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Mark Miller: Remaking Retirement

Top 10 Myths About Social Security

The discussion and analysis surrounding this retirement security linchpin and its future are remarkably fact-free, argues retirement expert Mark Miller.

Social Security is going bankrupt. It's a Ponzi scheme. The program's trust fund contains nothing but a bunch of worthless IOUs.

Those are just a few of the comments we hear frequently from journalists, politicians, and policymakers about Social Security. But they're all false--and that's a big problem.

Social Security is one of our most important linchpins of retirement security, yet discussion and analysis of the program and its future are remarkably fact-free--a situation that isn't likely to improve during this year's election season.

So, let's dispel the fog. Here's my list of the top 10 myths about Social Security--along with the facts.

Myth 1: Social Security is going bankrupt.
quick Google search turns up plenty of supporters for this myth--none more prominent than President George W. Bush, who floated it in his 2005 State of the Union address, as he campaigned to replace Social Security with private investment accounts. "The system . . . on its current path, is headed toward bankruptcy," he said. "And so we must join together to strengthen and save Social Security."

Facts: The word "bankruptcy" is meaningless in the context of a federal government program. Nancy Altman, an advocate for Social Security and historian of the program, notes in her book "The Battle for Social Security: From FDR's Vision To Bush's Gamble" that "As long as the federal government has, under the Constitution, 'Power to Lay and collect Taxes' and the authority to issue and sell Treasury bonds, it and its programs will not go bankrupt."

Social Security does face a long-term financial challenge. In April, the program's trustees reported acceleration of the drawdown of Social Security's vast trust fund reserves. The trust funds of the retirement and disability programs are on a course to be exhausted in 2033 as baby boomer retirements accelerate--three years sooner than projected a year ago.

But the trustees also noted that after 2033, there will still be sufficient assets from payroll taxes to pay about 75% of promised benefits. Although that isn't a fair or acceptable outcome, it's still a fact that Social Security will have substantial assets even after 2033. A far more likely outcome: Congress will take action to correct the imbalance (see Myth No. 10, below).

Discussing the trustee report, Social Security commissioner Michael Astrue went out of his way to emphasize that the program is far from broke. Social Security took in $69 billion more than it spent last year, when you include tax receipts and interest on bonds held in the Social Security Trust Fund. The SSTF had reserves of $2.7 trillion last year.

Myth 2: Social Security is a key driver of the national deficit.
Facts
: Social Security lends money to the federal government, not the other way around. It was designed as a pay-as-you-go program, and every penny it receives is credited to the SSTF. Social Security is prohibited by law from borrowing, so it needs some level of reserve to pay benefits whenever cash on hand runs short. It so happens that those reserves are at a historical high point right now as a result of reforms made in 1983 aimed at funding the anticipated retirement of the baby boom generation.

The surplus trust funds are lent via a special type of Treasury note to the federal government, which uses the funds to finance ongoing operations. But Social Security is no more a driver of the debt than China. Both are lenders to a government that chooses to spend significantly more than it levies in taxes--and both have the right to be paid back what they are owed.

Jeffrey Brown, a professor at the University of Illinois College of Business and director of the university's Center for Business & Public Policy, offers more on the debate about Social Security's role in the deficit in this blog post.

Myth 3: The Social Security Trust Fund is nothing but a bunch of paper IOUs. It doesn't really exist.
Facts
: This is a favorite argument of Social Security conspiracy theorists, who argue that the government has raided Social Security to fund other programs, and that the money will never be seen again. President Bush in effect amplified the myth during his 2005 privatization campaign by paying a visit to a file cabinet in West Virginia where the aforementioned Treasury notes are kept.

The 2012 Trustee report confirms--yet again--that the surplus funds are invested in "special issue Treasury bonds" and that they are "full faith and credit" obligations of the government. (Click here to see the relevant excerpt lifted directly from the Trustee report.)

Myth 4: Social Security is a Ponzi scheme.
Facts
: Social Security and a Ponzi scheme are as different as night and day.

The Merriam-Webster Dictionary defines a Ponzi scheme as: "An investment swindle in which some early investors are paid off with money put up by later ones in order to encourage more and bigger risks."

The perpetrators of Ponzi schemes lie to their investors; Social Security is an open and transparent system. Its trustees send a very detailed actuarial report to Congress that projects the program's finances 75 years into the future. The trustees include three cabinet secretaries, two independent appointees (one Democrat, one Republican), and the commissioner of the Social Security Administration.

It's irresponsible to suggest that the program is an unethical fraud or swindle. What's more, Social Security has never missed paying a dime's worth of benefits, and it will be there 25, 30, and 75 years from now.

Myth 5: We're all living longer, so we should raise the retirement age.
Facts
: Everyone isn't living longer. The country's longevity gains aren't spread evenly across the population because of differences in health care, lifestyle, and other factors. For example, in the past three decades, men in the top half of income distribution enjoyed a six-year gain in life expectancy from age 65, while lower-paid men had a 1.3-year gain. Paul Krugman, the Nobel Prize-winning economist, sums up the argument behind this myth: "(It basically says) that janitors should be forced to work longer because these days corporate lawyers live to a ripe old age."

The longevity argument also masks the fact that a higher retirement age results in a substantial across-the-board benefit cut--no matter when you retire--because it raises the bar on how long you need to wait to receive a full benefit.

Myth 6: We need to "fix" Social Security in order to save it for young people when they retire.
Facts
: The proposed fixes involve benefit cuts that would fall most heavily on the children and grandchildren of today's seniors.

Former Senator Alan Simpson, who co-chaired the Simpson-Bowles deficit reduction commission, has argued that he's trying to save the future of young people who "are going to get gutted" unless the reforms he recommends are adopted.

Simpson-Bowles relies on three types of benefit cuts for 63% of its proposed solution to Social Security's long-range imbalance. These include lower benefits for people with higher-than-median lifetime earnings, higher retirement ages, and smaller cost-of-living-adjustments, or COLAs.

The cuts would be gradual and cumulative, with the largest cuts coming in the out years. An analysis of Simpson-Bowles by the National Academy of Social Insurance concludes that most of its cuts would fall on people many decades away from retirement.

(Note: Simpson-Bowles is one of many Social Security reform plans that have been floated, but I reference it throughout this analysis because the commission was created by President Obama and it's what passes for centrist, bipartisan compromise in Washington these days.)

Myth 7: Benefit cuts would be phased in; today's seniors won't be affected.
Facts
: It's true that Social Security benefit cuts usually are phased in gradually over many years, giving beneficiaries plenty of time to plan and adjust. But there's a major exception this time around: a proposed change in Social Security's COLA formula.

COLAs are calculated using a formula tied to the Consumer Price Index. Simpson-Bowles proposes to substitute an experimental index maintained by the U.S. Bureau of Labor Statistics called the chained CPI. The chained index reflects changes that consumers make in their purchasing across dissimilar items in response to price changes; the theory is that a spike in gasoline prices will prompt consumers to spend less on fuel and perhaps more on food.

A chained CPI would affect today's seniors. The chief actuary of the Social Security Administration estimates that the chained CPI will rise about 0.3 percentage points less per year than the CPI. With compounding, that translates to huge lifetime benefit cuts. The National Women's Law Center calculates that the average beneficiary filing for benefits at age 65 would lose $8,100 by age 80, and $19,245 by age 90.

As an illustration, NWLC calculated the lost benefits into the number of weeks of groceries lost annually for a single elderly woman starting at 65 with a monthly benefit of $1,100: six weeks at age 70; 13 weeks at age 80; and 20 weeks at age 90.

Myth 8: Social Security pays generous benefits.
Facts
: Benefits are modest, and they're shrinking. The average retirement benefit this year is $14,800--about $3,300 above the the U.S. Census Bureau's poverty threshold for an individual.

Looked at another way, Social Security replaces 41% of pre-retirement income for the average worker. That's scheduled to fall to just 29% by 2030, the result of higher retirement ages already in place, taxes on benefits, and expected higher Medicare Part B premiums (which are deducted from benefits).

Higher-income seniors have other sources of income, of course. But the financial crisis and eroding middle-class incomes during the past decade mean Social Security will be the life raft for a very large segment of seniors in the years ahead.

Just 14% report they expect to have enough money to live comfortably in retirement, according to the Employee Benefit Research Institute. Sixty percent of households tell the EBRI that the total value of their savings and investments--excluding their homes--is less than $25,000.

Instead of cutting Social Security, we should be looking for ways to boost benefits. Some ideas: increase benefits for the very old, who are most likely to have exhausted their other resources and can't work; boost survivor benefits for widows; adopt a more generous COLA that more accurately reflects inflation faced by seniors, such as medical expenses (see the experimental BLS CPI-E).

Myth 9: Means testing can save Social Security.
This one sounds so reasonable and painless--which is why politicians love it. The wealthy don't really need Social Security, so let's cut their benefits. Supporters point to Simpson-Bowles for support of this idea, but Simpson-Bowles doesn't propose real means testing, which would require taking benefits away from people who have other available sources of income or resources.

Instead, Simpson Bowles looks at a senior's lifetime earning history and changes the formulas used to determine benefits. Those cuts would hit a wide swatch of beneficiaries: According to NASI, by 2070, 94% of beneficiaries would experience benefit cuts as a result of this provision, including 29% who would have major cuts of 20% or more. Eighty percent of beneficiaries in the lowest quintile of household income would experience cuts.

Anyway, real means testing wouldn't produce much in the way of savings because the program's benefits don't mainly go to the rich. Despite all the talk we hear about Warren Buffett's Social Security checks, only 2% of benefits go to seniors with non-Social Security annual income of more than $100,000.

Here's another problem with means testing. The phrase implies measuring seniors' financial adequacy to determine eligibility for welfare--that is, a test of inadequate means or poverty--not wealth. Social Security's retirement and disability programs aren't welfare at all; they are social insurance programs that we all pay into in return for a promise that benefits will be available when they're needed. Breaking that promise to wealthier Americans would be a breach of faith.

Myth 10: Social Security costs are exploding, so we need to cut benefits.
Facts
: Retirement program outlays are rising as the baby boom generation retires, but the program remains affordable in the context of our huge economy. The Social Security trustees report indicates that the combined retirement, disability, and survivor program outlays equaled 4.9% of gross domestic product in 2011. That will rise to 6.4% in 2035 before falling and leveling off at 6.0%.

What to do about that shortfall projected for 2033? Rather than cut benefits, a combination of gradual tax increases would close the imbalance and even create sufficient surpluses to boost benefits. For example, a coalition of Social Security advocates this month proposed several changes that would close the gap; the Social Security Administration offers a wider list of options--and the percentages by which they would close the gap--here:

  • Gradually eliminate the cap on payroll taxes (currently $110,000) over 10 years (71%)
  • Gradually raise payroll contribution rates for employers and employees from 6.2% to 7.2% over 20 years (53%)
  • Subject worker contributions to 401(k)s to payroll tax (8%)

Higher taxes might sound like tilting at windmills in the current political climate, but the idea enjoys substantial public support across political party lines and age groups.

For example, a 2010 survey for the National Committee to Protect Social Security and Medicare found 50% of Americans support removing the wage cap--with only 2- or 3-percentage-point differences between Democrats, Republicans, and independents. Upper-income Americans--who would pay the higher taxes--were the income group most likely to support removing the cap.

Mark Miller is a retirement columnist and author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living. The views expressed in this article do not necessarily reflect the views of Morningstar.com.