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Is Social Security really 'going broke'?

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Q: We keep hearing "privatizing social security" or "letting young people invest in private funds". What does this really mean? My understanding is that Social Security is a pay as you go program and if you divert those funds that we'll have to borrow to pay retirees today? Can you please clarify this — Linda B., Amelia, Ohio

A: Despite lots of noise, there’s been very little clarity in the current debate surrounding the federal retirement program that Americans have relied on since it was set up more than 65 years ago. And the debate is really two debates. The first centers on the question of whether Social Security is “going broke.” The second is over the more ideological question: Who should be managing your retirement savings, you or Uncle Sam?

The first question is pretty straightforward, even though much of what you’re hearing these days is simply dead wrong. While the Social Security system is in need of another overhaul (similar to the one it got in 1983), the fund is hardly “going broke.”

This year’s report by the trustees who oversee the fund found that, if left alone, the Social Security system will continue to be able to pay its bills for at least the next 40 years — thanks in part to a $1.4 trillion nest egg of Treasury securities that has been stashed away over the past several decades.  (A separate analysis by the Congressional Budget Office figures the fund is in good shape until 2052.)

True, some of the money to be paid to soon-to-be-retired Baby Boomers will have to come from future payments from younger workers. But a big chunk of the bill has already been set aside. And by 2015, the amount set aside in the trust fund will swell to five times the estimated annual payouts. So the idea that Boomers will somehow be sponging off the next generation for all of their retirement funds just isn't true. (Full disclosure: We're on the Boomer side of the ledger.)

So what happens after the 2044? By law, the trustees are required to make a 75-year forecast — which, of course, is virtually impossible to do reliably. (Who, when the fund was originally set up, could have forecast World War II, the Great Inflation of the 1970s, and the Internet bubble?) Still, even if no changes are made until 2078, the trustees figure that the amount of money going into the fund would pay 73 cents of every dollar of projected payouts by that year. (The six-member Board of Trustees, by the way, includes Treasury Secretary John Snow, Labor Secretary Elaine Chao, and departing Health and Human Services Secretary Tommy Thompson.)

You could make up that future shortfall, the trustees said, with either an increase in taxes today, or a cut in benefits (maybe by asking people to wait a little longer to retire.) Or a little of both. It wouldn’t be the first time the system needed to be tweaked. When the fund last got off track (largely because of the prolonged, painful inflation of the 1970s), the Reagan administration and Congress put together a relatively small tax increase, raising the amount paid by employers and workers from 5.4 percent each in 1983 to the current 6.2 percent.  

So, all in all, it doesn't looks to us like Uncle Sam is doing such a bad job of managing your retirement funds. But if that’s true, then why are we hearing all these dire predictions — from those who want to “reform” Social Security — that the sky is falling? The answer brings us to the second question behind the current debate.

What today’s Social Security “reformers” really want is to get Uncle Sam out of the business of taxing workers and employers to pay for retirement — and further cut taxes. But since the Bush administration’s trillion-dollar, first-term tax cut left the federal budget deep in the red, it’s going to be pretty hard to find ways to keep cutting taxes without going after Social Security.

The bigger question is this: Even if you believe philosophically that Uncle Sam should get out of the business of managing retirement funds, how do you “privatize” a system that still relies — at least partly — on payments from younger workers to balance the books? The answer is you either have to cut benefits or make up the difference with a huge, lump-sum payment now.

Since the details of the plan haven't been formally proposed, it's impossible to know how big that lump sum would have to be. It could be $1 trillion. Or $3 trillion. No one really knows until the details are formalized. But with the federal budget already coming up short by hundreds of billions of dollars a year, it's not a great time for the government to be spending even more money that it doesn't have.

What’s more, the “privatization” of retirement savings is already well underway — ever since Congress passed the Employee Retirement Income Security Act of 1974, which established the first tax-deferred Individual Retirement Accounts. Those plans, and their cousins, employer-sponsored 401(k) accounts, seem to be working just fine. Americans have already socked away an estimated $1.9 trillion in 401(k) plans (according to the Chicago-based Spectrem Group) and another $3 trillion in Individual Retirement Accounts. That means there's roughly three times as much money in private retirement accounts as there is in the Social Security trust fund.

The big difference, of course, is that Uncle Sam forces you to put money away for a rainy day, while existing private accounts are strictly voluntary. For a nation force-fed on credit by the financial services industry, involuntary savings may not be such a bad idea.

Private plans also have other pitfalls compared to Social Security. For starters, managing a retirement fund may not be for everyone: Just ask anyone whose 401(k) plan was heavily invested in tech stocks in 2000. (For more drawbacks to privatizing Social Security check out: Twelve Reasons Why Privatizing Social Security is a Bad Idea, a report by The Century Foundation, a New York-based think tank, formerly called the Twentieth Century Fund, that opposes Social Security privatization.)

Perhaps the biggest unseen cost of the current debate over the future of Social Security is the distraction it’s created from the much bigger problems facing Medicare — which is in serious trouble. The longer Congress and the White House wait to overhaul the massive U.S. public health care program, the sicker it will get.