The Complete Overhaul Social Security Needs to Survive

secret meeting
secret meeting

As the

Huffington Post reported last week, AARP is planning a "salon style" invitation-only gathering in Washington later this month. In this DailyFinance exclusive, two retirement experts propose dramatically different solutions to the Social Security crisis. Below, Chuck Saletta weighs in. Click here to read Dan Caplinger's take on the topic.

AARP's planned and formerly secret Salon-style meeting on the future of Social Security is causing quite a stir. After all, it wasn't that long ago that AARP itself voted to accept the inevitability of benefit cuts, given the deteriorating state of those programs' finances.

And "inevitable" really is the right word to use. Whether you want to believe it, Social Security as we know it is a collapsing program. Its spending on benefits outpaces its tax revenues, and its Trust Fund is expected to run dry in or before 2036, slashing benefits by about a quarter.

If I were in that secret salon meeting, I'd make it absolutely clear that what's needed is a way to:

  • Take care of the people who currently or will very soon depend on Social Security.

  • Move future generations to a far more sustainable retirement system.

  • Provide a smooth transition for those who've paid in but still have many years before collecting.

The Wrong Way to Fix Social Security

There are those who believe that with a few "minor tweaks," the current system can be saved. (You can read my colleague Dan Caplinger's proposal for fixing Social Security here.) With all due respect, Social Security has been "tweaked" -- repeatedly -- over decades, with little to show for it beyond pushing back that inevitable day of reckoning. It's also the same concept that brought us:

  • Tax rates that now sit at 12.4% (less a 2% temporary rollback), from an original 2% total.

  • Taxes levied on income as high as $110,100, up from an original $3,000.

  • Taxability of Social Security benefits (since 1984) for people with sufficient other income.

The suggestion of yet again raising taxes, at this point, starts running into the ugly reality that at high enough rates, one of two things is bound to happen:

  • Those who can figure out ways to legally reduce their exposure to the tax will find it much more profitable to do.

  • Those who can't reduce their exposure to the tax discover that the higher tax rates make it all that much harder to save anything else for their retirement.

There comes a point where the pain inflicted from the cumulative total of those "minor tweaks" outweighs any additional shoring up of the program's own financial standing. If we haven't hit that point yet, we likely soon will.

Here's a Better Answer

One of the key benefits of Social Security is that it's a mandatory retirement-focused program, without which many people would likely have nothing saved for their retirement. Any replacement system would also need some sort of mandatory savings component to it, or else all we'd really be doing is trading one problem (a collapsing system) for another (old-age abject poverty).

Even with that constraint, there are at least two existing retirement programs that can serve as a solid foundation for Social Security's replacement: Chile's equivalent of Social Security and the U.S. government's own Thrift Savings Plan.

Both options would replace the "guaranteed" payment aspect of Social Security with investment-like accounts. Still, as Chile's real-world outcome has shown, over a career-long period of time, the long-run improvements are more than worth the short-term variability.

Chile's program combines a series of investment options with a government-guaranteed minimum pension that in some ways is more generous than a typical U.S. Social Security benefit. The U.S. Thrift Savings Plan does not have a guaranteed pension amount, but it does offer both "lifecycle" funds and very low administrative fees (0.025%) that keep costs down and money flowing toward participants.

Either -- or perhaps a combination of both -- would make a far better long-term plan than the minimum-wage-like benefits of today's Social Security or the $29.02 a day expected after the trust fund is gone.

Remember, too, that the Chilean system is succeeding wildly, and it's based on a 10% mandatory contribution rate. On the flip side, America's Social Security system is floundering, and its fully loaded tax rate (aside from a temporary rollback) is already 12.4%.

What About the Transition?

As great as that future state can be, the elephant in the room is the tremendous obligations of the current Social Security system.

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More than $630 billion in taxes flow into that program each year, and the Congressional Budget Office projects that even that will be $60 billion short, just to cover 2012's benefits. Social Security does have a trust fund with around $2.6 trillion that can help soften the cost of a transition, but that transition is still the toughest nut to crack.

In Chile, the transition was handled in part by selling off state-owned businesses. For the U.S., the labor minister who led the transition for Chile has suggested that the U.S. has assets -- such as huge swaths of the nation's land -- that could also be privatized to help fund the costs, as well.

Regardless of how the transition happens, the pending collapse of America's current Social Security system makes it perfectly clear that the sooner it happens, the better for all involved. If nothing else happens, within the next 24 years, the current system's trust fund will be emptied and benefits cut. A transition starting now -- while there are still trillions in direct Social Security assets to help defray the costs -- will be far less painful than waiting until after the trust fund completely empties.