the Devil, I simply don’t see any way to make it a reality.