Pros and Cons of Privatizing Social Security

Should You Have More Control?

Social Security

Privatizing Social Security is a hot-button topic that even Washington tends to avoid talking about. Although the nation’s retirement program finds itself increasingly desperate for reform, the issue is simply too divisive for Washington as a whole to take on.

But would it work? Could privatizing Social Security be what saves the program and makes it a better retirement vehicle for retirees? Each side has their arguments.

Low Returns

First there’s the issue of low returns. The Social Security trust invests in special-issue bonds. It can invest in public, marketable securities but as of 2018, does not. In other words, the trust invests in itself—all government issued debt.

As a result, returns tend to significantly underperform the market. In 2016, the average rate of return for all investments was 3.154 percent—far lower than the 11.9 percent return seen by the S&P 500 the same year. Opponents will argue that bonds may significantly underperform in some years but in other years, the gap is much smaller. During years of negative stock market returns, bonds provide a safety net.

Nobody believes that the trust should take on the risk of being in all stocks but if some portion of a person’s Social Security balance was available for personalized investment, the account holder could choose to take on slightly more risk, according to those in favor of the plan.

Proponents believe that if 401(k) accounts were mandatory for all citizens, more flexibility in how the money is invested creates a higher rate of return. Even a few percentage points higher is a substantial amount of extra income over years or decades.

Just like most current 401(k)s, citizens could have a list of mutual funds or ETFs to choose from. With the help of a financial professional, citizens could choose a mix of funds that fits their risk profile.

Investing in a Failed System

Opponents of privatization of Social Security argue that the country already has a privatized retirement system that citizens control—it’s the 401(k), IRA, and other tax-advantaged accounts but with Americans now shockingly behind on retirement savings, the idea of giving them more control over their retirement money may do very little at best but push them further behind at worst.

Although the total investment value of 401(k)s continues to rise, the median value of an account of somebody 65 or over is about $60,000. If they live another 20 years, that’s $3,000 per year before taxes. Add the current average social security benefit of approximately $1,360 per person, that comes out to about $20,000 per year before taxes. Not exactly a comfortable yearly income.

Who Pays?

Opponents also point out that it’s not as easy as diverting funds elsewhere. Social Security has liabilities that the current system has to pay. The earnings that come in from today’s earners help to pay those liabilities. Putting any portion of the trust into private accounts would almost certainly doom the system.

Proponents argue that privatization doesn’t mean that Social Security will lose control of the funds—only that account holders will have more say in how those funds are invested.

Next, because the Social Security Trust invests in the federal government, the administrative costs of the fund are exceedingly low. Recipients aren’t paying the high fees that sometimes come with private, market-based investments. Creating a privatized option means more costs and cost is one of the largest sources of lost performance over time.

Finally, the AARP made the argument that Social Security is not an investment program and should not be treated as such. As an insurance program, it’s role is to generate safe and stable returns for the life of the person and potentially their families. It’s role is not to create outsized investment gains.

What Do We Think?

Americans, as a whole, are mixed on the privatization of Social Security. Gallup found that 53 percent of people support privatization while 44 percent are opposed. Although public sentiment has been largely positive over time, little detail of the pros and cons is provided along with the question—because nobody knows the details.

What’s clear is that although Social Security is currently a primary source of income for an increasing amount of Americans, the issue isn’t as important to Americans as others.