It’s Retirement Security, Not Social Security

Beyond the Narrow Budget Debate Over Entitlements, Two Different Ideas on How to Save Retirement Programs

In Washington, President Obama is expected to present his plans for changes in entitlements, including Social Security. Congress is taking up the debate. But when Social Security is discussed these days, it’s often in the context of the budget–even though the program’s purpose is to provide retirement security. So we asked: Given the country’s fiscal realities, is there a better way to enhance Americans’ retirement security? Below are two ideas.

Joshua Freedman

Expand Social Security

You’re not supposed to depend only on Social Security for retirement. The program has long been viewed as one leg of a “three-legged stool” of retirement security: your personal savings, your pension, and Social Security payments.

It hasn’t worked out that way. Today, Social Security alone provides the majority of income for nearly two-thirds of elderly Americans who are eligible for its benefits. Savings and pensions have been woefully inadequate. As a result, many Americans—particularly low- and middle-income earners—are facing a very uncertain retirement.

The simplest way to address this problem is to build on the piece of retirement security that has proven stable: Expand Social Security.

This is a controversial, not-much-discussed view in Washington, where the political focus is on the deficit and limiting “entitlements” like Social Security. This week, President Obama is expected to announce a new budget that includes cuts to Social Security benefits.

He should go in the opposite direction. Social Security should be augmented to cover a larger portion of retirement needs. One goal could be a Social Security “replacement rate” for retirement income that would be 60 percent of pre-retirement earnings for average workers—a big increase, though still less than the 70 percent rate that financial advisors often suggest.

This expansion is necessary to replace the disappearing defined-benefit pensions once offered by employers and risky, costly employer-based contribution plans like 401(k)s. An expansion would make up for individual private savings that are either too low or are tied up in illiquid assets like housing, which, as the financial crisis showed, are much less stable than once thought. An expansion also would help employers, who would benefit from having less of a direct burden for the retirement security of workers.

But how would you pay for it?

By using Social Security to replace the enormous amounts of money wasted on private retirement supports that have failed to do their job.

The current amount of “spending” on publicly-sponsored retirement programs, including 401(k)s, employer-defined benefit pensions, and IRAs, amounts to about 5 percent of GDP today and will rise to about 7.5 percent of GDP in 2035. In comparison, an expansion of Social Security along the lines suggested in this piece would require between 1 and 1.5 percent of GDP to close the existing Social Security shortfall—and another 3.5 to 4 percent of GDP to make it bigger.

The best way to raise this money would be to tweak the payroll tax in various ways, such as raising the cap on income subject to taxation or taxing unearned income, and to devote more from general revenues or a new value-added tax.

For those who care about progressive taxation, this plan will make the system fairer. Because most general taxation comes from more affluent individuals, to use these revenues for an expansion of Social Security is to supplement retirement income for all individuals from taxation that more heavily draws from high-income earners.

This is not to rule out private savings per se. Households still need to save; even with this sort of expansion, Social Security will not be able to provide adequate retirement security entirely on its own for middle- and upper-income earners.

But Social Security provides more retirement security than anything else—and provides it more efficiently than private or employer-based savings programs. Social Security has proven itself to be the best retirement support we have. The three-legged stool isn’t working—it’s time to find a new balance.

Joshua Freedman is a policy analyst in the Economic Growth Program at the New America Foundation.

Justin King

A universal, dummy-proof individual account

Social Security was supposed to be a baseline, a way to supplement pensions and other savings. Alas, for most Americans, Social Security is the main source of retirement income. The recent shift—away from employer pensions and toward individual accounts, such as a 401(k)—has not gone smoothly. Americans now doubt their ability to achieve a secure retirement.

So, what do we do about it? First, protect the existing Social Security system and shore up its finances. But we also need to empower people to create their own savings. Right now, we’re failing because 401(k)s and similar accounts only cover half of the workforce, deliver big benefits to the wealthy and very little to ordinary workers (since benefits are based on your income tax rate), and because families have so little in savings that they often have to raid their retirement piggy banks early. To correct all this, we need a system of individual accounts that’s universal, automatic, equitable, and flexible.

One solution might be a new creation we’ll call Universal 401(k). This would be an individual savings account that opens automatically when you enter the workforce and stays with you when you change jobs. You wouldn’t have to start the account. And steady contributions, facilitated by employers, would build up.  This turns inertia on its head, from obstacle (“I keep forgetting to start my 401(k)”) to benefit (“I do nothing and my savings account builds”).

This should be combined with a new tax credit—let’s call it a Financial Security Credit. This tax credit would allow poor and middle-class workers to receive a direct match, via government tax credit, for their contributions to their Universal 401(k). That credit would be available for other kinds of savings as well, including college or just an emergency fund. This is badly needed—44 percent of Americans don’t have the three months of savings for emergencies that financial advisors recommend.

This may sound costly, but the Universal 401(k) and Financial Security Credit can be established within the current budget structure. The tax credit could be paid for in part by reducing some of the current benefits that currently flow to upper-income savers who don’t need it. New revenue streams—such as a Financial Transactions Tax or narrower tax targeted at high-frequency trading—might provide the rest of the funds.

This would represent progress, within the current constraints of the federal budget. Essentially, this new kind of 401(k) and new tax credit would help to revise and complete the half-finished retirement security structure we have right now.

Justin King is the Federal Policy Liaison of the Asset Building Program at the New America Foundation.