Re: Social Security Investment Alternative

Dear Senator Schumer:

There has been much debate during the last few years about the present system of investing Social Security funds. The several sides to this issue all make good points, but seem to fall short of striking a balance that can work for taxpayers, government and even our democratic society. I am proposing a new method of allocating taxes paid so that taxpayers can share in the responsibility of investing the funds, with controls put in place so as to protect other taxpayers from having to support poor investments.

• raising social security taxes on earnings by increasing the taxable wage base or through rate increases;
• increasing the retirement ages which would entitle an individual to begin receiving benefits;
• using income tax revenues to supplement shortages in the Social Security fund;
• subjecting social security benefits to income taxes; and
• putting Social Security funds in more aggressive investments, including equity markets.

I will review these alternatives, indicating why each fails to solve the basic problem in an equitable manner. I then offer my own plan, which aims to address the concerns raised by the others.

Raising Social Security Taxes

This alternative provoked overwhelming objections from the present body of workers who believe that they pay at least their fair share of taxes without the introduction of a new increase. These taxpayers, especially the younger ones, did not welcome the idea of paying more taxes to "support the older generation" who, when they were among the workforce, paid in social security taxes on lower wage bases. Each year we experience an increase in the maximum taxable wage base ($72,600 in 1999) to reflect cost-of-living adjustments.

Increasing the Retirement Ages

One of the ideas discussed would postpone the ages at which retirees could begin to receive benefits. Our present system allows for "full" benefits at age 65 and reduced benefits at age 62. (The "Normal Retirement Age" of 65 is currently scheduled to increase gradually, beginning next year, until it becomes age 67.) Furthermore, beginning at age 70, a beneficiary can earn an unlimited income from work without having to reduce his/her benefits. Under some proposals, the three threshold ages would have been increased to effectively (a) bring in more tax revenues and (b) shorten the payout period of benefits. This met with obvious disapproval from the near-retirement group who were, by and large, counting on the Social Security fund to help them through the imminent change in life.

Using Income Tax Revenues to Supplement Shortages

This seemed like a good idea to many, largely because any such tax increase would likely have fallen on the wealthier minority of taxpayers. However, it met with resistance from a group of politicians supported by economists and other members of the financial sector. They insisted that income tax revenues and the government services they pay for should not affect the taxes and benefits of the social security fund, and vice versa. This proposal died as well.

Much to the dismay of Social Security beneficiaries, this proposal actually became law. Up to one-half of benefits received were subjected to income tax. As if the change weren't distasteful enough for this group, they were hit with a second blow a few years after the original law was enacted. Some of the retirees who were fortunate and/or prudent enough to accumulate a "higher" level of income could have as much as eighty-five percent of their benefits taxed. One could argue that paying tax on one-half of the benefits made sense: one-half of the monies contributed to the social security fund were pre-tax contributions made by employers and should be taxed on receipt. This creates parity with private pension plans. Maybe a little more taxation should apply to the tax-deferred earnings in the plan. But, it is difficult to justify why anyone has to pay tax on eighty-five percent.

Putting Social Security Funds in More Aggressive Investments

The last few years have certainly taught us that the stock market was the place to put investment dollars during this period. Never before have we seen such sharp contrast in the yields of fixed versus equity investments. It explains why the idea of putting a portion of the social security fund into equity has become so very popular. However, there are two major drawbacks to this concept. First, equity investments, despite the recent successes, are more risky than fixed income instruments. The system is designed, and even expected, to avoid risk in favor of security for the benefit of those who have paid into it and deserve its rewards upon retirement. Second, our democracy in large part depends on the private sector, not the government, owning private business. This should be taken as a serious concern for all of us. How could we feel certain, if facing an antitrust case involving a company in which our government invests, that a fair and impartial decision can be reached, even if it impacts negatively on the company? Which aim is better for the general public? Should our representatives protect us from monopolistic corporations? Even if, by doing so, the stock price plummets causing the Social Security fund to take a loss? It would present a dilemma for any decision making body. For these reasons, the shift to equity investments has not taken place.

A variation on this theme has recently been offered, but also never got off the ground. Under this plan, the taxpayer would decide whether to be (a) in the Social Security system or (b) invest the same money on his/her own, thereby putting the risk in private investments – for better or worse.But this too became unpopular and since went nowhere. Our society would not function as it is unless we "bailed out" – in one way or another - anyone who made bad retirement-oriented investments. Would we really stand back and say to such a person "You made your choice and you were wrong.Now it's your problem."?I don't think so.

Subsequent annual elections would be available only if the total value of all of the employee's "SS-Gap" accounts equaled or exceeded threshold amounts on September 30 of the preceding year. The threshold amounts would be published by the Social Security Administration and could be based on some SSA fund performance factor and applied to the number of qualified years of contribution since the first account was in effect. Financial institutions offering "SS-Gap" accounts would have to report the September 30 value to the participant and the SSA no later than October 10 of each year. The employer would have to keep a copy of proof of compliance for each year contributions are made.

One might ask, "If an "SS-Gap" account falls below the specified threshold level, can the accountholder add his/her own money to attain that level, thereby allowing contributions to continue?".Under my plan, no personal funds could be added to the account. To permit this would be defeating its purpose. The "SS-Gap" plan is designed to maintain controls that would protect against having to replace misspent retirement funds.Personal funds should be considered as available retirement funds for this purpose. Thus, "SS-Gap" participants will be advised to invest money wisely and somewhat conservatively to ensure continued compliance.

An electing employee would have to specify the name of the financial institution and the "SS-Gap" account number on the election form given to the employer for the applicable year. The employer would be obligated to make deposits to this account (in accordance with the employee's instructions) within the time frame required for depositing payroll taxes (under the appropriate "monthly" or "semiweekly" schedule, or quarterly if below certain dollar levels).

There would be two sub-accounts in the standard "SS-Gap" account.First, there is the "Basic SS-Gap" account. This sub-account represents funds maintained at the threshold level. Any amounts in the "Basic SS-Gap" account in excess of the threshold level would be automatically transferred into the second sub-account, the "SS-Gap Companion" account. If there were a shortfall in the "Basic SS-Gap" account, the deficiency would be made up from "SS-Gap Companion" account funds.

Under no circumstances would any withdrawals from an "SS-Gap" account be permitted before the participant begins receiving Social Security benefits. Beginning with the first receipt of SS benefits, the participant must withdraw each year from the "Basic SS-Gap" account an amount equal to one-third of the Social Security benefits to be received in that year. From the "SS-Gap Companion" account, he/she would have the option to withdraw any amount up to the actuarially calculated sum for the year, using the balance as of the beginning of the year. (Any distributions in excess of the allowed amount would be subject to a penalty-tax.)Under this plan, the account will continue to be available to supplement the retirement benefits from SSA.

When the participant dies, the remaining balance of the "SS-Gap" account will be paid to the beneficiary designated on the account. (This is a distinguishing feature of the "SS-Gap" account.Unlike SSA funds, which are terminated upon death, the "SSA-Gap" account provides a post-death benefit to the participant's beneficiary.) A spouse who receives the funds as a beneficiary would be permitted to a tax-deferred "rollover" of the same into his or her own "SS-Gap" account. Similarly, during their lifetime, "SS-Gap" participants would be able to rollover all or part of any "SS-Gap" accounts only to another "SS-Gap" account. Spousal and lifetime rollovers would not count as contributions in the year of receipt, but could be used in meeting the "threshold value test" each year.

Financial institutions would have to report distributions annually, presumably on Form 1099-R.

Of course, the obligation of the Social Security Administration to pay benefits to "SS-Gap" accountholders would be reduced. My plan would dictate that monthly benefits could accrue only on the beneficiary's SSA account balance. SSA would not have to be concerned about the amount of "SS-Gap" account withdrawals since only one-third of social security benefits payable for the year are withdrawn from the "Basic SS-Gap" account. (If SSA finds calculating the reduced "SSA account balance" overly complicated, it could alternatively use a non-"SS-Gap" participant's monthly benefit as a starting point. It would then reduce it for "SS-Gap" participants by the monthly equivalent of the applicable published threshold for the year during which the retiree begins receiving social security benefits.)

As you can clearly see, my aim is not to change everything all at once. Fundamentally, the present system for social security is working quite well for most people. It is the future we are concerned about. My plan provides an alternative approach to preserving the financial and political strengths of our present system while creating opportunities for maximizing investment returns.