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Is Social Security a Ponzi Scheme? (Part 3: How to Fix Social Security)

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The following is a continuation of the Is Social Security a Ponzi Scheme? (Part 1) and Is Social Security a Ponzi Scheme? (Part 2: An Explanation of Social Security Works). Those articles explained the history of Charles Ponzi and the original Ponzi scheme and explained how Social Security works. In this article, we'll cover how to fix Social Security

How to fix Social Security

As explained in part 2, the demands of the baby boomers are putting a strain on the system. The current system is not sustainable without some changes (unless the US adopts a Logan’s Run sort of policy, which seems somewhat unlikely).

There are two sides to the equation – the taxes being taken in and the benefits being paid out.

One way to help pay for benefits would be to raise the tax rate, which is currently 6.2% of wages $106,800. This is levied on both the employee and employer, resulting in the government collecting 12.4% of these wages. Ratcheting the rate up a point or two would put more money into the coffers – but would be very unpopular with the voters. In fact the employee share of OASDI (Social Security) was temporarily dropped to 4.2% for 2011 in an attempt to jump start the economy.

Alternately, the cap could be removed so that all earnings would be taxed. No longer would the contributions of Alex Rodriguez be capped at $6621.60 (with an identically capped contribution from the Yankees).

There are three ways to balance the equation from a benefits perspective.

The first, and least popular, is to simply reduce the benefits the program pays out. This is a hard sell to voters (and older voters are more likely to vote than younger ones) as well as powerful lobbying organizations such as AARP.

The second method is to reduce the duration of payments. The government has already begun doing this. People born in 1937 or earlier are eligible for full benefits at age 65, while those born in 1960 or later are not eligible for full benefits until age 67 (chart here). Will we see further tweaks in the future? Perhaps someday you’ll need to wait until age 70 (or later) to receive full benefits.

Benefit payments could also be reduced by instituting a means test. The intent of Social Security is to serve as a safety net, rather than a full-fledged pension. Billionaire Warren Buffet is entitled to Social Security payments – but does he need a financial safety net? Of course not. As the general populations begins to pay more attention to the funding of their retirement, it’s possible than many people in the current generation will not need the safety net of Social Security.

The downside to the means test is that it may discourage people from taking care of their finances. Why bother to invest for your retirement when those who don’t will get bailed out by Social Security? That’s a very penny-wise and pound-foolish sentiment, of course. The prudent investor may be able to afford a house on the beach and lobster for dinner, while the person who ignored their retirement with the plan to be bailed out by Social Security may end up renting a room in a rundown part of town and cooking dinner in a hot pot. Still, it's the kind of thing that many Americans could consider.

My advice: invest with the assumption that you won’t receive any Social Security benefits. The odds of this are extremely unlikely to happen as unless it taken down completely people will still be paying into the system. I still plan for my retirement as if Social Security doesn't exist - simply because a lot can happen in the 30 years before I get to take it. If I do end up receiving benefits, that’s just frosting on the retirement cake.

I was thinking of ending the discussion of Social Security and Ponzi Schemes there, but I could probably be persuaded to write a few words on what some famous other people have said about Social Security and Ponzi Schemes. I'm looking for feedback to tell me whether you like the discussion or if I'm beating a dead horse here. Thanks!

Last updated on October 1, 2011.

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15 Responses to “Is Social Security a Ponzi Scheme? (Part 3: How to Fix Social Security)”

  1. John says:

    I’ll be waiting for installment 4.

  2. After this series, I would suggest that you be the replacement for Tim (Tax Return, What Tax Return?) Geithner as Secretary of the Treasury, but you might actually have some workable plans for Social Security. So you have no chance. Thanks for the series.

  3. Cat says:

    The sad thing for me is I invested for retirement the same 40 years as I paid into the Soc. Sec. Every time there was a steep decline I held my breath but sat it out and happily watched it all return and kept investing. I have never used food stamps, been on welfare or even considered using Soc. Sec. but always had been thankful these funds were available if my life imploded. Then 2008 happened. I still kept my retirement intact until this year. I no longer have faith in any of it. I am too old to recoup what I need to keep me until I am 90. My big fear now is pushing a cart down a street. I played by all the rules, as diversified as possible, and I am holding on for dear life. More taxes? Yes that will solve everything.

  4. robyn says:

    i’ve posted links to this series on my facebook page, yes please continue. my personal opinion on what would ‘fix’ social security: lower the rate, eliminate the cap. eliminate AMT,too, but that is another kettle of rotten fish.

  5. Evan says:

    When SS was created the average life expectancy was actually BEFORE payout dates (they blame infant mortality but even ignoring that their rationale is pretty shitty)

    http://www.ssa.gov/history/lifeexpect.html

    ***

    Lets jack the age to 75 or 80…and we’ll see just how many retirees are there to protect this failing government program.

    ****

    Notwithstanding, the cap part is ridiculous without significantly increasing what one could earn from SS. Fine tax Rodriguez (or maybe Ortiz – although he doesn’t have all that post-season income) but then be prepared to write them a 20K/month check when they hit 66…NOT a 2400/month check.

  6. I’m surprised they didn’t go the extra step and multiple the columns. That would give the average years of Social Security benefits for those who reached age 21.

    1940: 6.8 years for men, 8.9 years for women
    1990: 11.1 for men, 16.4 for women

    Now, you can’t divide those numbers and say that Social Security needs to stretch the dollars nearly twice as far, because some of the folks who would have turned 65 in 1940 died at age 22, 23, 24, etc and didn’t pay much into the system. However, the death rate certainly would have increased with age and many died after putting money into the system for 30+ years – resulting in an inflow to SS but but no outflow.

  7. Tommy Z says:

    Your suggestions to fix social security would not really fix social security, it would prolong the problem of social security. The only real fix is ending it.

    Increase Revenue:

    A. Increasing the tax rate above the 12.4% that it is at now is insane because we cannot afford more. We are already being beaten over the head with federal income taxes, state taxes, property taxes, sales taxes, and hidden taxes. More taxes are not a real solution.

    B. You cannot honestly raise the $106,800 cap unless you also raise the cap on benefits.

    Decrease Benefits:

    A. Reduce payments? We already are doing this through understated inflation numbers (and no COLA’s).

    B. Increase retirement age? It is not fair to younger workers.

    C. Means test? I guess so. At least it would expose the program for what it really is – welfare.

  8. mlathe says:

    I’m disappointed that you didn’t compare SS with a Ponzi scheme more fully. In part two you mention a few points (that SS recipients don’t have accounts, and that SS is transparent). Those seem like pretty weak arguments to me.

    I don’t think SS is a Ponzi scheme, but if it becomes insolvent then the lines start to get blurred and SS becomes harder to defend.

    @TommyZ:
    A: Agreed, lower earners should not need to pay more into the system.
    B: Agreed to a point. 100k is not really that much money. Raising the cap to something like 500k per year and raising the benefits too seems to make sense

    A: benefits are already really low. It is very hard to get by on SS only.
    B: younger workers like me can expect to live longer. For me I’d rather live longer than get benefits sooner. It’s crazy that people are retiring for 20-30% of their life.
    C: Agreed

  9. “B. You cannot honestly raise the $106,800 cap unless you also raise the cap on benefits.”

    Why not? The rich already get a lower yield than the poor, so it’s not as if this would be a revolutionary idea.

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  11. Tommy Z says:

    I think one of the reasons people support the idea of social security is so the older generations can live out their golden years as retired people (no need to work) while at the same time having some money to live on. While it sounds like a good idea, I’m afraid that by the time us younger folk reach that age, retirement will only exist on TV re-runs much like the 1950’s housewife exists on TV re-runs. Our women are entering the workforce not always by their choice, but because that 2nd income is needed. Likewise, I think it is realistic to see more and more older workers getting jobs as Walmart greeters.

    @mlathe:

    “For me I’d rather live longer than get benefits sooner. It’s crazy that people are retiring for 20-30% of their life.”

    Me too. However, how long we live is not a choice that people make (unless you are thinking about suicide) like they do when they decide to retire. I am concerned that just because life expectancies are increasing now does not mean that they will turn around and start decreasing. If you compare how healthy we are as a people today vs. how healthy our grandparents were at our ages, I think we will live shorter lives with more health problems. Look at obesity, diabetes, and cancer. These health problems are exploding while at the same time the cost of healthcare is increasing so fast that more and more people cannot afford it.

    @Kosmo:

    Yes, your logic seems to make sense. Although just because we have a system in America where you get penalized the better you do (progressive taxation, etc), does not mean it is fair.

  12. Right – I’m not saying that it’s fair, just that I wouldn’t be surprised to see the cap removed with a corresponding adjustment to max benefits, since SS is already a case of diminishing marginal returns.

  13. I’d be fine with them reducing the duration of payments. Like you, I don’t plan on receiving Social Security when I’m older — anything I may happen to receive is simply icing on the cake.

    As for the argument that it’s “unfair” to younger workers — I’d argue that it’s eminently fair to those of us who are in our 20’s and are receiving fair warning. It’s not fair to renegotiate the SS contract with someone currently in their 40’s or 50’s, who has spent decades planning for SS benefits. But if you’re currently under 25, consider yourself warned.

  14. Tommy Z says:

    @Paula:

    “I don’t plan on receiving Social Security when I’m older”

    This is probably a good idea.

    “anything I may happen to receive is simply icing on the cake.”

    There are many factors you will encounter in your lifetime that may actually destroy the “cake.” You cannot control or necessarily predict with precision when the stock market or bond market will crash next. If it happens right before you retire, this can be devastating.

    “I’d argue that it’s eminently fair to those of us who are in our 20?s and are receiving fair warning.”

    Let me give you a more extreme example to make a point…What if a murderer gave you fair warning that he was going to kill you at some point in the future? When he actually did kill you, would that be fair? Afterall, you had warning in advance.

    Even somebody in their 20’s today still has the first part of their retirement savings stolen from them via social security taxes. That is money they could have otherwise saved in an individual retirement account. Giving them warning of this does not mean they can stop paying the ss tax.

    Granted, nothing that we do to try and make social security solvent will seem 100% fair to everybody.

    However, it is more fair to ask EVERYBODY to take some sort of hit than to force 100% of that hit on the younger generation while the older generation gets away scot free. In fact, it is the older generation that voted in the politicians that caused the problems with social security, if anything, it would be even more fair for them to take the full hit. Why should people too young to vote suffer the consequences of the generation before them?

  15. None of my friends are expecting to receive SS payments when they retire. On the other hand most of them aren’t planning for retirement either (seems self destructive doesn’t it?). Ambiguity in terms of one’s status in retirement is not a good thing. A sooner rather than later decision is required so that the 20-somethings in this country can start planning accordingly (since most have not at this point).

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